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INTU | 4 | 2,024 | 2024-08-22 20:03:09 | Operator: Good afternoon, ladies and gentlemen. My name is Bo and I will be your conference operator. At this time, I would like to welcome everyone to Intuit’s Fourth Quarter and Fiscal Year 2024 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 period. [Operator Instructions] With that, I will now turn the call over to Ms. Kim Watkins, Intuit’s Vice President of Investor Relations. Please go ahead, Ms. Watkins.
Kim Watkins: Thanks, Bo. Good afternoon and welcome to Intuit’s fourth quarter fiscal 2024 conference call. I’m here with Intuit's CEO, Sasan Goodarzi, and our CFO, Sandeep Aujla. Before we start, I’d like to remind everyone that our remarks will include forward-looking statements. There are a number of factors that could cause Intuit’s results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2023 and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit’s website at intuit.com. We assume no obligation to update any forward-looking statement. Some of the numbers in these remarks are presented on a non-GAAP basis. We’ve reconciled the comparable GAAP and non-GAAP numbers in today’s press release. Unless otherwise noted, all growth rates refer to the current period versus the comparable prior-year period, and the business metrics and associated growth rates refer to worldwide business metrics. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. With that, I’ll turn the call over to Sasan.
Sasan Goodarzi: Thanks Kim, and thanks to all of you for joining us today. We delivered very strong results for the fourth quarter and full-year, and made meaningful progress with our AI-driven expert platform strategy and Big Bets that position the company for durable growth in the future. Our full-year revenue grew 13% and we delivered strong operating margin expansion demonstrating the strength and momentum of our investments and innovation. As we exit the year, we are confident in delivering another year of double-digit revenue growth and margin expansion in fiscal year 2025. Intuit is the global AI-driven expert platform that is powering prosperity for consumers, small and mid-market businesses. Our strategy and five Big Bets position Intuit as a mission critical platform that delivers end-to-end solutions, driving sustained growth. We made an early bet on AI. We have a significant advantage with the scale of our data, investments in AI capabilities such as knowledge engineering, machine learning, and GenAI, and our large network of AI-powered virtual experts. This is enabling us to disrupt the categories in which we operate. We are transforming how we serve our customers by delivering done-for-you experiences, where we do the hard work for them, connecting them with AI-powered human expertise to fuel their success. With the introduction of GenAI, we are now delivering reimagined customer experiences and bolstering businesses' growth potential, while driving efficiencies in how work gets done within Intuit. This has enabled us to build our large AI-driven expert platform to fuel the success of consumers, small and mid-market businesses. The progress we've made has bolstered our confidence, leading us to accelerate investments in five key areas within our Big Bets to deliver greater impact in the future. I’ll spend a moment unpacking the progress we’ve made and our investment plans for the future: First, within Big Bet 1, we are delivering done-for-you experiences with Intuit Assist. In fiscal year 2024, we made strong progress making Intuit Assist, our GenAI-powered financial assistant, available to millions of consumers and approximately 1 million small and mid-market businesses. We are accelerating our investments to rollout Intuit Assist at scale in the coming year. Second, within Big Bet 2, we are accelerating platform and go-to-market investments for TurboTax Live and QuickBooks Live, embedding AI-powered experts across our business offerings. In fiscal year 2024, TurboTax Live revenue grew 17%, and full-service customers doubled while those new to TurboTax tripled. QuickBooks Live customers more than tripled. We expect our accelerated investment in these areas to deepen our penetration in very manual, high-priced, and dis-aggregated assisted categories. By digitizing how services are delivered, an integral part of our done-for-you platform experiences, we will become the AI-powered financial assistant for consumers, small and mid-market businesses. Next, within Big Bet 4, our money solutions, we are making additional investments to accelerate digitizing the experience end-to-end for consumers, small and mid-market businesses, from estimate, to invoicing, to getting paid and paying bills. In fiscal year 2024, the total online payment volume we facilitated on our platform grew 20%. We also helped small businesses access $2.4 billion in financing through QuickBooks Capital, up 28%, and we made significant progress digitizing B2B payments with our bill pay offering, for which monthly payment volume processed quadrupled over the last six months. In fiscal year 2025, we expect these accelerated investments to deliver best-in-class, seamless payments, capital, banking, bill pay, and invoicing solutions. Next, within Big Bet 5, we are doubling down on mid-market with additional investments in the platform and go-to-market motions. In fiscal year 2024, QBO Advanced customers grew 28%. In fiscal year 2025, we are accelerating investments to better serve customers who have more complex needs, such as more sophisticated accounting and reporting requirements, business intelligence, money solutions, human capital management, professional services, and customer acquisition solutions with Mailchimp, all assisted by AI-powered human experts. And finally, accelerating international growth with Mailchimp and QuickBooks. We’ve translated the Mailchimp offering into five different languages for markets where we see a large TAM. Looking ahead, we are bringing QuickBooks and Mailchimp together to create a single growth platform, differentiated in the markets where we have product market fit, including in Canada, U.K., and Australia. In other geographies, we are leading with Mailchimp's strong international footprint to help small businesses get customers as we continue to localize the offering. Wrapping up, with the progress and momentum we are delivering, and the accelerated investment areas I've shared, we are in a great position to win as an end-to-end platform with experiences that fuel the success of customers. Intuit is the AI-driven expert platform that is powering prosperity for consumers, small and mid-market businesses. With that -- now let me hand it over to Sandeep.
Sandeep Aujla: Thanks, Sasan. We delivered very strong results in fiscal 2024 across the company, including total revenue growth of 13%, GAAP and non-GAAP operating margin expansion of 40 and 100 basis points, respectively, and GAAP and non-GAAP EPS growth of 24% and 18%, respectively. Our fourth quarter results include: Revenue of $3.2 billion, up 17%. GAAP operating loss of $151 million, versus GAAP operating income of $17 million last year, reflecting a restructuring charge of $223 million recognized in the quarter related to the organizational changes we announced in July. Non-GAAP operating income of $730 million, versus $627 million last year, up 16%. GAAP diluted loss per share of $0.07, versus diluted earnings per share of $0.32 a year ago, also reflecting the restructuring charge. And non-GAAP diluted earnings per share of $1.99, versus $1.65 last year, up 21%. Turning to the business segments: In the Small Business and Self-Employed Group, the revenue grew 20% during the quarter, and 19% for the full-year. This momentum demonstrates the power of our small and mid-market business platform and the mission-critical nature of our offerings as customers look to grow their business and improve cash flow in any economic environment. Online ecosystem revenue grew 18% during the quarter and 20% for the full-year, driven by our progress serving customers with more complex needs and adoption of our ecosystem of services. As a result, online ecosystem ARPC grew 11% in fiscal 2024. With the goal of being the source of truth for small businesses, our strategic focus within the Small Business and Self-Employed Group is three-fold: grow the core, connect the ecosystem, and expand globally. First, we continue to focus on growing the core. QuickBooks Online accounting revenue grew 17% in Q4 and 19% in fiscal 2024. Growth for the quarter and year was driven by customer growth, higher effective prices, and mix-shift. We delivered growth in our declared strategic areas this year, with our emphasis on serving customers with more complex needs. This focus drove U.S. QBO customers excluding self-employed up 11%, QBO Advanced customers up 28%, while QBO self-employed customers declined 14%, resulting in total online paying customers up 6%. Second, we continue to focus on connecting the ecosystem. Online services revenue grew 19% in Q4, driven by payments, payroll, capital, and Mailchimp. For the full fiscal year 2024, Online services revenue grew 21%, driven by payroll, payments, Mailchimp and capital. Within payments, revenue growth in the quarter reflects higher effective prices, ongoing customer growth as more customers adopt our payments offerings to manage their cash flow, and an increase in total payment volume per customer. Total online payment volume growth in Q4 was 19%, relatively consistent with the range we’ve seen over the last several quarters. Within payroll, revenue growth in the quarter reflects an increase in customers adopting our payroll solutions, higher effective prices, and a mix-shift towards higher end offerings. Mailchimp revenue growth was driven by higher effective prices and paid customer growth. Revenue growth continues to be impacted by the lapping of a larger benefit from price and line-up changes that we made last year in Q2 and Q3. Third, we continue to make progress expanding globally, by executing our refreshed international strategy, which includes leading with both QuickBooks Online and Mailchimp in our established markets and leading with Mailchimp in all other markets as we continue to execute on localized product and line-up. On a constant currency basis, total international online ecosystem revenue grew 11% in Q4 and 13% in fiscal 2024. Turning to desktop. We successfully concluded the three-year transition to a subscription model, which contributed to 25% desktop ecosystem revenue growth in Q4 and 16% revenue growth in fiscal 2024. QuickBooks Desktop Enterprise revenue grew in the low-30s in Q4, and in the high-teens for fiscal year 2024. Our Q4 desktop ecosystem revenue growth also reflects the offering changes we made in early fiscal 2024 to complete the transition to a recurring subscription model. These changes resulted in approximately $60 million of desktop revenue recognized in Q4 and approximately $50 million recognized in the first three quarters of fiscal 2024, all of which would have otherwise been recognized in Q1 of fiscal 2025. We also expect approximately $50 million of desktop revenue that would have otherwise been recognized in Q1 fiscal 2025 to shift to later quarters in fiscal 2025. In total, these changes lower Q1 fiscal 2025 revenue by approximately $160 million and are largely related to more frequent product updates, beginning in Q4 of fiscal 2024, to align the customer delivery experience to our subscription model. Accordingly, we expect Q1 desktop ecosystem revenue to decline approximately 20% for Q1, but for desktop ecosystem revenue to return to growth in Q2. Overall, we expect desktop ecosystem revenue to grow in the low-single-digits in fiscal 2025. Turning to Credit Karme. Credit Karma revenue growth improved each quarter during fiscal 2024, from a 5%, decline in Q1 to 14% growth in Q4. On a product basis in Q4, auto insurance accounted for 6 points of growth, personal loans accounted for 5 points, credit cards accounted for 2 points, and Credit Karma Money accounted for 1 point. Full-year revenue was $1.7 billion, up 5%. We are pleased with the momentum driven by our relentless focus on what matters most to our members and partners. We made strong progress this year redesigning the Credit Karma app to enable members to see much more of their financial life and find the products right for them. We also introduced Intuit Assist to deliver personalized financial insights using data and AI, increased monetization in the underpenetrated Prime segment, and made it easier than ever for consumers to benefit from the Credit Karma and TurboTax product integration. I’m proud of the progress the team made innovating on behalf of our members and partners. Consumer and ProTax Groups. Consumer Group revenue of $4.4 billion grew 7% in fiscal 2024 as we continue to revolutionize how taxes get done for consumers and small businesses. TurboTax Live revenue grew 17%, and customers grew 11%. Full-service customers doubled, while those new to TurboTax tripled. We are pleased with the momentum we saw with TurboTax Live again this season. Turning to the ProTax Group, revenue was $599 million in fiscal 2024, up 7%. In summary, I’m pleased with our continued momentum this fiscal year and our opportunities ahead. Shifting to our balance sheet and capital allocation. Our financial principles guide our decisions, they remain our long-term commitment, and are unchanged. We finished the quarter with approximately $4.1 billion in cash and investments and $6 billion in debt on our balance sheet. We repurchased $255 million of stock during the fourth quarter and $2.0 billion during fiscal 2024. Depending on market conditions and other factors, our aim is to be in the market each quarter. The Board approved a quarterly dividend of $1.04 per share, payable on October 18, 2024. This represents a 16% increase versus last year. Moving on to guidance, our fiscal 2025 guidance includes: Total company revenue of $18.16 billion to $18.347 billion, growth of 12% to 13%. Our guidance includes revenue growth of 16% to 17% for the Small Business and Self-Employed Group, including online ecosystem revenue growth of approximately 20% and desktop ecosystem revenue growth in the low-single-digits. Our guidance also includes revenue growth of 7% to 8% for the Consumer Group, and 5% to 8% for Credit Karma. GAAP diluted earnings per share of $12.34 to $12.54, growth of 18% to 20%; and non-GAAP diluted earnings per share of $19.16 to $19.36, growth of 13% to 14%. We expect a GAAP tax rate of approximately 23% in fiscal 2025. GAAP guidance reflects an expected $24 million restructuring charge related to the reorganization we announced in July. Our guidance for the first quarter of fiscal 2025 includes: Total company revenue growth of 5% to 6%, including: Small Business and Self-Employed group revenue growth of 6% to 7%, reflecting the revenue shift in Q1 resulting from the desktop offering changes that I noted earlier. We expect desktop ecosystem revenue to decline approximately 20% in Q1, and the online ecosystem, which is our growth catalyst, to accelerate to approximately 19% growth in Q1. For Credit Karma, we expect revenue to grow in Q1. And for Consumer Group and ProTax revenue to decline in Q1, as we are lapping the period a year ago that included the extended California tax filing deadline. GAAP earnings per share of $0.61 to $0.66, and non-GAAP earnings per share of $2.33 to $2.38. GAAP guidance reflects an expected $19 million restructuring charge that we expect to incur in Q1 related to the reorganization we announced in July. You can find our full fiscal 2025 and Q1 guidance details in our press release and on our fact sheet. I will now shift to our long-term growth expectations for each of our business segments. First, small business. With the momentum we see in online ecosystem growth, we are reiterating our long-term revenue growth expectations for the Small Business and Self-Employed Group of 15% to 20%. As part of this, we continue to expect online paying ARPC growth of 10% to 20%, and we now expect online paying customer growth of 5% to 10%. This reflects our shift in emphasis towards ARPC as we scale mid-market, drive growth in services, and reshape how we go-to-market as one business platform to significantly increase adoption of all our offerings. While there are relatively fewer mid-market customers, the ARPC of mid-market QuickBooks Online customers is nearly 3 times higher than other QuickBooks Online customers. Turning to Credit Karma, we are excited about the opportunity ahead as we execute our strategy to more deeply penetrate our core verticals, scale in growth verticals and execute our consumer ecosystem strategy. With the learnings from operating in the current business cycle, we are updating our long-term revenue growth expectations to 10% to 15%, reflecting the current size and scale of the business, and as we focus on creating seamless, end-to-end experiences with TurboTax that benefit consumers from year-round. Finally, the Consumer Group. Based on the momentum we saw this season, and the significant runway we have ahead to penetrate our TAM, we expect assisted penetration to be the key driver of future growth. TurboTax Live revenue accounted for approximately 30% of Consumer Group revenue in fiscal 2024, and we expect it to become the majority of Consumer Group revenue in the coming years. With that context, while we are scaling assisted, we are adjusting the Consumer Group long-term revenue growth rate to 6% to 10% in this interim period, with TurboTax Live revenue expected to grow 15% to 20%. One final note before I wrap up. Starting in Q1, we will be changing the name of our Small Business and Self-Employed Group to Global Business Solutions Group. This new name better aligns with the global reach of the Mailchimp and QuickBooks platform, and our focus on serving both small and mid-market businesses, and our vision to become the end-to-end platform that customers use to grow and run their business. With that, I’ll turn it back over to Sasan.
Sasan Goodarzi: Thanks Sandeep. We are confident in our long term growth strategy, including double-digit revenue growth and operating income growing faster than revenue. We have the strategy to win given the green shoots we're observing, and with less than 5% penetration of our $300 billion in TAM, with a massive runway ahead. We look forward to seeing all of you at our Investor Day next month, where we’ll unpack all of this and more. Let’s now open it up to your questions.
Operator: Thank you, Mr. Goodarzi. [Operator Instructions] We'll go first this afternoon to Siti Panigrahi at Mizuho.
Siti Panigrahi: Great. Thank you. If one question, then Sasan, I will focus on small business segment, 19% growth is pretty good in this environment, where we are hearing about SMB weakness. But I want to focus on your growth in ‘25 -- fiscal '25 and beyond. Now it looks like your focus is now driving growth through targeting mid-market. You talked about that and renamed that. So help us understand how big is that opportunity to expand into mid-market? And why is this the right time for Intuit to increase focus on mid-market? And is it mostly targeting this, your QuickBooks customer base? Or are you planning to gain share from other vendors?
Sasan Goodarzi: Yes, Siti, thank you for your question. First of all, I want to start with our focus will continue to be Small Businesses that are formed and because we want to fundamentally continue to grow with them. With that as context, we've just simply doubled down on our focus on mid-market. And as you know, it's not new. This has been five years in the making. It's one of the five Bets that we declared more than five years ago. But I would just say, five years later, Siti, we are just building an incredible amount of momentum. With that as context, let me just now answer your question. One, the way to think about it is we now have a business suite. And our business suite provides all the capabilities to -- for our business to be able to grow their customers, manage their customers, be able to manage their cash flow, get their accounting done, all in 1 place. And with our really AI-powered innovation and AI-powered experts, we really have tilted the professional grade help and services to all of our businesses. And we are now at a place where we are really accelerating on two fronts. One, we are going to go to market as one platform versus pieces and parts to really accelerate services penetration because of the one thing we continue to hear from businesses is that they want to do everything in one place and now we have the business suite for them to do everything in one place. Secondarily is our acceleration in mid-market. We're actually excited to announce at Investor Day a platform that will take us even further up market, and that really positions us to not only grow with our customers but to really acquire new customers. I would just remind us that the majority of mid-market customers are nonconsumption. And they pay a lot of money to use multiple different apps, discrete apps that don't talk to each other. Excel spreadsheets, Google Sheets, shoe boxes, and paying for multiple different bookkeepers, marketing agents and ultimately, accountants. And now we have packaged all of that as one enterprise suite to be able to pursue and accelerate pursuing mid-market customers. And our ultimate goal is to go far beyond 10 to 100 employees. And so I think this is five years in the making. And to round out the answer to your question, this is both focusing on the smaller customers, but we're really doubling down on the larger customers and really being able to penetrate services. And that's really what gives us confidence in the 20% online ecosystem revenue growth at a far bigger scale that you heard from Sandeep, along with our acceleration in Q1.
Siti Panigrahi: Thank you. I look forward to hearing more at the investors' day.
Sasan Goodarzi: Thank you for your question.
Operator: Thank you. We go next now to Alex Zukin at Wolfe Research.
Alex Zukin: Hey, guys. Thanks for taking the question. I wanted to ask about Consumer, the guide for the coming year, the updated mid-term guide. If you can just walk through a little bit of the puts and takes where -- why was that the right place to start the annual guide, what could drive upside surprise as the tax season progresses? And maybe, Sasan, just your view on kind of the macroeconomic backdrop that, that Consumer guide is set against?
Sasan Goodarzi: Yes, absolutely, Alex. Thank you for your question. Let me start with the last part of your question, which is around the macro environment. We have not assumed anything other than the current environment. We're not assuming any tailwinds coming from the macro environment. So that's really been one of the elements that's informed our guidance. It's really about our current trends that we're seeing our current momentum that we're seeing and really all focused on our own execution. So that's really the first part of your question. I would say the second part is just as a refresher, the total tax market is about $35 billion in TAM, $5 billion of that is do-it-yourself and about $30 billion is both -- is all assisted, but consumer and on the business side. We've got great momentum. As you know, TurboTax Live grew 17% this past year, but the number of full-service customers that we got double, new to the franchise tripled. And so we have a lot of momentum as we look ahead, and that's why we have a lot of confidence in really providing an expectation that we expect TurboTax Live to grow between 15% to 20%. And that really leads to -- we wanted to just adjust our long-term expectations to be really prudent because until TurboTax Live, which today is 30% of our franchise, growing high-double-digits, until that becomes a larger part of our franchise, we wanted to be prudent with our long-term expectation. I will just end with saying that DIY is actually very important, and I would parse it into two. One, we're actually growing quite rapidly, and I would say, high-single-digits with complex customers with higher income, and we're actually accelerating taking share. And based on our learnings this year and based on our trade-offs that we made this year and our focus this year, we're going to be quite assertive in continuing to pursue lower income customers this year because we have a lot of green shoots from this past year with our experiments of how to deliver benefits and monetize beyond tax with our Credit Karma platform. And so we're going to be leaning into that. And I'll just end with the final aspect of the question that you asked, really are upside to our guide, which is, I think, a question you asked around TurboTax comes from really two dimensions. One, accelerating in assisted tax beyond the 15% to 20%; and two, actually accelerating where we've seen a lot of green shoots, which is the more complex, higher income customers that are DIY. We have positioned ourselves for the innovation and the lineup that's required to win on both fronts in the coming years. So that's where our confidence comes from.
Alex Zukin: Okay. Thank you, guys.
Sasan Goodarzi: Yes. Thank you, Alex.
Operator: Thank you. We go next now to Brad Zelnick with Deutsche Bank.
Brad Zelnick: Great. Thanks so much for taking the question. Sasan, I wanted to ask about the restructuring, which I know you take very seriously. We appreciate it wasn't motivated by cost savings, but rather to better position the company ahead. How are you thinking about reinvesting any savings as it takes time to staff back up to prior levels? Are there specific initiatives that dollars get allocated to? Any additional color would be great. Thanks.
Sasan Goodarzi: Yes, sure, Brad. First of all, I just want to start with acknowledging we are a culture about talent and people and compassion and care. And this is a very, very tough decision. And we took great care of our teams internally, both those that are staying and getting them excited about why we're doing this and what's in the future and they remain extremely energized. But secondarily, taking great care of those that were impacted. And I just wanted to start there because these things are hard for us. We take it very seriously. We also believe that it's critically important to position the company for the future. And as we communicated, which is really the plan that we're executing against and a lot of what my upfront comments were, we are really taking all of the dollars and reinvesting it in five areas, which I articulated earlier in my prepared remarks. And really, our intent is to put all of those dollars back in the five areas that we've seen a lot of green shoots in this past several years. They accelerated towards really the latter part of last fiscal year, which is hence the decision to really double down in those five areas. So our intent is to allocate all of those dollars to those five areas. And of course, it's spread across marketing, customer success and additional headcount, engineering headcount in the areas that I mentioned. And we expect -- by the way, there's no expectation of any of these paying off in the coming year. None of our guidance that we provided resides on the added headcount back in. This is really positioning us for the next two, three years plus. That's an important note for all of you know because there's really no risk to our execution plan as we think about the coming year, but really this is about positioning us in the future. I'll just end with the following: we have a lot of confidence with the margin expansion that Sandeep articulated, and not only from the platform leverage that we're getting, but from all of our AI investments internally to drive a lot of efficiency and productivity.
Sandeep Aujla: Brad, the only thing I would add is we didn't have a standing start as we made that announcement. We were already contemplating as you probably saw from our open job listings, those had increased over the last quarter. We started building out our mid-market go-to-market function as well as scaling our marketing activities, particularly as we go after the assisted tax category, which has a different marketing timing than the DIY category.
Brad Zelnick: Thanks, Sandeep. Look forward to seeing you guys at Investor Day.
Sandeep Aujla: Thank you. We do this. We look forward to it as well.
Operator: Thank you. We'll go next now to Brent Thill at Jefferies.
Brent Thill: Thanks. Sasan, when you think about the Mailchimp reacceleration, what do you need to put in place to enable that to get to the level you'd like to see?
Sasan Goodarzi: Yes. There are really three areas that we've been executing that are worth calling out that we're excited about. One is the integration with the QuickBooks platform. As I mentioned earlier, one of the biggest areas why we're able to accelerate our customer growth with U.S. QBO, customer growth of 11%, the QBO advanced to 28% is really creating a suite where our platform is all in one place. So that's one area that we are aggressively focused on data and tech integration. And of course, workflow integration, and we're making great progress on that front. That's number one. Number two is mid-market. That is an area where it was critical when we declared the acquisition of Mailchimp, we're building momentum. Both, by the way, what we're doing to integrate the offering, but also our go-to-market capabilities. As we announced, I think, last quarter, Greg Johnson is now back with Intuit. He runs all of our go-to-market for all of small business, and we've brought together our sales and marketing and customer success across Mailchimp and QuickBooks to be able to be better positioned for mid-market. And then last is international. Those are the three areas that we're very focused on. And when we look at our KPIs, we're making solid progress against those three areas, and that's one of the reasons why it leaves us excited about the coming year and the future.
Operator: Thank you. We go next now to Keith Weiss at Morgan Stanley.
Keith Weiss: Excellent. Thank you guys for taking the questions and congratulations on a really solid quarter. I wanted to ask about the acceleration in QBO into Q1. We've seen two quarters of deceleration in both QuickBooks online subscriptions and the online services. The confidence in the acceleration, is that based upon like price increases? Or is there something you're seeing in units or other parts of the business that are giving you guys confidence in guiding towards an acceleration for Q1? And then as a follow-up, talked a lot about where the reinvestment of the dollars or the heads from the headcount reduction came from. Can you give us a little bit of visibility of where those heads came out of? Like what are the parts of the business that you guys are paring back investment in?
Sasan Goodarzi: Yes. Great. Thank you for your question, Keith. I'll start with your first question. Really, our acceleration comes from three areas. One, acceleration in services. And this is services across payments, across payroll, across our live platform and what we expect in Mailchimp. So that's one key area. The second key area is mid-market, where as we shared earlier, we've seen very good traction with QBO events, and we really continue to build out our go-to-market efforts on our platform capabilities. And that's informing by the way, what we're seeing in Q1, but also the fact that we shared earlier that we expect our online ecosystem revenue to be 20%, which is what it was this past year. And the third is price. Those three have played a big role in our acceleration. And the thing I would just call out on price, everything that we really learn and hear from our customers is because we have a business suite in one place, they're actually saving time they need less labor. They're able to drive customer growth based on our capabilities and better manage their cash flow because we're digitizing their cash flow. And that plays a very big role in terms of just the pricing power that we have, especially in our higher-end SKUs. But those are the three things that give us confidence into Q1 and beyond. And as you know, the majority of this business is subscription-based. So it's very predictable. In terms of the -- your second question around, well, where did the heads coming from in terms of the restructuring, there was really several key areas. I would say the largest area as we looked across the company and we looked at talent that we felt there was an opportunity for better performance. This was about 8% of our talent. These are, by the way, very talented folks that will lend great opportunities elsewhere. But it was across the company. It was not from any particular area, which, by the way, why there's really no execution risk from the actions that we took because this wasn't from one area. This was from across the company and talent that was we believe we have an opportunity to upgrade talent. So that was really one area. The second is, we really consolidated some of our technology talent across multiple sites, closing down Boise and Edmonton and consolidating technology talent in our key areas, Tel Aviv, Bangalore, Atlanta and Toronto. But those, I would say, were the main drivers of where the restructuring came from. And then, of course, we're allocating all of it to the 5 areas that I mentioned earlier.
Sandeep Aujla: The only thing I would add, Keith, to Sasan's first part of that question. If you recall in my prepared remarks, I talked about QBO U.S. growing 11%, advance growing 28%. These larger customers tend to adopt and use services at a higher rate than the self-employed that decline, so that's an important attribute to keep in mind. And secondly, on pricing, we look at pricing very carefully, our price volume mix and well over half of our growth comes from volume and mix. And at the company level, the contributions for price are relatively consistent year-over-year while they are slightly higher in the Small Business group. So that's the second component to keep into mind as we look at the trajectory heading into Q1.
Keith Weiss: Super helpful. Thank you guys.
Sandeep Aujla: Thank you.
Operator: We'll go next now to Kash Rangan at Goldman Sachs.
Kash Rangan: Thank you very much, team here. A nice finish to the fiscal year and quite positive on the guidance too. One, I couldn't help but notice that your Small Business, the Self-Employed Group is now running at the rate of $10 billion, I think, as of this most recent quarter, 10-ish. Very few companies in software -- in the enterprise software market hit the $10 billion. And congrats, you are there, you've done it with finance accounting for the most part you got payments and payroll. So this puts you on track with ServiceNow, I believe also tendering at a run rate business growing a little bit faster and you're moving upmarket, your SKU mix is decidedly more advanced and less so of lower-value units. So this has been, at least from my perspective, more successful, your tendering dollars and revenue, one of the largest enterprise software companies in the world. So haven't come this far, where else could you go with this business? And I'm glad I'm not asking your tax question. Thank you so much
Sasan Goodarzi: Thank you for the question, Kash. And also, by the way, the setup, as you saw in our guide we're guiding our Global Business Solutions Group to be north of $11 billion, growing 16% to 17% in the coming year, and particularly with online growing at 20%. And I would just tell you all of that has been done without really much, I would say, massive contribution from mid-market. So the best is yet to come because we are going to continue and if you look at where we are today versus three years ago, we truly have a business suite where we have all of the key capabilities for a business to be able to grow and run their business. And we've been investing in the last five years to be positioned to go after mid-market. And our ultimate goal is to have all of the big brand names, be on our mid-market platform, and we will announce something I think you'll find exciting at our Investor Day that really positions us to be able to serve these larger customers. And that's really when you look at the future -- when we look at the future, where we get really excited is that we're actually at where we are with an incredible franchise without really having a significant contribution from mid-market. And that's what excites us about the future because we want to continue to serve smaller businesses, but we now have a real opportunity to win in mid-market. And I would remind us of the following. It's probably the most important point that I'll make. Mid-market, when it comes to financial management platforms is actually not a crowded space. And so we have an incredible right to win. And this is really precisely what we hear from accountants and from mid-market businesses. We're really excited about the next chapter of taking our business group from we're $10 billion today to much larger as we look into the next three to five years.
Kash Rangan: Thank you, Sir. $10 onto $20. Thank you.
Sasan Goodarzi: Yes, indeed. See you at Investor Day.
Operator: Thank you. We'll go next now to Kirk Materne at Evercore ISI.
Kirk Materne: Yes, thanks. I’ll echo my congrats on the quarter and upbeat guidance in the next year. I guess, Sasan, my question comes around sort of the Global Business Solutions Group. How are you thinking about Intuit Assist impact on that in the coming year. Where is that sort of in the integration process? I'd just be curious about how you see that empowering your customers, maybe growing, helping in areas like mid-market or attach rates on some of your other products in that area. So why don't you just answer that, discuss Intuit Assist on the small business side.
Sasan Goodarzi: Yes, Kirk, thank you for the question. First of all, let me just start with we haven't accounted for or assumed anything in our guidance or around Intuit Assist for the coming year. So I just wanted to start there. Now let me get to your question. We actually have an incredible amount of momentum with Intuit Assist, you're going to see it at Investor Day. But let me start with the foundation of what I shared in the prepared remarks, which was we have about 1 million businesses that are engaging with Intuit Assist. And it is going to play a significant role in the future because that is actually the foundation of what we bet the company on six years ago, which was really around data and AI. But really the bet was about delivering experiences where we do the work for our customers. And so a number of areas that our customers are using today as part of the million that I mentioned is along the lines of marketing campaigns with proposed revenue that our customers could garner that we could then execute on the behalf of our customers. Things like taking, by the way, pictures of an estimate that you may have written on the go then you can take a picture of them, we will create a digitized estimate, invoice your payment schedule that you want, all within the platform. Send it to your customer, remind you in the business feed of, in essence, invoices that are overdue, capital that we can give you access to. And that's what I just mentioned are elements of what some of our customers are using today. And so we're really right now focused on sort of money in, money out because those are the most critical areas for our customers. And if I just take a step forward, ultimately, our entire goal because of our advantage, which is data and AI. Our goal is that we do all of the work for our customers. These examples I just illustrated is all on that path. Now what it means for us as a company beyond the -- of course, the benefit of helping drive revenue growth and profitability growth for businesses. What it means for us is, we believe it will have an impact in a couple of areas. One, new customer growth; particularly the smaller customers; but then two, adoption of our services because the examples I just mentioned, take a picture of a scribble note, upload a PDF file will create estimates invoicing progress payments that all turns into revenue for us. And that, by the way, doesn't even touch on the fact that embedded in our platform going forward is going to be AI-powered live expertise, which is a monetizable event ultimately with the goal of we do everything for you and with you. And so it will be an enormous sort of part of our experience and growth in the future. And we're making really good progress. All of which, by the way, will also show all of you at Investor Day. And I'll end with where I started. None of this is contemplated in our guidance, but it's a big part of our future, and we're excited about it.
Kirk Materne: Super. Thank you so much.
Sasan Goodarzi: Thank you.
Operator: Thank you. We'll go next now to Kartik Mehta at Northcoast Research.
Kartik Mehta: Good evening, Sansa and Sandeep. Just a question on tax. Sasan, it seems as though you're executing on the live products, you're starting to execute on the full service. I'm just wondering what was the thought of maybe lowering guidance now, considering the momentum you're building in the business?
Sasan Goodarzi: Yes. Thank you for the question. First of all, I would start with -- it's actually one platform, and that's the power of our scale. Customers, ultimately, can do it themselves, they can do it with assistance or we'll do it for customers. And it's all on TurboTax platform and our experts, our virtual experts all sit on the same platform, except they're on the other side of the platform, which is leveraging the customers' data and AI capabilities to do their taxes for them or with them. So I just wanted to start with that foundational point that it's not a lot of different products. It's actually one platform, which is what gives us the scale that we're looking for. When we make decisions around long-term expectations, we don't make them lightly. In fact, I think it was 5.5 years ago, right when I became CEO, we had updated the long-term expectations of tax. And so we take these decisions very seriously. And really what -- and so it's something we've been thinking about for some time. And really, it comes down to a very a simple math equation. When you look at the TAM, which is $35 billion, $5 billion do it yourself and $30 billion assisted both consumer and business, that's where the largest growth opportunity is. That's where we're really growing high-double-digits, 17% with customers growing 11%. And it's 30% of the franchise today, and we are also being very aggressive with DIY, both complex higher-income customers. But based on some green shoots that we saw this year, we're also going to be very assertive with lower income folks that are in the do-it-yourself category. And in that context, we just felt like the time was right to not only guide prudently for the coming year. But also adjust the long-term expectations. And I want to reiterate what you heard from Sandeep it's an interim adjust. And once we get to sustained, growth double-digit, we'll then rethink the long-term guidance. But until then, that's what informed the decision that we made.
Kartik Mehta: And just one follow-up, Sasan, as you look at the health of the Small Business, any change as you look throughout the quarter? Any changes that may be give you concern or hope what's happening to your customers?
Sasan Goodarzi: The headline I would give you, Kartik, is stable. Across our small businesses, we generally, differs by the way, by sector, by state, by country. But at an Uber level, we see revenue and profitability up in this fiscal year for businesses that we serve. We see cash reserves still down 6% to 7% compared to last year, but it's way up compared to pre-pandemic levels. We also see hours worked higher. So headline is stable. And by the way, we see the same thing on the consumer side, which is stable.
Kartik Mehta: Okay, thank you very much. Appreciate it.
Sasan Goodarzi: Yes, very welcome.
Operator: We'll go next now to Daniel Jester with BMO Capital Markets.
Daniel Jester: Great. Thanks for taking my question. It was great to hear about QBO Live, the number of clients more than tripling. Can you maybe spend a moment talking about what's resonating there? And as you sort of move more into the middle market, what's the opportunity for QBO Live to accelerate that more upmarket push?
Sasan Goodarzi: Yes. Thank you for the question. Let me start with your question of what's resonated with the smaller businesses. For us, we've actually had product market fit, meaning that our experts on our platform can really help our businesses with bookkeeping, accounting, providing advice. Really, the biggest challenge that we've been working through in the last year is how to think about the benefit? How to think about the offering? How do we actually go to market because the great news is every business at some point in their life throughout a year, they're engaging a bookkeeper and an accountant. So we're not trying to create opportunity. The opportunity is there. It's just it's manual, it's disaggregated. It's high price. And so really, the biggest thing has been our focus on how do you really help the customer understand that this is now a part of our platform and that we can help them with all the key problems that they have. And I would say that, that's an area where we really uncovered how to do that, and we're accelerating. And I don't want to make you feel like we've reached the destination. I think we still have a lot of work to do in this area. But we’ve really, I would say, cracked a nut that we're excited about, particularly around our decision to embed AI-powered experts into our offering as we look ahead. And lastly, this is a far bigger opportunity with larger customers because they expected. They expect a CFO for a hire and HR for hire. They expect an assistant to be able to help them with their books, with their accounting, with their employee inventory decisions. And so part of what you'll hear us talk about at Investor Day is as we're accelerating our focus with mid-market, with a business suite that has all the key capabilities that a business needs a big element of it is the expertise that it comes with. I think the differentiator for us is these are AI-powered experts that sit on the platform, can really provide a range of services for customers. But we believe it's a bigger opportunity as we move upmarket. And last thing, by the way, I'll end with, these are small sample sizes still. But the -- those that have live experts, the attach and use of services like payments and payroll actually higher, which really is a great benefit for customers and for us.
Daniel Jester: Great, thank you very much.
Sasan Goodarzi: Yes. Very welcome.
Operator: We'll go next now to Arvind Ramnani at Piper Sandler.
Arvind Ramnani: Hi, this is Arvind. Thanks for taking the questions. Just a couple of questions. In some of the prior calls, you have provided some additional color on some of the kind of benefits you're seeing with AI. And given [Technical Difficulty]
Sasan Goodarzi: In and out. We can now, please go ahead and continue.
Arvind Ramnani: Yes. I'm just trying to get some color on your -- some of the impact of AI that you've seen both from a revenue add but also from a cost perspective across your business, is there any additional information you're able to kind of provide in terms of quantification of those benefits you're starting to see?
Sasan Goodarzi: Yes. Thank you for your question. I think a couple of things I would say. First of all, we're seeing the impact of our usage and innovation across all of our platforms. Across Credit Karma, it's really driving a lot of the automation and do it for our customers within TurboTax, even with TurboTax full service, we're doing a lot of the work for experts so that they can serve more customers and, of course, across our business platform that I articulated the examples earlier. So I want to first be clear, this is broad-based across our entire platform. And we are really focused on how AI reimagines our internal work within Intuit as well. I would say the -- really, the revenue is immaterial this year, and we didn't account for anything in the coming year, but we believe it will be a large driver of growth in the future years. And the growth will be really usage of services, better conversion, better retention, and these are the green shoots that we're seeing with, for instance, our million businesses that are using it today. And in terms of our cost structure, remember, data and AI have been core to our investment thesis and our Bets over the last five, six years. And what we do is not capital intensive. At the same time, we're very intentional about the investments that we've had to make and any investments we need to make to win in this world of AI has been contemplated in the guidance that you heard from Sandeep. I don't know, Sandeep, if you add anything?
Sandeep Aujla: No, I think that covers. 1 thing to keep in mind as we compare us to possibly other companies in your portfolio, one point, AI sort of really been in our run rate. So I wouldn't expect any meaningful change in our cost structure. Secondly, we use AWS for a lot of the processing. So it's not like we're building up our own data centers. So that's also very asset light for us. And the other factor, as Sasan alluded to, we are quite frankly also seeing improvements in our own productivity. We are seeing improvements in our developer productivity. We're seeing improvements in our overall G&A productivity. So just factors to keep in mind that AI should not be not getting in the way of our commitment to continue to find operating leverage and continue to scale our margin over time.
Arvind Ramnani: Perfect. And just one quick follow-up. Just on TurboTax Live, as you're thinking of kind of directing questions or your customers to having kind of AI sort of answer it versus QuickBooks Live or sort of the kind of accountant or CPA. Obviously, the AI is going to be like a lower ARPU versus like directing someone who is basically like more like service-oriented. How do you balance that? Because does come at like a higher ARPU, but lower margin. And of course, AI is lower revenue, lower ARPU but higher margins. How do you balance it out?
Sasan Goodarzi: Yes. I think the premise of what you're articulating is not what we're seeing. We actually believe that based on all of our investments with data and AI, it's actually higher ARPU because it drives better attach of our services. It actually drives more attach of our human-powered expertise. And by the way, when our human-powered experts or AI-powered human experts get involved, they're actually quite effective and productive because they're sitting on our data and AI platform. So we're actually seeing two things. One, higher ARPU over time because of what I articulated, but also more effective and efficiency on our platform because we are as aggressive as we are in applying AI externally we are as aggressive internally based on what you just heard Sandeep talk about. So it's actually the reverse of the premise that you talked about in terms of what we see. I don't know, Sandeep, if you would add anything.
Sandeep Aujla: Yes. The thing to keep in mind is AI is -- the name of the game is confidence and eliminating fear, uncertainty and doubt. And by using AI, by using our AI powered experts, we're actually doing that at scale. And the important thing to keep in mind is it actually helping us open up the aperture of the customers we can serve and really go after penetrating a TAM. That's driving a lot of the success that you've seen in the assisted category. Some of those are fully outsourced to us, some of those that do it with me. So just something to keep in mind as you look at the strategic opportunities that this opens up for us as well.
Arvind Ramnani: That's been really helpful, Thank you very much.
Sasan Goodarzi: Thank you.
Operator: Thank you. We go next now to Brad Sills with Bank of America.
Brad Sills: Okay, wonderful. I wanted to ask a question around the platform for AI, the GenOS and the studio that you've outlined in the past, I know it's a little further out to start thinking about separate SKUs, and it sounds like this is more of a conversion and a retention play in the near term. But what were some of the learnings that you had over the course of the year in building out that platform for AI, harnessing the data and some of the platform components that you've outlined at the Analyst Day last year that are underpinning that.
Sasan Goodarzi: Sure. First of all, let me start with your question around the SKUs. This is a progression, and this is a really important element to call out. What you heard us talk about is that we believe, and we're seeing this in our proof points. And the green shoots that we're seeing is that, one, this will drive new customer growth because we will just make it far easier and simpler for a new customer to use our digital platform that comes with AI-powered experts. Two, we believe that it's an opportunity for the adoption of our services, which also includes Live. Services like payments, payroll, Mailchimp and our live platform, which is our AI-powered human experts. And those are significant customer and growth drivers for us. The progression is as we are focused on the innovation that we articulated earlier, things such as literally a customer being able to take a picture of a scribble note, upload a PDF document for us to be able to put together an estimate all the way to getting them paid following up with their customers, putting marketing campaigns together for them. The progression is we'll get to a place where we'll actually test stand-alone SKUs where the AI agent is doing everything for the customer. And that could be a stand-alone SKU that we could test sometime in the future, but you have to progress your way to that. And that's really what the element of progression talks to. The last thing, which I think was the other element of your question, what we're doing is really hard, which we love because it's hard to replicate. And what's hard about it is, first, you have to have the data. And we have a lot of data. It's our customers' data. But when you look at for every business, we have 500,000 data points. That means we are uniquely positioned to be able to help them with managing their cash flow because it's about their cash flow. It's not about something generic because we see all of their money coming in, money going out, the creditworthiness of their vendors, the employees that they have. And so the investments that we've made in the data has been more than ever crucial because then it allows us to leverage our GenOS platform, which is our GenAI capabilities and train the Intuit LLM on the customer's data to be able to then deliver the experiences that I was just articulating and our LLMS have agency and authority to be able to use other LLMs that could enhance the experience. So the biggest thing that we've learned to sort of punchline answer your question is the combination of the data investments, the investments we've made in knowledge engineering, machine learning and our LLM that really delivers accuracy performance cost effectively is extremely hard to copy because we live in a world of financial management, and that's really our biggest advantage going forward and really our biggest growth opportunity as we look ahead.
Brad Sills: That's exciting. Thanks, Sasan.
Sasan Goodarzi: Yes, thank you.
Operator: Thank you. And ladies and gentlemen, that is all the time we have for questions this afternoon. At this time, Mr. Goodarzi, I'd like to turn things back to you for any closing comments, sir.
Sasan Goodarzi: Well, listen, everybody, thank you for your time. Thank you for all of your questions, and we hope to see all of you at Investor Day. Be safe. We'll see you soon. Bye-bye.
Operator: Thank you. Ladies and gentlemen, that does conclude Intuit's Fourth quarter and fiscal year 2024 conference call. Again, thanks so much for joining us, everyone. We wish you all a great evening. Good-bye. |
GILD | 2 | 2,024 | 2024-08-08 20:47:04 | Operator: Good afternoon, everyone, and welcome to Gilead's Second Quarter 2024 Earnings Conference Call. My name is Rebecca, and I'll be your host for today. In a moment, we'll begin with our prepared remarks followed by a Q&A session. [Operator Instructions] I'll now hand the call over to Jacquie Ross, Vice President of Investor Relations and Corporate Strategic Finance.
Jacquie Ross: Thank you, Rebecca. Just after market closed today, we issued a press release with earnings results for the second quarter of 2024. The press release, slides and supplementary data are available on the Investors section of our website at gilead.com. The speakers on today's call will be our Chairman and Chief Executive Officer, Daniel O'Day; our Chief Commercial Officer, Johanna Mercier; our Chief Medical Officer, Merdad Parsey; and our Chief Financial Officer, Andrew Dickinson. After that, we'll open Q&A where the team will be joined by Cindy Poretti, the Executive Vice President of Kite. Before we get started, let me remind you that we will be making forward-looking statements. Please refer to Slide 2 regarding the risks and uncertainties relating to forward-looking statements that could cause actual results to differ materially. With that, I'll turn the call over to Dan.
Daniel O'Day: Thank you, Jacquie, and good afternoon, everyone. I’m pleased to share that this was another strong quarter of commercial execution with growth across HIV, Liver Disease, and Oncology. Biktarvy for HIV treatment was up 8% year-over-year, Trodelvy was up 23%, and Cell Therapy was up 11%. In addition, we continued to demonstrate disciplined operating expense management and delivered exceptional bottom-line growth, highlighting the leverage in our business model. Given the results for the first half of the year, we are raising our non-GAAP operating income and EPS guidance for the full year. Moving to clinical updates, this is an important time for our Virology and Inflammation therapeutic areas. A key highlight of the quarter was the readout of our Phase 3 PURPOSE 1 trial evaluating lenacapavir for HIV prevention. The results showed 100% efficacy with zero HIV infections in cisgender women. The presentation of these results at AIDS 2024 in Munich generated considerable excitement, and we’re delighted to have reached this milestone with such a positive outcome. Lenacapavir, with its twice-yearly dosing, could set a new bar for HIV prevention and allow PrEP to reach a much broader population of people who could benefit from a prevention regimen. The PURPOSE program, which is expected to include more than 9,000 participants in over 10 countries, is designed to highlight the efficacy of HIV prevention in a wide range of groups, including cisgender women, transgender men and women, Black and Latino individuals, and young adults. We expect an update for PURPOSE 2 late this year or early next year, with a commercial launch as early as late 2025. The PURPOSE data were part of several updates at AIDS 2024 that highlight the strength of Gilead’s innovation in HIV, for both prevention and treatment. Our pipeline has the promise to extend our HIV leadership well into the late 2030s and beyond. Updates at AIDS 2024 included data from our daily oral combination of bictegravir and lenacapavir, which is now in pivotal Phase 3 trials for people with HIV, including those on complex regimens. We also shared data from our broad long-acting program, including our once-weekly orals GS-4182 and GS-1720. We plan to start the Phase 2 study evaluating these in combination before the end of the year. This is in addition to the once-weekly oral combination of lenacapavir and islatravir in partnership with Merck that will begin Phase 3, also before the end of the year. On the immediate horizon, our PDUFA date for seladelpar is next week. The body of clinical evidence behind seladelpar for the treatment of primary biliary cholangitis, or PBC, continues to grow, most recently with the Phase 3 ASSURE data shared at EASL. The Gilead team is excited by the opportunity to launch seladelpar and bring a promising new treatment to the patients who could benefit. Moving to Oncology, we are ready to manufacture anito-cel for multiple myeloma at our Maryland Kite facility, and we are preparing to support the Phase 3 iMMagine-3 trial from the site starting later this year. The iMMagine-3 trial is expected to reach a broader set of 2nd- to 4th-line multiple myeloma patients with our potentially best-in-class BCMA CAR T. At ASCO, we shared new data from our Phase 2 EVOKE-02 program evaluating Trodelvy in combination with pembro in first-line metastatic non-small cell lung cancer. The results showed meaningful efficacy compared to the historical standard-of-care, supporting the Phase 3 EVOKE-03 trial currently underway. We continue to assess the path for Trodelvy in second-line metastatic non-small cell lung cancer and metastatic bladder cancer following the EVOKE-01 and TROPiCS-04 readouts earlier this year. In the meantime, I’d highlight the strong commercial results this quarter in breast cancer where Trodelvy remains the first and only approved TROP2-directed ADC on the market and is the standard of care for second-line metastatic triple-negative breast cancer. To date, we have served over 40,000 cancer patients, and remain confident that Trodelvy will continue to be an important treatment option. We also shared Phase 2 EDGE-Gastric data at ASCO for domvanalimab plus zimberelimab and chemotherapy in first-line upper GI cancers. These results showed compelling efficacy that supports the Phase 3 STAR-221 program, which has completed enrollment. Moving to our 2024 key milestones on slide 6, we look forward to the upcoming updates from the Phase 3 ASCENT-03 trial and Phase 2 iMMagine-1 trial. ASCENT-03 is an event-driven trial evaluating Trodelvy in first-line PD-L1 negative metastatic triple-negative breast cancer patients. A positive progression-free survival outcome would support global filings, potentially moving Trodelvy into earlier lines of triplenegative breast cancer. Our iMMagine-1 trial could support regulatory filings for anito-cel in later-line relapsed or refractory multiple myeloma. Overall, the second quarter was a strong performance for the Gilead team, with the highlights including some remarkable clinical results in HIV, solid revenue growth across therapeutic areas, tangible impact from our disciplined cost management initiatives, and planning for the imminent launch of seladelpar. With that, I will hand it over to Johanna.
Johanna Mercier: Thanks Dan, and good afternoon, everyone. I’m very pleased to report the continued momentum we saw in the second quarter, and would like to thank the Gilead teams who contributed to another strong quarter of execution. As shown on slide 8, total product sales, excluding Veklury were $6.7 billion in the second quarter, up 6% year-over-year, with growth across HIV, Liver Disease, and Oncology. Including Veklury, total product sales were $6.9 billion, up 5% year-over-year. Starting with HIV on slide 9, sales of $4.7 billion were up 3% year-over-year, driven by strong demand across treatment and prevention, partially offset by lower average realized price due to channel mix. Quarter-over-quarter, sales were up 9%, reflecting favorable pricing and inventory build following the typical first quarter dynamics, as well as higher demand. Looking to the full year, we remain on-track to deliver HIV sales growth of approximately 4%. Turning to slide 10, total second quarter Biktarvy sales of $3.2 billion were up 8% year-over-year, primarily due to higher demand. Sequentially, sales were up 10%, largely reflecting favorable pricing and inventory following the typical first quarter dynamics. Highlighting our leadership position, Biktarvy represents more than 49% share of the treatment market in the U.S. This was up almost 3% year-over-year, our 24th consecutive quarter of year-over-year market share gain. With a meaningful share lead over all other branded regimens for HIV treatment, Biktarvy firmly remains the HIV treatment-of-choice, particularly for those starting or switching regimens in the U.S., as well as across other major markets. Overall, the HIV treatment market continues to grow in-line with our expectations of 2% to 3% annually. Turning to Descovy, we continued to see higher demand with sales of $485 million in the second quarter. Year-over-year, sales were down 6% as demand growth was more than offset by lower average realized price due to channel mix. As a reminder, shifts in channel mix will continue to impact average realized price in addition to our ongoing efforts to ensure people who want or need PrEP have access to the prevention regimen of their choice. Sequentially, sales were up 14%, reflecting favorable inventory and pricing following typical first quarter seasonality, in addition to the higher demand. Descovy for PrEP once again maintained its over 40% PrEP market share in the U.S., despite the availability of other regimens, including generics. We’re particularly excited to note that the HIV PrEP market in the U.S. continues to expand, with total volumes up more than 12% in the second quarter of 2024 compared to the same period last year. With that in mind, we are thrilled with the unprecedented results seen in our pivotal Phase 3 PURPOSE 1 trial, achieving 100% efficacy with zero cases of HIV infections in a broad population of cisgender women, including those who are pregnant or lactating. This is just the beginning of our larger, landmark PURPOSE program which includes multiple populations and communities where PrEP is underutilized or more difficult to access today, such as cisgender women, transgender men and women, Black and Latino individuals, and young adults. Overall, we expect lenacapavir will emerge as the regimen-of-choice for those who want or need prevention as the first and only long-acting option with twice-yearly subcutaneous dosing. We are preparing for potential launch as early as late 2025. Moving to the Liver Disease portfolio on slide 11, sales were up 17% year-over-year and 13% sequentially, driven by higher demand and higher average realized price due to channel mix in the U.S. Our Liver Disease franchise continues to differentiate itself, with leading share in HCV despite fewer HCV starts year-over-year together with growing demand in HBV and HDV. As you know, our PDUFA date for seladelpar is next week, and we stand ready to launch commercially in the U.S. We are able to leverage our existing commercial footprint in liver diseases, and continue building upon these relationships to quickly bring seladelpar to many of the 130,000 people impacted by PBC in the U.S. who progress after initial treatment. Outside the U.S., commercial preparations are well underway, and we look forward to the European regulatory decision in early 2025. Turning to Slide 12, while severity of COVID infections and hospitalization rates remain variable, Veklury continues to be recognized as an important part of the standard of care for hospitalized patients treated for COVID-19. This includes the U.S. where Veklury has maintained well over 60% share in this setting. For the second quarter, Veklury sales were down 16% year-over-year and down 61% sequentially, as expected. Moving to Oncology on slide 13, sales were up 15% year-over-year and up 7% quarter-over-quarter to $841 million. With over 60,000 patients treated with a Gilead or Kite therapy to date, we’re proud of the positive impact our oncology medicines have made across multiple cancer types. Looking in more detail at Trodelvy on slide 14, sales for the second quarter were $320 million, up 23% year-over-year and up 4% sequentially, primarily driven by higher demand in the U.S. and Europe across its metastatic breast cancer indications. Trodelvy is the only approved and available TROP2-directed ADC to demonstrate clinically meaningful survival benefits across two types of metastatic breast cancers. And with increasing awareness amongst physicians, Trodelvy has remained the leading regimen in the U.S. and Europe for second-line metastatic triple-negative breast cancer with growing adoption in the pre-treated HR+/HER2- metastatic breast cancer setting. We are working to expand Trodelvy’s reach beyond the 40,000-plus patients treated to date across multiple tumor types as we look to new and existing markets, as well as new indications. In bladder cancer, we are planning to further discuss the results of TROPiCS-04 and next steps with FDA. At this time, Trodelvy continues to be available under an accelerated approval in the U.S. for second-line plus metastatic or advanced bladder cancer. Turning to Slide 15, and on behalf of Cindy and the Kite team, Cell Therapy sales in the second quarter were $521 million, up 11% year-over-year and up 9% quarter-over-quarter, with solid growth in all regions. In the U.S., sales were up 11% sequentially as we've begun to see momentum from our focused efforts at the authorized treatment centers, including further educating providers and patients on the curative potential of our cell therapies. Despite these efforts, in-class and out-of-class competition remain a near-term headwind in the U.S. As we extend the reach of cell therapy, we are making important in-roads with key community practices, including working with national payers to unlock broader commercial reimbursement, and as a reminder, expect impact from these initiatives towards the end of 2024. We’ll continue to refine this “blueprint” as we work to onboard new centers and patients over time. Outside the U.S., demand for Yescarta and Tecartus across Europe and other international geographies remains strong, and we’re encouraged by the solid progress in our newly launched markets such as Japan and Saudi Arabia. Overall, it was a strong second quarter for our commercial portfolio, and the teams are energized by the potential to bring two more transformational therapies to market – first with seladelpar for PBC next week, and then, lenacapavir for HIV prevention as early as late next year. And with that, I’ll hand the call over to Merdad.
Merdad Parsey: Thank you, Johanna. We were very pleased to wrap up the second quarter with two New England Journal of Medicine publications and a number of important readouts across our portfolio. Most exciting was the readout of our Phase 3 PURPOSE 1 trial evaluating twice-yearly, subcutaneous lenacapavir for the prevention of HIV infection in cisgender women. As you can see on slide 17, this was the first Phase 3 HIV prevention trial to ever achieve 100% efficacy. We have since shared data at the International AIDS Society meeting in July, where our presentation was the highlight of the plenary session. The data were simultaneously published in the New England Journal of Medicine. Our second registrational trial for lenacapavir, PURPOSE 2, has enrolled approximately 3,300 men, transwomen, and non-binary people who have sex with men. This trial completed enrollment globally in December 2023, approximately four months after PURPOSE 1. As a result, we expect to provide an update in late 2024 or early 2025. Assuming positive data from PURPOSE 2, we plan to file based on data from both trials, with the goal of bringing transformative HIV prevention to people at risk of HIV as early as late 2025. Beyond our registrational trials, we are generating Phase 2 data from the PURPOSE 3, 4, and 5 trials in key populations across the U.S., UK, and France, including people who inject drugs. These trials reflect our commitment to evaluate lenacapavir across diverse populations that could benefit. These studies are also intended to drive greater awareness amongst physicians and patients, including geographies where prevention options have not been effective historically. In addition to HIV prevention, we are of course intensely focused on next generation HIV treatment options, and slide 18 highlights our comprehensive HIV treatment pipeline. Our recent updates at the AIDS Society meeting included: Longer-term Phase 2 data from our once-daily oral combination of bictegravir and lenacapavir that showed the regimen was highly effective at maintaining viral suppression. These results further support our ongoing Phase 3 studies in people with HIV, including those on complex regimens. We also reported safety and PK data for both GS-4182, an oral pro-drug of lenacapavir designed to provide 2- to 3-times greater oral bioavailability, and GS-1720, our long-acting oral integrase inhibitor. Initiation of the Phase 2 trial evaluating the combination of these agents as a once-weekly oral regimen is expected later this year. Additionally, we are on-track to initiate our Phase 3 ISLEND-1 and ISLEND-2 trials evaluating once-weekly lenacapavir in combination with Merck's islatravir. This regimen is expected to be the first once-weekly oral treatment option. Looking at our longer-duration treatments, we expect to provide Phase 1 updates from our every 3- month injectable programs and to initiate the Phase 1 studies for our potentially every 6-month integrase inhibitors in the second half of the year. Moving to our Liver Disease portfolio, on slide 19, we presented more than 25 abstracts across both viral and inflammatory liver diseases at the EASL Conference in June, highlighting our continued leadership. Importantly, as shown on the right of the slide, new interim results from the open-label Phase 3 ASSURE study of seladelpar for PBC were consistent with the pivotal RESPONSE study that formed the basis of our global regulatory filings. As you know, we expect an FDA regulatory decision shortly, with a decision from European regulators to follow in early 2025. In viral hepatitis, Gilead shared final, Week 144 results of the Phase 3 MYR301 trial at EASL. These data continue to support monotherapy bulevirtide 2mg as a chronic treatment for HDV. Additionally, we presented promising Phase 2b data evaluating bulevirtide 10mg with interferon alfa-2a as a finite regimen. The post-treatment response rates were the highest ever posted in HDV and were simultaneously published in the New England Journal of Medicine. We’re encouraged by the data, and continue to be engaged with KOLs and health authorities - including FDA - as we work to bring bulevirtide to patients as quickly as possible. Switching to Oncology, on slide 20, we’re pleased with the progress across our mid-to-late stage programs. In the front-line setting we shared mature Cohort A data at ASCO from our Phase 2 EVOKE-02 trial with Trodelvy plus pembro, demonstrating a median progression-free survival of 13.1 months. These data exceeded the historical performance of PD-1 monotherapy in first-line PD-L1 high non-small cell lung cancer and support our ongoing Phase 3 EVOKE-03 trial where enrollment is going well. In an all-comer non-small cell lung cancer population, our Phase 3 STAR-121 study evaluating dom plus zim is ongoing. Our Phase 3 STAR-221 study in upper GI cancers evaluating dom with zim and chemo has completed enrollment. The updated Phase 2 EDGE-Gastric data presented at ASCO supported the use of this combination. If successful, dom plus zim and chemo would be the first TIGIT-based regimen for upper GI cancer patients. In addition, we have several Phase 3 programs underway in earlier settings of breast cancer, including ASCENT-03 evaluating Trodelvy in PD-L1 negative metastatic triple-negative breast cancer. Turning to our second-line programs, we have discussed the results of EVOKE-01 in metastatic non-small cell lung cancer with regulators, and as expected, have confirmed there is no immediate regulatory path based on EVOKE-01 alone. We are currently assessing next steps for Trodelvy in this setting. We will also provide updates on our bladder cancer program, including the full trial results at a future scientific conference, after discussions with FDA and KOLs. Moving to slide 21, and on behalf of Cindy and the Kite team, we shared updates for Yescarta and Tecartus at both ASCO and the European Hematology Association meeting. At ASCO we shared encouraging new efficacy data from a pilot study of Yescarta in 18 patients with relapsed or refractory primary or secondary central nervous system lymphoma in collaboration with the Dana-Farber Cancer Institute. Yescarta demonstrated greater than 26 months median overall survival with no reported treatment-limiting toxicities and no apparent additional risk of adverse events in these patients with high unmet need. Based on these results, we are engaging with regulators to expand the use of Yescarta to include these patients. Additionally, we reported that treatment with Tecartus resulted in a 40% 4-year overall survival rate and median overall survival of almost 26 months in the pivotal ZUMA-3 trial in relapsed or refractory adult B-cell acute lymphoblastic leukemia. At EHA, we shared preliminary analysis from the Phase 2 ZUMA-24 trial further supporting outpatient use of Yescarta in relapsed or refractory large B-cell lymphoma with the use of prophylactic steroids and other early intervention strategies, real-world manufacturing experience of Yescarta for second- and third-line large B-cell lymphoma, reinforces our strong manufacturing success rate of 96%. Further, on slide 22, I will highlight our promising clinical development program for anito-cel, a potential best-in-class BCMA CAR T that we are developing in partnership with Arcellx. Notably, we shared our study design for our Phase 3 iMMagine-3 trial that will include a broader set of earlier-line, relapsed or refractory multiple myeloma patients. We expect to have first patient in for this trial in the second half of this year. We are pleased to note that the tech transfer and transfer of the U.S. IND of anito-cel to Kite are now complete. The Kite manufactured product will be used in the iMMagine-3 trial, and we anticipate the turnaround time for anito-cel to be on par with Kite’s commercially available products. Wrapping up with our key 2024 milestones on slide 23, we completed all of our first half milestones, and are pleased with our program execution overall. We’re off to a good start for the second half with the readout of PURPOSE 1 occurring ahead of our committed timeline. We look forward to the FDA decision next week for seladelpar in PBC, as well as an update from the pivotal Phase 2 iMMagine-1 trial in later-line relapsed or refractory multiple myeloma, in addition to an update on the pivotal Phase 3 ASCENT-03 study in first-line PD-L1 negative metastatic triple-negative breast cancer. Along with these updates, we have a maturing inflammation pipeline that includes several Phase 2 programs, such as a once-daily oral alpha-4-beta-7 integrin inhibitor and an oral TPL2 inhibitor for inflammatory bowel disease. And now, I’ll hand the call over to Andy.
Andrew Dickinson : Thank you, Merdad, and good afternoon, everyone. Starting on slide 25, the team delivered an excellent quarter, with our base business up 6% year-over-year to $6.7 billion. Product sales growth across HIV, Liver Disease and Oncology more than offset the expected decline in Veklury, with total product sales up 5% year-over-year. Moving to our non-GAAP results on slide 26. Product gross margin was 86%, down 84 basis points from last year. R&D expenses were down 3% year-over-year, primarily due to the wind-down of certain magrolimab, obeldesivir and Trodelvy studies following recent data and regulatory updates. Sequentially, R&D was down 5%, primarily due to the timing of clinical and manufacturing activities, partially offset by the initiation of new studies. These savings reflect disciplined management of R&D resources towards the most meaningful opportunities. Acquired IPR&D was $38 million, reflecting new and ongoing collaboration payments in the second quarter. SG&A was down 27% year-over-year, primarily due to the $525 million legal settlement in 2023 that did not repeat in 2024. Excluding this payment, SG&A was up 2% year-over-year, and includes commercial investments ahead of the launch of seladelpar. Operating margin for the second quarter was 47%, our strongest operating margin since the third quarter of 2022, highlighting the leverage we have in our business model. Turning to tax, our effective tax rate was approximately 18%, reflecting settlement with a tax authority in the second quarter. On a reported basis, our non-GAAP diluted EPS grew 50% year-over-year from $1.34 to $2.01 per share. As mentioned earlier, we had a $525 million legal settlement, representing $0.32 per share, in the second quarter of 2023 that did not repeat in the second quarter of 2024. Excluding this settlement, EPS grew 21% year-over-year, reflecting higher product sales and lower expenses including acquired IPR&D expenses. As highlighted on Slide 27, we had a strong first half of the year, with solid performance in each of our core franchises across Virology and Oncology, driving base business growth of 6% year-over-year, which is at the upper-end of our full-year guidance of 4% to 6%. Switching to our expectations for 2024 on Slide 28, we continue to expect total product sales in the range of $27.1 billion to $27.5 billion, and total product sales, excluding Veklury, in the range of $25.8 billion to $26.2 billion. Given the inherent variability experienced historically, and as stated previously - we are not updating our Veklury guidance at this time. As we think about the second half of the year, here are some of the factors that we are continuing to monitor. First, we continue to expect the normal, quarter-to-quarter variability in our HIV business that we have always experienced relative to average realized price associated with channel mix. Second, we expect quarterly variability in cell therapy due to continued in-class and out-of-class competition. Third, there is some uncertainty associated with Trodelvy bladder revenue following TROPiCS-04. As a reminder, bladder represents less than 10% of total Trodelvy sales today; and finally, there is a possibility of incremental FX headwinds in the second half of the year. For the rest of 2024, we continue to expect to deliver strong volume growth across all therapeutic areas, and assuming approval seladelpar as an incremental contributor to revenue growth. Continued HIV volume and revenue growth, consistent with our full year expectation to grow HIV product sales by approximately 4%; and continued focus on disciplined operating expense management. Moving to the non-GAAP guidance, there is no change to our non-GAAP gross margin range of 85% to 86%. For R&D, we now expect total R&D expense to increase by a low to mid-single-digit percentage compared to 2023, reflecting lower than previously expected R&D expenses in 2024, despite absorbing the late-stage seladelpar program. For SG&A, there is no change to our prior guidance pointing to a mid-single digit decline compared to 2023. Consistent with our expectations last quarter, we have been able to absorb the incremental expenses associated with the CymaBay transaction. For acquired IPR&D, we now expect full-year expenses of $4.7 billion, up from $4.4 billion last quarter to reflect a $320 million transaction with Janssen to buy out the global seladelpar royalty. This expense will be included in our third quarter results. Finally, with the strong operational expense control demonstrated in both the first and second quarters, and despite this new $320 million acquired IPR&D expense, we are increasing our operating income guidance to $7.2 billion to $7.6 billion, and increasing our non-GAAP diluted EPS guidance to $3.60 to $3.90. Slide 29 highlights that the increase to our EPS guidance fully absorbs the $320 million, or approximately $0.20 per share, expense associated with the buyout of the seladelpar royalty from Janssen. This transaction removes Gilead’s royalty obligation to pay 8% of seladelpar sales. Excluding this transaction, our EPS guidance increase would have been even more significant today, up $0.30 or 8% at the midpoint, again highlighting the financial discipline that has translated into operating leverage. Moving to slide 30, we continue to have sufficient flexibility in our balance sheet to execute on our capital allocation priorities. In the second quarter, we returned $1.1 billion to shareholders, repaid $1.75 billion of senior notes, and paid $1.2 billion as part of the federal transition tax associated with the Tax Cuts and Jobs Act of 2017. The remaining transition tax payment of $1.3 billion is scheduled for April of 2025. Overall, we believe that Gilead is well-positioned for near and long-term growth and we continue to be focused on commercial execution, expense management discipline, and to delivering on our strategic commitments. And now, I’ll invite Rebecca to begin the Q&A.
Operator: [Operator Instructions] [Audio Gap] Please go ahead your line is open.
Evan Seigerman : Hi there, this is Evan Seigerman from BMO Capital Markets. I wanted to touch on TIGIT. There's been a lot of updates in the TIGIT space in ASCO. We had the Roche update and most recently Merck discontinued their KeyVibe study in small cell lung cancer. So Merdad, you could walk us through how you think about the opportunity for TIGIT? And what looks good, what good would look like for you in terms of safety and efficacy with the STAR-121 program? Thank you so much.
Merdad Parsey : Thanks, Evan for the question. Yeah, I think as you know as you noted, there have been a lot of updates on TIGIT over the past six months or so. And I think that gets to our approach which I think is somewhat differentiated from our competition in that. As we've said along, we have a differentiated molecule first off and that is that we have an Fc-silent molecule relative to an Fch-active molecule that the competition has. And I would note that that is demonstrating a difference in terms of the adverse event profile including the data that we've highlighted today. Additionally, I think we've tried to stay focused in areas where we believe that there is the best chance of activity and so for example, we have not initiated any trials with small cell. We look forward to. Capitalizing on the data, we have seen so far both and non-small cell lung cancer and gastric cancer. As you know, we provided an update on the EDGE-gastric study ASCO. And as I noted in the call we have completed enrollment of that of the Phase 3 trial of that. So we've - we continue to be cautiously optimistic about TIGIT and are doing it in a data-driven way based on the data we've generated in our trials so far.
Operator: Our next question comes from Terence Flynn at Morgan Stanley. Go ahead, your line is open.
Terence Flynn : Great. Thanks for taking that question. A two part for me. Just Merdad, wondering if you can help frame expectations for the Purpose 2 trial, just given this is a slightly different population relative to Purpose 1. So just as we think about level setting their ahead of that data. And then, the second part is for Johanna, so obviously, you guys noted that you've seen growth in the PrEP market recently, which is encouraging. But what other steps can you as a company take to maybe help alleviate some of the payer roadblocks that are really still in the way of branded PrEP use given the still high level of generic truvada use? Thank you.
Merdad Parsey: Thanks, Terrence. I'll start and then I'll hand it off the Johanna as you said. It's a great question and a good thing for us to make sure that everyone remembers. Our Purpose 1 was the trial that was in cisgender women and as I noted Purpose 2 is our ongoing study in the cisgender gay men transgender women and men and gender non-binary people. Now that study is ongoing. It is the second trial that's necessary for filing and like Purpose 1, Purpose 2 is designed to evaluate the superiority of lenacapavir against the background HIV rate. That’s the primary endpoint and the secondary endpoint would be similar to Purpose 1 will be superior to truvada as a secondary endpoint. So, once we – if hopefully we’d demonstrate a positive results in Purpose 2, we will combine this data with Purpose 1 and move as quickly as possible to filing those data to lenacapavir for PrEP.
Johanna Mercier: So maybe just to complete the second part of that question around the growth in PrEP and like the opportunities lies ahead despite some of the payer roadblocks that you are referring to just a couple of points on that, one is, today the market for PrEP is growing at about 12% or so year-on-year, so nice consistent growth that we have seen over the last couple of years. Descovy coverage is over 90% of all lives are covered from an access standpoint. So today the daily orals do not have any concerns from an access standpoint. I think maybe what you're referring to is potentially as we think about medical benefits versus the pharmacy benefits that might create a little bit more access headwinds from a payer standpoint and we've seen that already with some of our competitors. As we think about lenacapavir, in light of not only the data, just most recently with Purpose 1, but also just the profile that it offers with a twice yearly sub cu I think it really allows us to redefine the PrEP market as a whole. And as much as we're seeing today maybe over 400,000 users in the US. We really see three major growth opportunities. One is around market size growth, the other one's around market share growth and the third one is on endurance. So if I just break those down a little bit, the market size growth is around reaching more users. So we'll beyond just white MSMS thinking about cisgender women, transgender men and women Latino black individuals, as well as young adults, reaching more prescribers in different settings than we are today and over time reaching more countries, right? Because right now PrEP revenues are really coming primarily out of the United States. From a market share growth standpoint Descovy is the number one branded daily oral today with over 40% share. And we believe lenacapavir will be number one from a long-acting standpoint and between the two together, we believe the Gilead presence in HIV prevention will also be leading and greater than where we are today. And then last but not least, it’s hired adherent and not just has to do with a domestic - the frequency of administration when you think about a twice the early subcu has much adherence than a daily oral and obviously, better outcomes. So all of those pieces together is what we are focused on as an opportunity for the future of prevention and with not only Descovy but obviously with lenacapavir around the corner potentially. And from an access standpoint we are thinking ahead as we think about even the work that CMS is doing when they think about making it our Part B drug, for a medical benefit in PrEP to ensure greater access, but we're also thinking through how is this going to impact from both from a prescriber standpoint and how do we support that reimbursement, challenges that I think others have been facing and how we basically do a very high touch approach here to make sure everyone who needs or wants PrEP gets access to their drug of choice.
Operator: [Operator Instructions] Our next question comes from [Inaudible] Leerink Partners. Go ahead, your line is open.
Daina Graybosch : Hi, thanks for the question. I want to ask on Anito-cel, a two-part. One is just the process fact. So I wonder if you can confirm whether you have completed enrollment in Imagine 1 and that’s what kind of follow-up time we can expect from the data should it be accepted at ASH? And then a deeper question on Imagine 3. I wonder what your approach is in Imagine 3 to bridging therapy so as to avoid the higher risk of death that was observed in the competitor trials soon after enrollment? Thank you. Thanks, Daina, so we've got Cindy Perettie here. We'll turn it up and heard answer that thank you for the question.
Daniel O'Day: Thanks Daina. We sort of got Cindy Perettie here. We’ll turn over to her to answer that. Thanks for your question.
Cindy Perettie: Thanks, Daina, we continue to be really excited about the potential with Anito-cel with a best-in-class profile and our enrollment target for Imagine 1 has been met. I think the second question you asked is what type of follow-up would we expect to see at ASH, and I think we're in the process of we did an initial cut obviously for the abstracts we'll do the second cut for the final sharing of the data. So I don't have the exact follow-up time. But we can certainly look to follow-up with you once we have that. Your second question was around Imagine 3 and bridging therapy. Right now, we will be moving - so we were able to complete the tech transfer as you heard from Dan into our Maryland production facility. So we will be supplying therapy out of our Maryland facility and we expect to apply a lot of the learnings that we have with our existing products on the market today and be able to get Anito-cell back to those patients in Imagine 3 as it relates to having time upfront to do bridging therapy. However, with the protocol design today, we do have the option to do bridging therapy if necessary for patients.
Operator: Our next question comes from Umer Raffat of Evercore. Go ahead, your line is open.
Umer Raffat: Hi guys. Thanks for taking my question. I'm very intrigued about your lenacapavir plus bictegravir trial heading into Phase 3. And I'm just trying to understand could this regimen possibly replace Biktarvy to a meaningful extent? Or would you rather have some sort of a low-dose nuke in that combination as well as a second alternative? I'm just thinking back to some of the [Indiscernible] experience, as well.
Johanna Mercier: So maybe I'll take that one Umer. So the len-bic combination is a single treatment regimen that really combined a best-in-class integrates inhibitor with the first-in-class capsid. The studies that we are doing both Phase2 and 3 are really first, that we looked at the complex regimen which that was kind of the first step and as we go into Phase 3, we believe we can get a broader label indication to also include all of our allergically suppressed. So as we think about that opportunity, we think it's an opportunity for an FTI that's optimized, simplified for complex regimens but also provides optionality in the viral decree to press the switch segment of the marketplace, So as we think about it as a portfolio perspective, we still believe that today Biktarvy is the standard of care and will remain as the standard of care from a daily oral standpoint. But we also see that's an opportunity in the switch segment. So naïve is a big piece probably the biggest piece for Biktarvy’s growth. And the switch because we have such a large share obviously, right? So from a switch segment that offers us another opportunity for us to play bigger market space in HIV.
Operator: Our next question is from Carter Gould at Barclays. Go ahead Carter. Your line is open.
Carter Gould: Great, thank you. Good afternoon. Thanks for taking the question. Maybe another one on Purpose 1. So again, the efficacy was very impressive. However we could see that north of 20% of patients that have nodules out to week 52. And I guess for Johanna, as you think about that profile in this setting recognizing they were only grade one, but sort of the long-term nature of those nodules, how do you see that influencing or impacting the profile, its demand and the potential for those patients then go back and you get retreated after six months? Thank you.
Johanna Mercier : Sure and Carter, just to explain a little bit, the nodules are because it's a drug depot, right? So the nodule actually gets smaller over time. What we've seen is actually very little discontinuation in Purpose 1 due to that. That's number one. Two is the nodules are sometimes palpable not all? But sometimes palpable but not visible and generally speaking. And so we believe that actually we will have some. flexibility as well as to where those injections play out and where because I think, they've been studied in different places not just in the stomach in the site. And so, I think that'll be an opportunity as well for people to be a little bit more flexible as to where they get their injections. So we're not overly concerned there at all. Actually, and really we're taking it from the data that we're getting from Purpose 1 and hopefully, we'll have similar data to learn from Purpose 2.
Operator: Our next question comes from Michael Yee at Jefferies. Mike, go ahead your line is open.
Michael Yee : Thank you, guys. We have one question on long-acting HIV, specifically. The potential for a Q6 month which I think could be a game changer. I think you have one or two of them on your slide and they are advancing. Can you tell me your confidence level on what you have there? Because if you follow HIV development you know that if it's generally safe and of all taller than significant barrel over reduction. You're in a pretty good spot in Phase 1, 2. Thank you. Let me know.
Merdad Parsey: Hi, Michael, it’s Merdad. Thanks, yeah. I think you raise the right question, which is that whenever we're looking at the long-acting, new long-acting agents, we have to be cautious about the transition from preclinical to clinical. We don't - we're not always able to predict the injection site reactions that you might get from the long-actings in particular. We were just talking about the nodules for lenacapavir but other more severe injection site reactions and then the human pharmacokinetics. So, I think we need those to play out to allow us to move forward and that's why you see multiple agents going into Phase 1. We have generated the number of molecules. We move them forward. We've been pretty aggressive in moving them forward in order to maintain our leadership in long-acting HIV treatment and prophylaxis. And so, once we start to see those data in Phase 1, I think that will help us decide both choosing between those molecules and where we want to go forward. Remember we're also moving our bNAb program forward, which will be our - which is our most advanced long-acting program with lenacapavir plus bNAbs and we should - we expect to get Phase 2 data from that that study, as well. So for those early programs, it's the usual risks and that which is why we take multiple shots and hopefully we'll be able to advance one of them quickly.
Operator: Our next question comes from Brian Abrahams at RBC Capital Markets. Brian, go ahead. Your line is open.
Brian Abrahams: Hi, there. Thanks so much for taking my question. You guys have an oral GLP-1 GS 4751 in your preclinical pipeline. Are you planning to move it forward? And as you've continue to diversify that portfolio, how are you guys thinking about the obesity landscape and potentially participating? Or are there other metabolic areas in adjacencies that you may be more interested in pursuing? Thanks.
Merdad Parsey: Thanks, Brian. Yes, we have shared some preclinical data on 4571. As you know, it is an internally developed oral GLP1 agonist which came out of our initial interest in our NASH program. And based on the data so far both preclinical and the toxicity we are planning a Phase 1 study for that molecule and that'll help us evaluate 4571 for weight management, obesity and other metabolic diseases. Once we generate those data, we will decide in a data-driven way, how best to proceed from there. And we'll just have to see how that plays out. We want to make sure if we dealt something as best-in-class and allows for a best-in-class profile. So we will update more as the data are generated.
Operator: Our next question comes from Chris Schott at JPMorgan. Chris, go ahead, your line is open.
Chris Schott : Great. Thanks, so much. My questions or just my other question was just on the US CAR-T franchise. Just want to get your latest view on how we should be thinking about sequential growth from here and maybe as part of that can we just get an update on kind of your community physician engagement with the CAR-T is any leading indicators that you're seeing there that'll help could move the guide some of the efforts or when we could start seeing the impact from some of these efforts in the US? Thank you.
Johanna Mercier: Thanks, Chris. We are really pleased with our strong cell therapy growth this quarter. And this is really part and parcel to our US refresh strategy. So as a reminder we restructured our sales team at the end of last year and we got our new sales team in place and trained and ready to go. And as part of that strategy we also focused for the next couple of quarters on really within the authorized treatment centers making sure those referrals occur between the lymphoma specialist to the CAR-T specialist. And that's what you're seeing as part of the excellent performance that we had this quarter. And we'll continue to deliver and really focus on the referrals within the AGC. We are also in parallel building up that those community practices and spending time educating both the community practices, I'd say regional hospitals and those institutions about the curative potential of CAR-T and why it's important to bring this into the therapy that they're offering to their patients. And we're making really good progress there including a lot of work with national payers. But despite all this, as you heard earlier from both Dan and Johanna, we are facing, it's a dynamic market. We're remaining cautious for the second half of this year as we continue to see some competitive headwinds both in cost competition. So we have new indications that came out in late May, early June time frame which are capturing physician mind share initially and we're also seeing out of cost competition with the bispecifics. But with all of that said, we are focused on execution and working with our physicians and institutions to raise awareness of the curative potential for CAR-T and will continue to do so in the second half of this year. As it relates to community practices, I shared last quarter that it's taking us a little bit longer than we had expected to get them up and fully operating. But we're making great progress as it relates to that and learning a lot along the way. So we're continuing to refine our blueprint as we onboard new centers.
Operator: Our next question comes from Steven Seedhouse at Raymond James. Steve, go ahead. Your line is open.
Steven Seedhouse: Yes, thank you very much. Just given some of the newer tailwinds out of oncology, so lenacapavir obviously which you indicated could redefine the PrEP market and then seladelpar, of course as well. When you just combine that with the updated view of oncology pipeline, are you still expecting the 2030 revenue mix to be about a third of oncology? Or is that more of a moving target? So when you could comment on the long-term outlook. Thank you.
Merdad Parsey: Yeah, thanks Steven for the question. So one-third of sales remains our target with the portfolio that we have today and what we believe is achievable without additional BD. I'll just remind you - keep in mind that the indications in that target are probability adjusted and many of them around 50% So, you'd expect to see puts and takes in that pipeline evolution. We certainly expected that when we when we set that target. So it allows for some programs to fail or fall short of initial expectations and others obviously succeed to support achieving that goal. I would just note that our oncology sales today are already more than a third of the way there. In quarter two 2024, they're about 12% of the total product sales growing nicely. So it's highlighting the progress we're making on this on this overall goal. I think you're right to point out also the progress and as you put at the tailwinds with a virology business and lenacapavir data as well as seladelpar, obviously, as that grows that that puts even more stretch to our ambition. It's a good problem to have. But I think the ambition we have is very much along the lines of diversifying our business as well as solidifying our base in virology and we're firmly committed to that strategy.
Operator: Our next question comes from Tim Anderson at Wolf Research. Tim, go ahead. Your line is open.
Tim Anderson: Thank you. I have a question on the tro toothpaste, so sometime before or around your end will get your phase 3 first line triple negative readout with trodelvy from the ASCENT-03 trial and we'll also be getting Astra's TROPION-Breast02 and the design of those trials are quite similar, which will allow try for the best side-by-side comparisons thus far of your drug versus Astra’s. And I'm sure you thought about this a lot. What's your prediction for how those results will likely stack up against each other? I'm guessing you'll show less ILD as one benefit, but how do you think efficacy and other safety metrics will compare?
Merdad Parsey: Sure, this is Merdad. Maybe, like I think you hit the highlights. We are – trodelvy has demonstrated great efficacy in the triple negative breast cancer space and we remain I think the only approved Trop-2 ADC and that space in triple negative is definitely where trodelvy is doing very well and has become the standard care for most physicians. So, I think that sets us up nicely and ASCENT-03 as we update the status of that trial as the end of the year rolls around I think will be part of the continuation of that story and our expectation for trodelvy’s success in triple negative breast cancer. We have felt that there are areas where our programs aren't differentiated and for Trodelvy as you mentioned our adverse event profile has remained largely predictable and very manageable on the part of physicians we certainly both the ILD you mentioned as well as stomatitis has been very different in their manifestations and mostly for trodelvy it's been neutropenia and diarrhea, which I think clinicians have gotten very comfortable with managing certainly when we speak to our KOLs. So we'll be looking for those data and we'll look for our data and in particular and I think is a continuation of where we think trodelvy can go and really solidify our position in triple negative breast.
Johanna Mercier : Yeah, I would just re-emphasize what Merdad said, I think just the fact we are the ones on the market today and so well established as the number one standard of care and triple negative breast cancer second line. I do think that that is a big differentiator here as we think about some of these data points.
Operator: Our next question comes from Salveen Richter at Goldman Sachs. Salveen, go ahead. Your line is open.
Salveen Richter : Thank you. Good afternoon, everyone. With regard to the long-acting program, could you speak more about potential read through from Purpose 1 to Purpose 2 and whether they're typically any differences in responses to HIV drugs in these different patient populations? And regarding the strategy to expand the PrEP market, could you speak to specific strategies here? And why you haven't been able to reach these patients already? Thank you.
Daniel O'Day: Thanks, Salveen it’s kind of a two-part. So I'll have Merdad start and maybe have Johanna add, as well.
Merdad Parsey: Yeah, Salveen, you're absolutely right that the patient populations are different is why we did the broad Purpose program to really get a diversity of patients early in our program to ensure that we can bring PrEP to a variety of populations early on in our in our development. And the patient populations are different we're talking really cisgender women relative to the Purpose 2 population, which is a different population. And our expectation is that those populations have different levels of awareness, different levels of compliance and there are use of PrEP otherwise for example with the oral PrEP agents. And despite that, I think the strength of the Purpose 1 data and the fact that you have people who are essentially protected for six months with no infections occurring in the cisgender women so far I think give us a lot of confidence that with I would expect some variability in the background infection rate in the population. If we are able to maintain that degree of protection in Purpose 2 we remain really confident that the outcome will be very powerful.
Johanna Mercier: And maybe to pick up on the second part of that, Salveen. So just to take a step back, I think it’s important to understand how much we have moved the needle actually when you think about the penetration in the prevention market. Just a couple of years ago, you were about 25% penetrating when you if you consider it from a CDC standpoint estimate, we're now over a third of that. So we have really grown this market and expanded it. I think one of the challenges has definitely been this is not a typical market that you it's not HIV treatment. It is a market where these are individuals that are not sick. They have no asymptomatic, obviously they have nothing and so therefore it's very challenging when you think about a daily oral pill, which is today over 95% of the total market where you think about current generics or Descovy share. And taking a pill every single day is incredibly challenging. So many use PrEP on demand. And I do think and in that the biggest population that we see are actually wide MSMs so very much a high commercial market here. And we believe that there is a real opportunity to whip something that has the profile of lenacapavir with a twice yearly subcu that we can truly expand the reach of the people, the individuals that could truly benefit from prevention for the future. And so, so that's kind of the steps. So I think it's an ongoing growth that we've been seeing. I think we have to do a step change here as we think about the future of prevention. I think we have to think completely differently about what lenacapavir could offer all of these people and really make a dent in this HIV epidemic.
Operator: Our last question comes from Olivia Brayer at Cantor Fitzgerald. Olivia, go ahead. Your line is open. Our next question comes from James Shin at Deutsche Bank. James, go ahead. Your line is open.
James Shin : Hey guys, thanks for the question. For PrEP, is the move to PARPI a net positive to access and when Len is eventually proved for PrEP. Do you expect the markets remain mostly by and bill? Thank you.
Johanna Mercier: Sure. I’ll take that one. So the move the entity for PrEPs that CMS is working on, I do think it's positive. I think it's really around providing greater access and potentially providing also the services that go with it. So the D2B could actually be a nice move despite the fact that today Medicare is a very small piece of the total prevention market. As we think about lenacapavir, I think it'll be both. I think there's probably opportunities for it to be both a pharmacy benefit as well as a medical benefit and be a buy and bill and I think we just need to think very differently because buy and bill in the current users of prevention this is not something that they're familiar with. And so this is something we're really thinking about today for tomorrow is to setting up that system to make sure they understand how to do this, if they want to do it, but that they have an option if they don't want to do it. And I think that's what we're kind of planning for us as we think about the future of lenacapavir.
Operator: That concludes the time we have for questions. I’ll invite Dan to share any closing remarks.
Daniel O'Day: Thank you, everybody. In closing, we the team here would like to summarize the quarter as follows: we had a very strong quarter of revenue growth and impressive bottom-line growth that highlights the leverage in our model. Secondly, we made progress that should enable us to build on that growth in the future including really remarkable data from the Purpose 1 one trial and from across the HIV portfolio with the promise to extend our HIV leadership well into the late 2030s and beyond; the imminent launch of seladelpar in the US and continued progress in oncology; and all this leaves us well positioned for the second half of 2024 when we will continue to focus on quarter after quarter of strong clinical commercial and financial execution. My thanks to the Gilead teams and to all of you for joining today. I want to hand it over to Jacquie Ross for some final comments.
Jacquie Ross: Thank you, Dan and thank you all for joining us today. One final housekeeping item. I can share that we are tentatively planning to release our third quarter 2024 earnings results on Thursday, November 7th? Please note that this date is provisional and could be changed to accommodate scheduling conflicts that arise between now and then. As always, we will announce our confirmed date following the close of the third quarter. We appreciate your continued interest in Gilead and look forward on updating you on our progress throughout the quarter. |
AMGN | 2 | 2,024 | 2024-08-06 22:18:02 | Operator: My name is Julianne, and I will be your conference facilitator today for Amgen's Second Quarter 2024 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. There will be a question-and-answer session at conclusion of the last speaker’s prepared remarks. In order to ensure that everyone has a chance to participate, we will like to request that you limit yourself to asking one question during the Q&A session. [Operator Instructions] I would now like to introduce Justin Claeys, Vice President of Investor Relations. Mr. Claeys, you may now begin.
Justin Claeys: Thank you, Julianne. Good afternoon, everyone, and welcome to our second quarter 2024 earnings call. Bob Bradway will lead the call and be followed by a broader review of our performance by Murdo Gordon, Vikram Karnani, Jay Bradner and Peter Griffith. Through the course of our discussion today, we will use non-GAAP financial measures to describe our performance and have provided appropriate reconciliations within the materials that accompany this call. We will also make some forward-looking statements, which are qualified by our safe harbor statement. And please note that actual results can vary materially. Over to you, Bob.
Bob Bradway: Okay. Well, thank you, Justin, and let me thank all of you for joining the call today. We're especially grateful in light of all of the volatility in the markets that you would carve out the time to be with us. So thank you. Through the first half of the year, our business is performing well, and we remain confident in our ability to deliver attractive long-term growth. We're achieving strong results the same way we always have, which is by providing innovative medicines to address challenging diseases. Starting with the in-market portfolio. Second quarter revenues grew 20% to $8.4 billion with numerous medicines delivering double-digit sales growth, including in general medicine, Repatha and EVENITY, in oncology, of course, BLINCYTO, an inflammation TEZSPIRE, and then turning to rare disease, which delivered more than $1 billion on the quarter. I would highlight that KRYSTEXXA, UPLIZNA and TAVNEOS, each delivered at least double-digit sales growth in the quarter, and TEPEZZA grew 8% year-over-year and 13% quarter-over-quarter. All of these first or best-in-class medicines are still early in their life cycles and have plenty of room to run through geographic expansion, new indications and/or new formulations. You'll hear more about these brands in a moment. Turning to research and development. We believe our pipeline looks very promising as well, not just in obesity, but across all of our therapeutic areas. We told you at the beginning of the year that we were anticipating more than a dozen significant pipeline milestones in 2024. We are, so far, so good. In the second quarter alone, we received accelerated approval for IMDELLTRA, a landmark new medicine for small cell lung cancer. And in fact, the physicians I've spoken to since approval are really excited about this drug as the first meaningful innovation in decades for these patients. We also received approval for BLINCYTO in the frontline treatment for B-cell precursor acute lymphoblastic leukemia, based on significantly improved overall survival rates. The frontline approval meaningfully expands the potential impact of BLINCYTO for all patients with B-ALL. We announced impressive Phase III data for UPLIZNA in IgG4-related disease, which is a grievous illness for which there are no currently approved therapies of any kind. Building on our success with TEZSPIRE in treating severe asthma, we announced exciting data from our Phase II study in patients with chronic obstructive pulmonary disease that earned this molecule breakthrough therapy designation. COPD is the world's third leading cause of death, and new treatment options are very much needed. We look forward to additional data readouts later this year across therapeutic areas, highlighted, of course, by top line data from the ongoing MariTide Phase II study. We're encouraged by the emerging data in this field, particularly in cardiovascular and renal disease areas of long-standing strategic focus for us. We are laser focused on preparing to launch a broad Phase III program for MariTide that includes obesity, obesity-related conditions and type 2 diabetes, and we're further ramping our investment to support MariTide in the rest of the pipeline. You'll hear more about that pipeline shortly on this call. All in all, this is a very exciting time for us at Amgen. And as always, I'm grateful to my Amgen colleagues all around the world for their enduring commitment to patients. And now let me turn things over to Murdo.
Murdo Gordon: Thanks, Bob. Execution was strong in the second quarter, driving 20% year-over-year sales growth and all of our regions delivered attractive growth. Sales of 12 products grew at least double digits, including Repatha, TEZSPIRE, EVENITY, TAVNEOS and BLINCYTO, all brands that are important to our future growth. Starting with our General Medicine portfolio. Sales of Repatha, EVENITY and Prolia collectively grew 20% year-over-year in the second quarter, driven by volume growth. Repatha sales increased 25% year-over-year to $532 million for the second quarter, now well on its way to becoming a multibillion-dollar business. In the quarter, we saw year-over-year volume growth of 46%, partially offset by lower net selling price. In the U.S., we see increased recognition of the importance of lowering LDL cholesterol by health care providers, payers and patients, which has significantly accelerated volume growth for Repatha. Our efforts have broadened insurance coverage and removed prior authorization requirements by several payers. In a recent survey, roughly 95% of cardiologists responded that Repatha is accessible and that access has improved significantly versus two years ago. EVENITY sales increased 39% year-over-year to $391 million for the second quarter. In the U.S., volume growth was supported by both increased prescription volume from existing EVENITY prescribers and an expansion of new prescribers. In Japan, EVENITY has been prescribed to approximately 600,000 patients to date and continues to be the segment leader with 45% of the bone builder segment. There are many women who remain at risk of a fracture due to postmenopausal osteoporosis. We're encouraged by the growth momentum we are driving and have conviction in the potential for EVENITY to help even more patients. Prolia sales increased 13% year-over-year to $1.2 billion for the second quarter. Volume growth continues to be supported by real-world evidence demonstrating Prolia superiority in reducing fracture risk when compared to alendronate in treatment-naive patients with postmenopausal osteoporosis at high risk of fracture. In inflammation, TEZSPIRE continues its strong trajectory with $234 million sales in the second quarter. Sales increased 76% year-over-year, primarily driven by uptake of the prefilled single-use pen. We see strong growth opportunity for TEZSPIRE given its unique differentiated profile and its broad potential to treat the 2.5 million patients worldwide with severe uncontrolled asthma. Otezla sales decreased 9% year-over-year for the second quarter with 2% volume growth offset by lower net selling price and unfavorable changes to estimated sales deductions. In the U.S., we saw a 3% year-over-year growth in new patient prescriptions in the quarter, driven by strong execution by our dermatology sales force and increased Otezla direct-to-consumer media activity. We've seen an increasingly competitive environment in dermatology with the introduction of novel topicals and new biologic treatments. Otezla retains an important role in this landscape given its broad label, safety profile and unique positioning as a first systemic treatment option for patients with cirrhosis. Enbrel sales decreased 15% year-over-year for the second quarter, primarily driven by lower net selling price. Going forward, we expect continued declining net selling price and relatively flat volumes. Enbrel is known for its efficacy and trusted by physicians. Its substantial health benefits and cash flow generation provide a solid foundation for our business. Turning now to biosimilars, where sales of our biosimilar products were relatively stable year-over-year for the second quarter. We're positioned for future growth with upcoming launches, WEZLANA, a biosimilar to Stelara and BEKEMV, a biosimilar to Soliris, are both expected to launch in the U.S. in Q1 of 2025. Our vertically integrated biosimilar business model ensures efficiency and provides attractive cash flows and returns for our shareholders. In oncology, sales of our seven innovative products, BLINCYTO, LUMAKRAS, Vectibix, KYPROLIS, Nplate, XGEVA and IMDELLTRA grew 12% year-over-year for the second quarter, driven by volume growth and higher net selling prices. In total, these products contributed almost $2 billion of sales in the second quarter. BLINCYTO sales grew 28% year-over-year to $264 million for the second quarter, driven by broad prescribing across academic and community segments for patients with B-cell ALL. BLINCYTO was recently granted approval by the U.S. Food and Drug Administration as a frontline consolidation treatment for patients with Philadelphia chromosome-negative B-cell ALL. Our commercial and medical teams are engaging key academic, regional and community customers in establishing BLINCYTO as a standard of care in this setting. LUMAKRAS sales increased 10% year-over-year to $85 million for the second quarter. We see future growth opportunities for LUMAKRAS coming from launches in new markets and additional indications. Back to back sales increased 9% year-over-year to $270 million for the second quarter, now annualizing at over $1 billion. We also drove strong performance of KYPROLIS, which grew 9% year-over-year and Nplate, which grew 12% year-over-year. Since our U.S. launch of IMDELLTRA in mid-May, we generated $12 million of sales in the second quarter. IMDELLTRA was recently approved for the treatment of adult patients with extensive stage small cell lung cancer with disease progression on or after platinum-based chemotherapy. We're seeing strong clinical conviction in IMDELLTRA in both academic and community settings, and while very early in the launch, we're encouraged by the adoption of IMDELLTRA and look forward to its potential to bring new possibilities to patients living with this aggressive disease. I'm pleased with our execution in the quarter, driving accelerated performance for our most important growth brands. And with that, I'll turn it over to Vikram, who will cover our rare disease portfolio.
Vikram Karnani: Thank you, Murdo. I am pleased to provide an update on rare disease, which delivered product sales of over $1.1 billion in Q2. Beginning with TEPEZZA for the treatment of thyroid-eye disease, second quarter sales were $479 million, reflecting growth of 8% year-over-year and 13% quarter-over-quarter, when compared to results from the legacy Horizon business. Recall that there are roughly 100,000 TED patients in the U.S., and penetration is currently only in the single digits. The main growth opportunity is within the roughly 80% of TED patients who have a low clinical activity score or CAS. We are expanding our reach among new prescribers, particularly ophthalmologists and endocrinologists who manage many of the low cash patients who can benefit from TEPEZZA. The impact of thyroid-eye disease on quality of life is often underestimated. So our focus is on educating health care providers about the significant effects on patients, even those with less visible symptoms. In addition, we are increasing our strategic focus in endocrinology with a dedicated sales force to engage in this important space. We are also making significant strides in improving access. Thanks to the recognition of TEPEZZA's efficacy by payers. To date, we have achieved favorable medical policy changes for greater than 55% of U.S. covered lives, compared to 50% last quarter and just 5% roughly one year ago. We expect to continue this momentum throughout 2024. International expansion remains a meaningful long-term growth opportunity for TEPEZZA with regulatory filings complete or underway in multiple geographies. With Japan as the next significant launch expected by early 2025. We also initiated a Phase III subcutaneous study and see this as an opportunity to increase adoption and improve the patient experience with an alternative option to our current IV formulation. KRYSTEXXA for patients with chronic refractory gout, delivered $294 million in sales in Q2, representing 20% year-over-year growth driven by volume growth from strong commercial execution. KRYSTEXXA with immunomodulation continues to redefine the standard of care for uncontrolled gout. UPLIZNA, for patients with neuromyelitis optica spectrum disorder, or NMOSD, delivered $92 million in sales in Q2, representing 35% year-over-year growth. International expansion of UPLIZNA is also underway with launches in multiple ex U.S. markets, including Canada, which launched earlier this year. In addition to NMOSD, we are excited about the impressive Phase III results with UPLIZNA in IgG4-related disease. And the potential it has to address a debilitating condition that impacts more than 20,000 patients in the U.S. We also look forward to the Phase III readout for UPLIZNA in myasthenia gravis later this year. Jay will address these in more detail in a moment. Sales of TAVNEOS were $71 million for the second quarter. Sales increased 137% year-over-year driven by volume growth. In the U.S., more than 3,500 patients with ANCA-associated vasculitis have been treated with TAVNEOS. Over 2,300 health care professionals have now prescribed TAVNEOS, a roughly 35% increase in the prescriber base so far this year. The integration of the legacy Horizon business is progressing nicely as we leverage Amgen's leadership in inflammation, world-class manufacturing and process development and extensive global footprint. Now I will pass it over to Jay for our R&D update.
Jay Bradner: Thank you, Vikram, and good afternoon, everyone. In the second quarter, we rapidly advanced our broad clinical pipeline of potentially first-in-class or best-in-class programs. We received two approvals in the quarter, a breakthrough therapy designation and delivered exciting clinical data for many programs, while eagerly awaiting additional data readouts later this year. Let's begin with general medicine. As previously mentioned, based on the interim analysis, we are seeing a differentiated profile with MariTide and are confident it will address important unmet medical needs in obesity, obesity-related conditions and type 2 diabetes. We remain on track and look forward to top line 52-week data from the ongoing MariTide Phase II study in late 2024. We are actively planning and expect to initiate a broad Phase III program in obesity, obesity-related conditions and diabetes, along with a Phase II trial investigating MariTide for the treatment of diabetes in patients with and without obesity. Beyond MariTide, we continue to progress our early obesity programs that consists of both oral and injectable incretin and non-incretin approaches. We expect one of these programs to enter clinical development later this year. Also in Gen med is olpasiran, our potentially best-in-class Lp(a) targeting small interfering RNA medicine, the fully enrolled Phase III cardiovascular outcomes trial of olpasiran continues to progress. To remind, Lp(a) is a genetically defined cardiovascular risk factor that is elevated in approximately 20% of individuals and for whom no effective or targeted therapies currently exist. In oncology, we continue to deliver on high conviction targets with differentiated therapies capable of delivering transformative clinical benefit for patients. Let's begin with IMDELLTRA, a first-in-class bispecific T-cell engager or BiTE molecule targeting DLL3 for small cell lung cancer. We're very pleased that the FDA granted accelerated approval to IMDELLTRA for the treatment of adult patients with extensive stage small cell lung cancer with disease progression on or after platinum-based chemotherapy. Further, we are pleased that the NCCN guidelines have been updated to include IMDELLTRA as a preferred option for patients with a chemotherapy-free interval less than or equal to six months and as an other recommended treatment option for patients with a chemotherapy-free interval greater than sixmonths. Based on the remarkable activity observed as a single agent in patients receiving second and third-line therapy, we are rapidly advancing IMDELLTRA into frontline therapy with three Phase III studies underway in both extensive and limited stage disease. One of these studies, DeLLphi-304, our confirmatory Phase III study in second-line small cell lung cancer has completed enrollment. Notably, IMDELLTRA is the first bispecific T-cell engager approved to treat a common solid tumor. The present study of tarlatamab in earlier lines and in the context of lower tumor burden, draws from our experience with our first approved bispecific T-cell engager BLINCYTO and B-cell acute lymphoblastic leukemia. Here, we observed a dramatic improvement in overall survival in minimal residual disease negative patients, along with improved tolerability. These BLINCYTO data provide evidence that directing the T cell in this manner is an effective means of finding and eliminating residual cancer cells that are drivers of occurrence. This June, based on the profound survival benefit observed in the treatment of frontline disease, the FDA approved an additional indication for BLINCYTO for the treatment of adult and pediatric patients one month or older with CD19 positive, Philadelphia chromosome negative, B-cell ALL and the consolidation phase of treatment, here regardless of minimal residual disease status. We continue to seek to expand the impact of BLINCYTO in newly diagnosed B-ALL through ongoing studies and with the further investigation of subcutaneous administration. Our first-in-class STEAP1 CD3 bispecific molecule, xaluritamig, has also demonstrated profound clinical activity in metastatic castrate-resistant prostate cancer, importantly, demonstrating our ability to target a second common solid tumor with a bispecific T-cell engager therapy. We are rapidly advancing this program and have now fully enrolled the monotherapy Phase I dose expansion as we continue to enroll patients in reduced monitoring and outpatient cohorts. Further, we are advancing the study of xaluritamig earlier in the prostate cancer treatment paradigm with combinations of xaluritamig and enzalutamide or abiraterone ongoing while we plan additional studies in earlier disease settings. In sum, with regard IMDELLTRA, BLINCYTO, xaluritamig as major advances, further establishing the broad potential of our leading bispecific T cell engager platform. To round out oncology, we have completed enrollment of FORTITUDE-101, a Phase III study of bemarituzumab, a first-in-class fibroblast growth factor receptor IIb directed monoclonal antibody administered in combination with chemotherapy in frontline gastric cancer. We are also rapidly advancing AMG 193, our oral PRMT5 inhibitor developed for MTAP-null solid tumors as both a monotherapy and in combination with other therapies. Additional data from the Phase I dose escalation and initial dose expansion study of AMG 193 in patients with MTAP-null solid tumors will be presented at ESMO in September. Lastly, we are pleased also to share that the FDA has granted an orphan drug designation to AMG 193 for the treatment of pancreatic cancer. Turning to inflammation. We are encouraged by the data arising from our Phase II study of TEZSPIRE in patients with moderate to very severe COPD. Together with AstraZeneca, we are actively planning for Phase III development in COPD. We are also pleased to announce that the FDA recently granted TEZSPIRE, a Breakthrough Therapy Designation as an add-on maintenance treatment of patients with moderate to very severe COPD, characterized by the eosinophilic phenotype. Beyond COPD, we continue to explore TEZSPIRE in separate Phase III studies in eosinophilic esophagitis and in chronic rhinosinusitis with nasal polyps, where top line data are expected later this year. Turning to rocatinlimab, a first-in-class T cell rebalancing monoclonal antibody targeting the OX40 receptor. The comprehensive rocatinlimab Phase III ROCKET program has successfully enrolled over 3,100 patients with moderate to severe atopic dermatitis. Five of the eight studies are now fully enrolled. The Phase III HORIZON study, part of this ROCKET program evaluates rocatinlimab monotherapy versus placebo in adults with moderate to severe atopic dermatitis. And it is ongoing with data readout anticipated in H2. Beyond atopic dermatitis, we continue to explore the potential of rocatinlimab in additional indications and have initiated a Phase II study in moderate to severe asthma as well as a Phase III study in prurigo nodularis. Shifting to rare disease, we are encouraged by the advancements of our rare disease pipeline with several mid- to late-stage opportunities. UPLIZNA, a CD19 B-cell depleting therapy offers a differentiated mechanism of action than other autoimmune therapies, durable efficacy with a convenient every six-month IV dosing schedule. This could be very important for chronic inflammatory diseases. Recently, we were excited to announce positive top line results from a Phase III clinical trial evaluating the efficacy and safety of UPLIZNA for the treatment of immunoglobulin G4-related disease. The trial met its primary endpoint, showing an astonishing 87% reduction in the risk of IgG4-related disease flare, as compared to placebo during the 52-week placebo-controlled window. All key secondary endpoints were also met and no new safety signals were identified. This is the first randomized controlled trial to demonstrate efficacy in the IgG4-related disease patient population. Regulatory filing activities are underway and full data from the trial will be presented at a future medical meeting. We are also studying a UPLIZNA in generalized myasthenia gravis through the ongoing Phase III MINT study. The MINT study is evaluating the efficacy and safety of UPLIZNA in patients with generalized myasthenia gravis, who are of a comparable disease severity and a comparable treatment experience to other recently approved biologic therapies. We are investigating UPLIZNA in the two predominant antibody serotypes that drive this disease, acetylcholine receptor positive and in muscle specific tyrosine kinase positive patients. MINT is the only trial attempting to demonstrate efficacy while removing the treatment benefit of steroids. Patients in the MINT trial who entered on steroids had a protocol specified taper by 24 weeks. We look forward to data readout in the second half of 2024. To expand the impact of our CD19 directed therapeutics to even more patients suffering from serious inflammatory diseases, compelled by both biological inferences and insights from small studies of CD19-directed therapies, we are launching a development program targeting CD19 positive B cell-mediated autoimmune disease with UPLIZNA and blinatumomab. This is an exciting and promising space with Amgen's strong capabilities in inflammatory disease and two well-characterized assets, we are very well positioned to lead in this rapidly advancing field. We will have more to say about these programs in due course. Lastly, in May, the FDA approved BEKEMV as the first interchangeable biosimilar to Soliris or eculizumab. Also in biosimilar development, registration-enabling studies are underway for ABP 234 and a biosimilar candidate to KEYTRUDA and ABP 206, a biosimilar candidate to OPDIVO. In closing, I'd like to thank my Amgen colleagues for their strong sense of service to patients facing serious illness, their intense focus and spirited collaboration during this momentous year and their commitment to growing the impact of both our research and our business through this portfolio of potential first-in-class and best-in-class medicines. I'll now turn it over to Peter.
Peter Griffith: Thank you, Jay. We're pleased with our strong second quarter performance and are on track with our 2024 full year goals and long-term objectives. We have a strong long-term growth outlook across our four therapeutic areas, driven by the breadth and depth of our innovative pipeline and in-market products, serving patients with serious illnesses around the globe. Starting with our second quarter results, as shown on Slide 27 of the slide deck, we delivered $8.4 billion in total revenue, a 20% increase year-over-year. It's the highest quarterly revenue in Amgen history, achieved with 26% volume growth. This means more patients than ever are receiving Amgen medicines. Excluding the addition of Horizon, product sales increased 5% year-over-year, driven by 10% volume growth. In the second quarter, we delivered a non-GAAP operating margin of 48.2% as a percentage of product sales with total non-GAAP operating expenses increasing 30% year-over-year. Non-GAAP cost of sales as a percent of product sales increased 0.4 percentage points on a year-over-year basis, primarily driven by higher royalties and profit share due to changes in sales mix. Non-GAAP R&D spending in the second quarter increased 30% year-over-year as we strategically invested in the late-stage pipeline, including MariTide, rocatinlimab and bemarituzumab as well as Horizon acquired programs. Non-GAAP SG&A expenses increased 36% year-over-year, primarily driven by the addition of Horizon. Excluding the addition of Horizon, non-GAAP SG&A expenses increased 14% year-over-year, driven by investment in Repatha, Otezla and EVENITY. Our non-GAAP OI&E resulted in a $700 million expense, up $400 million year-over-year, almost entirely due to increased interest expenses from the Horizon acquisition. We remain on track to deleverage with line of sight to retiring greater than $10 billion of debt by the end of 2025. This includes $1.4 billion of debt retired in the second quarter and $2.0 billion year-to-date. Our non-GAAP tax rate decreased 1.5 percentage points year-over-year to 14.9%, primarily due to the change in sales mix from the inclusion of our Horizon. In the second quarter of 2024, the Company generated $2.2 billion of free cash flow, a decrease of $3.8 billion -- a decrease from $3.8 billion in the previous year, driven by the timing of tax payments. In 2023, federal tax payments, including our repatriation tax were made in the fourth quarter, whereas in 2024, these payments were made in the second quarter. The Horizon integration is progressing well, and we expect to reach $500 million in pretax synergies by year three post acquisition, with roughly 50% to be realized by the end of this year. We expect accretion to non-GAAP earnings per share in 2024. We continue to execute on our capital allocation priorities. We're investing in the best innovation, both internally and externally to rapidly advance an innovative pipeline, multiple potentially first-in-class and/or best-in-class medicines across the four therapeutic areas. As I said earlier, this is reflected in our second quarter non-GAAP R&D spend of $1.4 billion, an increase of 30% year-over-year. Second, we continue investing in our business for long-term growth. We are expanding capacity in our state-of-the-art manufacturing facilities, including investments to support MariTide. Beyond manufacturing, we are opening a new global technology and innovation center in Hyderabad, India, which will attract talent at scale and accelerate digital capabilities across the organization, including artificial intelligence, data science, life science and medical. And third, we returned capital to shareholders as we paid competitive dividends of $2.25 per share in the second quarter. This represented a 6% increase compared to 2023. Turning to the outlook for the business for 2024 on Slide 29. We expect our 2024 total revenues in the range of $32.8 billion to $33.8 billion in non-GAAP earnings per share between $19.10 and $20.10. I will mention a few considerations as you model the remainder of 2024. On revenues, we expect mid-single-digit growth quarter-over-quarter in the fourth quarter compared to Q3. Our full year non-GAAP R&D expenses are now expected to increase more than 25% year-over-year as we further invest in our late-stage pipeline to support multiple late-stage studies underway across all therapeutic areas. As a result, we now project the full year non-GAAP operating margin as a percentage of product sales to be roughly 47% with Q3 operating margin lower than Q2. Total non-GAAP operating expenses for the third quarter are expected to grow at a similar rate to the first two quarters of this year. We expect OI&E to be approximately $2.5 billion, which includes the interest expense related to the $28 billion of debt raised for the Horizon acquisition. We continue to expect the non-GAAP tax rate to be in the 15% to 16% range, including the full year benefits associated with the inclusion of the Horizon business. As we have previously indicated, we have initiated activities to further expand MariTide manufacturing capacity. To support these initial efforts, we now expect capital expenditures of $1.3 billion in 2024 versus our most recent guidance of $1.1 billion to $1.2 billion. Our long-term outlook remains robust, and I am grateful to our 27,000-plus colleagues worldwide for their dedication to serve patients. This concludes our financial update. We will now begin our Q&A session. Julianne, please remind our participants of the process. Thank you.
Operator: [Operator Instructions] our first question comes from Yaron Werber from TD Cowen.
Yaron Werber: Jay, maybe a question for you, actually. I want to start with the UPLIZNA. And we noticed a few things. The MINT study was supposed to have complete -- completion around mid-May. And Amgen just posted a whole bunch of new job postings for GMJ and you have a slot on October 15 at the MGFA to present the data. As you noted, you're doing steroid tapering. It's a different trial design but you also did steroid tapering and the other two indications, NMO and IgG4. Can you talk a little bit sort of what are you hoping to see and what are you expecting to see from the data?
Jay Bradner: Thank you, Yaron, for the question, and for following the program so closely. we're Very excited about UPLIZNA, the CD19 B-cell depleting monoclonal antibody is showing really remarkable activity, the results in IgG4-related disease is a bellwether and is quite dramatic with a hazard ratio of 0.13, a P value of what, five to the minus seven. This was a stunning result and the first positive Phase III for patients with IgG4-related diseases. As you nicely picked up in your question, one of the opportunities of UPLIZNA is to get patients off steroids, and this is, therefore, a predefined ambition of UPLIZNA in both IgG4-related disease setting in that study as well, as in the generalized myasthenia gravis setting. Now these results won't be available until the second half of this year. And so I have no further update on that timing. But do stay tuned. We're so hopeful that this once every six months CD19 B-cell depleting therapy can differentiate substantially from available treatments like steroids and other B-cell targeting therapies and make a big difference for these patients.
Operator: Our next question comes from Salveen Richter from Goldman Sachs.
Salveen Richter: Just following up here on Yaron, could you speak to the clinical bar for UPLIZNA and myasthenia gravis, both on a placebo-adjusted basis and also on an absolute basis, given the notable steroid taper, which I believe the other therapies did not have included in their design. And with regard to this MGFA scientific session meeting, should we expect top line results before that presentation?
Jay Bradner: Thanks, Salveen. As I just mentioned to Yaron, we won't be providing further guidance on the timing of the results from the UPLIZNA study, the MINT study in myasthenia gravis of that you stay tuned. And as also, as shared knowing that patients with myasthenia gravis are repeatedly and over many, many months of treatment challenge by the requirement for persistent steroids, we built in a taper steroids on to this study. And these results to read out in the second half of this year will bring to light exactly how successful we are at liberating patients from steroids with every six months UPLIZNA.
Operator: Our next question comes from Evan Seigerman from BMO Capital Markets.
Evan Seigerman: Well, not a huge growth driver. I'd love if you could characterize on some of your negotiations with CMS on Enbrel. Many of your peers are pleased with kind of the fair price that they negotiated with CMS. Do you feel the same way? I'd also love to know how you're seeing about the impact of Part D redesign?
Murdo Gordon: Thanks, Evan, for the question. It's Murdo here. Overall, Enbrel continues to do well in the market despite a very competitive market in psoriatic arthritis and in rheumatoid arthritis. We also continue to have relatively stable volume despite all of the conversion that's going on in adalimumab with biosimilars. So we're quite pleased with prescribers adoption and continued value of Enbrel safety and tolerability, which is well established over a long period of time now in many, many years of experience. The process with CMS has concluded. We do have our price. I would just remind you that roughly 25% of Enbrel revenues come from Medicare Part D. So that will, in part, mitigate the impact of the CMS price reduction. And we continue to see that this is not a good mechanism to incentivize and reward innovation and it does not resemble one we've commonly described as a negotiation. So we've concluded that process. And we continue to look to help patients and support them with Enbrel in the market and we will watch the Part D redesign closely. We will look to see how PBMs redesign their formularies, and we will look to see how patients are impacted by the new model. While the cap may help, the out-of-pocket for many patients may actually rise. So we're watching it closely.
Operator: Our next question comes from Mike Yee from Jefferies.
Mike Yee: Pivoting to obesity. I know that you are on track for data later this year for the injectable product, which you claim as differentiated as other competitors have moved quickly both with their programs with injectables but also oral multiple companies are putting off. Can you just comment about how you feel about your positioning in this space, given others have multiple products moving to late stage and how you feel you can position yourself here, given just 133.
Jay Bradner: Thanks, Mike. Why don't I get started and Murdo, perhaps you could add on at the end. We are very pleased with the results that we've seen at the interim with the overall conduct of the Phase II study. Though there's been no further analysis since the interim, as of the interim all the arms were active, dropout had not been an issue. And we saw a differentiated profile with MariTide and remain confident that this medicine can address significant important unmet medical need in obesity, obesity-related conditions and, in particular, type 2 diabetes, as shared earlier in the call. There's no question that there is quite a democratized and broad base of innovation in this space. And potentially oral medicines could serve to address some of that still vast and remaining unmet need, and we follow these programs very closely. Still, the development of MariTide is advancing very briskly, as we now move to rapidly initiate a broad Phase III program. And we remain confident in what MariTide can offer for patients with obesity-related conditions as well as diabetes. Murdo?
Murdo Gordon: Yes. Thanks, Jay. I think the data continue to emerge in the obesity and obesity-related conditions landscape, and show a clear benefit that reducing weight will indeed -- with GLP-1-based mechanisms will indeed improve outcomes in many disease settings. So that continues to expand the market and grow it. I do agree with Jay that there will be patients who may seek oral options but I continue to believe that we have a very good, differentiated product here and that monthly dosing or even less frequently will continue to help patients persist on their weight loss medication and achieve, hopefully, some of those hard endpoint risk reductions that we're seeing in clinical trial presentations. I would say that we would report that we have a really good convenient dosing here with a single-use pen that we're working on. And that weekly injectable products are probably more vulnerable to orals than a convenient monthly dosing.
Operator: Our next question comes from Umer Raffat from Evercore ISI.
Umer Raffat: I wanted to focus on MariTide, if I may. A two-part question. First, it looks like your competitors are moving forward to Phase III on either smaller data sets or lesser further along from a Phase II, Phase III perspective. Just curious why you thought you definitely needed 52-week data? Was that mostly conservatism? Or is that some FDA feedback as well? And then also on CapEx, I feel like the $150 million guidance increase seems relatively trivial but it does imply CapEx being up 80% over first half. Could you please expand on whether it's API related or something else you have in mind?
Jay Bradner: Yes. Thanks. Pete, why don't I start on the overall development plan for MariTide and the value of the Phase II data that we'll have at the end of this year. Umer, as you know, this medicine coming out of Phase I showed a quite remarkable impact on obesity with a dramatic reduction in BMI, actually proved quite durable after just three doses, MariTide in that Phase I study, we saw persistent weight loss really out 150 days or more at some doses. The Phase II study is a much larger concern. This is a 592 patient study. It has 11 arms, it has monthly or as Murdo said, even less frequent dosing. As a part two that allows us to really follow up on this durability signal, and it will allow the precision selection of dose or doses that patients and their practitioners really desire. This also confirms to regulatory requirements entering into Phase III.
Peter Griffith: Umer, it's Peter on CapEx, as we previously indicated, we have initiated activities to further expand MariTide manufacturing capacity. So of course, those efforts, I said we now expect CapEx of $1.3 billion in '24 versus the most recent guidance, which was $1.1 billion to $1.2 billion.
Operator: Our next question comes from Jay Olson from Oppenheimer.
Jay Olson: Congrats on all the progress, especially in your BiTE platform. Can you talk about any feedback you're getting from clinicians on the IMDELLTRA launch and potential lessons learned from BLINCYTO that you can leverage for IMDELLTRA, especially since you're launching BLINCYTO now in B-ALL and developing a subcu formulation?
Bob Bradway: Take it in a couple of parts here. Murdo, do you want to share what we're learning from the launch?
Murdo Gordon: Yes. Thanks for the question, Jay. Obviously, it's very early given that this was a mid-May approval but I have to say we are extremely pleased with how both thought leaders and community oncologists are receiving IMDELLTRA in the market. Their clinical conviction is very high. They are moving quickly to establish care pathways for these patients given the monitoring requirement for IMDELLTRA. And this is -- this disease setting, as you know, is a really difficult disease setting. Patients can progress relatively rapidly after platinum-based chemotherapy in the front line. And so we're obviously moving very quickly with our medical teams, our account management teams and our sales organization to build rapid awareness and to help both academic and community oncology accounts, be able to treat patients easily and safely and have the appropriate settings for care follow-up. So very early, but this product is seen as a major transformation in this disease setting. Jay?
Jay Bradner: Yes. Thanks for the question, Jay. You picked up on something really interesting and that's leveraging the learnings of BLINCYTO. I mean this really is a platform capability that we enjoy with bispecific T-cell engagers. And already in the development of IMDELLTRA after its first approval, we are seeing significant readthrough of the BLINCYTO lessons, moving from later lines of therapy to earlier lines of therapy, to drive efficacy in the setting of reduced tumor burden. The utility of these medicines in combination, which is so much easier to access and assess than other complex modalities, say, like CAR-T and moving these medicines to the point of therapy where they can have the greatest impact, namely frontline, also pathways to reduce monitoring. Jay, we are leveraging all the learnings of BLINCYTO to drive and expedite the development of IMDELLTRA to be a component of frontline small cell lung cancer therapy, both with extensive stage and limited stage disease. And as Murdo shared, we do this work really quite inspired by the impact of the medicine, even so early in its launch, significant demand to learn and access and offer this medicine.
Bob Bradway: And Jay, I'd just add that when it comes to xaluritamig, I think you're question applies well there, too. So stay tuned. We'll talk more about xaluritamig's data emerge but we're optimistic about how we can apply the lessons of BLIN and IMDELLTRA to that as well.
Operator: Our next question comes from Mohit Bansal from Wells Fargo.
Mohit Bansal: I have a question for Jay. Again, on MariTide. Is there any reason to think that MariTide may or may not exhibit a different profile versus [indiscernible] on parameters such as lipid blood pressure or C-reactive protein? And how important is benefit on those parameters while you design your Phase III trial, something like outcomes trial or not?
Jay Bradner: Yes. Thank you, Mohit. I can surely understand the interest. And indeed, we are making all these measurements and more. We won't dimensionalize what we mean when we say differentiated profile at this time. We're so focused on completing this ongoing and well-conducted MariTide Phase II study but do expect to learn and listen more when ultimately we're able to be in a position to share the outcomes of Part A of the Phase II study. We are taking a comprehensive assessment to optimize dose and schedule and impact of this medicine.
Operator: Our next question comes from Gregory Renza from RBC Capital Markets.
Gregory Renza: Congratulations on the quarter. My question is just on the obesity franchise. As you and the team had mentioned to expect one of the early obesity programs to enter clinical development later this year. Just curious if you could elaborate on what lens you're using to nominate that first or that next program? I'd imagine it's rather complex in the assessment and any color you have on determining that choice and how to take that forward, would be great.
Jay Bradner: Gregory. Thank you. This is Jay, and thanks for following the early pipeline in its development. It's developing very nicely. As we've shared our strategy in the development of obesity medicines and medicines for obesity-related conditions. We're interested in really harvesting the insights of the incretin pathway but also moving beyond this pathway to other novel targets, some supported by genetic inferences but all of them supported by strong preclinical development packages. And so it is a multifactorial assessment that leads to the decision to resource the medicine in human clinical investigation. But it's a high degree of conviction that's required as the bars are ever rising within our portfolio for that resource as well as in the field. So more to follow on the mechanism and characteristics of this new medicine that we're intending to advance in the clinical investigation in the second half of this year.
Operator: Our next question comes from Chris Raymond from Piper Sandler.
Chris Raymond: And if I may, another obesity question. Just on MariTide, and I've heard you guys now talk for a long time about planning for a broad Phase III program. But I don't think you guys have ever talked even in generalities, when exactly this will happen. Can you maybe give a range here for when you anticipate kicking off enrollment in that program?
Bob Bradway: Chris, as you can expect, we're focused now on completing the Phase II trial and moving as swiftly as appropriate into Phase III. So we'll have more to say that over the course of the coming year. You can appreciate it's a competitively intense field. So we're not giving dates at this point.
Operator: Our next question comes from Carter Gould from Barclays.
Carter Gould: For Peter, on August 2, the U.S. Tax Court entered a decision against Coke. Their litigation was often referenced as sort of the best benchmark for sort of what you're facing. Appreciating that you took the deposit earlier this year but why shouldn't there be read through from that case? And maybe you could speak to your overall confidence in the outcome.
Peter Griffith: No. Thank you very much for the question, Carter. Nothing has changed in our evaluation of the case. Court dates set for November 4. We're confident in our position, right, where we've always been. We're confident in our reserves are at an appropriate level. And -- what I would say is, first of all, I don't see -- and Coke hasn't been as much a reference and I won't get into making comparisons. We refer once in a while to the Medtronic situation. But in general, what we've seen is that the tax court in the last several years has reinforced the value of manufacturing down in Puerto Rico. And so we look forward to stating our case. We're very confident where we're at. And that's all we've got to say at this time. No change. We're at where we were in terms of confidence, which is in the same place for the last 2.5 or 3 years now.
Operator: Our next question comes from Terence Flynn from Morgan Stanley.
Terence Flynn: Peter, another one for you here. I appreciate the incremental guidance on CapEx, but just was wondering if you could speak directionally about margins in 2025, given the likely scope of the MariTide obesity program.
Peter Griffith: Terence, we don't -- as you know, we don't guide long-term margins but let me just comment on what you're seeing this year. I'm happy to speak to that. And I think it's important. We're -- at Amgen, we're committed to a capital allocation hierarchy, where we first invest in innovation and first internal innovation. And so with that in mind, Terence, we've consistently said that we would flex out margin, which remember, with us, as a percentage of product sales, not revenue, if there were opportunities to achieve strong after-tax cash returns on our investment in excess of our hurdle rate. And then we would communicate that ahead of time. So this year, we shared with you at the beginning of the year, we felt operating margin to be about 48%. We see an opportunity here during the year to make some investments in the research and development activities with an emphasis, I would say, on development. That's up 30% year-over-year in the quarter, non-GAAP R&D. We now see non-GAAP R&D spend up over 25% year-over-year for '24, which we think is great because you've heard about the deep mid- and late-stage pipeline we have, driving MariTide in that deep mid- and late-stage pipeline. We're always focused Terence, whether it's this year or next year on productivity and prioritization, always looking for opportunities to generate capital to allocate the innovation. We've got a new program called technology and workforce strategy that we're moving along at speed and scale. I spoke about opening a new talent and innovation center in Hyderabad, India. So we are doing everything we can to preserve that margin, reallocate capital innovation and be the disciplined spenders of capital that Amgen always has been.
Operator: Your next question comes from Chris Schott from JPMorgan.
Chris Schott: Just had a question on MariTide and your plans in that Phase II diabetes study. Company, obviously, very excited about the broader opportunity for the drug but it does seem like diabetes is a more established market with maybe less of the capacity constraints than we've see in obesity. So can you just talk a little bit about what you think you need to see to be able to compete here in dislodging [compens]. And can you also confirm that the study is not needed to move forward in the Phase III obesity studies, or it's just a completely separate program related to the diabetes piece of things?
Bob Bradway: Can take this in two pieces again. Jay, why don't you address the first piece and then Murdo feel free to jump in.
Jay Bradner: Yes, absolutely. As you nicely identified later this year, we will initiate an additional dedicated Phase II study that will characterize MariTide from the treatment of diabetes in patients with and without obesity. And this new study is not a gating step at all for the Phase III program for patients with obesity, but conforms to regulatory guidance and importantly, allows us to optimize dosing for the diabetic patients, where medically, I can say [indiscernible], your considerable perspective, I'm unaware of a highly efficacious monthly or less frequently administered medicine for the treatment of diabetes. Murdo?
Murdo Gordon: Yes. Thanks, Jay. I would agree with you that the differentiation that we've talked about for chronic weight management would hold in a robust way in type 2 diabetes. And while there are lots of products that can control hyperglycemia and provided HbA1c control, there is a significant benefit if you can improve adherence and persistence. And we do believe that our monthly dosing could do that.
Operator: Our next question comes from Kripa Devarakonda from Truist Securities.
Kripa Devarakonda: Another obesity question but slightly tangential. I'm not sure if you've talked about this before but there's been a conversation about muscle preservation in people who are losing weight on glip. Have you evaluated this aspect with MariTide? Do you see this being the problem broadly in the space? And -- if so, where do you think MariTide would fit into that landscape?
Bob Bradway: Sure. Jay, why don't you jump in there?
Jay Bradner: Sure. No, thank you for your question. We -- as you apparently do as well, are following this class and class of medicines that provoke remarkable weight loss or the impact on healthy tissues, including but not limited to muscle, and the associated muscle loss that has been reported in the literature may relate mechanistically and may also relate to the quite dramatic cadence of weight loss of patients treated with these medicines. And in the fullness of time, we and others will have that answer. As you can imagine, we're making many of these measurements on our own study and don't have any report -- any data to report to you here today but we too are following this. And also the progress of some organizations that are seeking to administer medicine to support muscle loss with obesity medicines that is quite interesting to us given our legacy of muscle biology. But I would say these are early insights from the field. To my knowledge, they have not proven has yet to be debilitating to the patient but we like you follow with interest.
Justin Claeys: Julianne saying we're getting to the top half of the hour here. Maybe we'll just take two more questions.
Operator: Our next question comes from James Shin from Deutsche Bank.
James Shin: For the next obesity asset that's entering clinics later this year, can you specify whether this asset is aimed to fill in for 786, and whether there's no next obesity asset will work in tandem with 133?
Jay Bradner: Thanks, James. We won't today provide any further insight into this medicine. It's just too early. And as Bob shared, this is nicely for patients, a very competitive space. But as I shared earlier, in our deeper pipeline in obesity, we remain interested in the increasing pathway. We remain interested injectable. We're also pursuing oral medicines. And so in the fullness of time, we'll have a chance to share more. We're really playing the long game to drive true differentiation benefits to the patient and to access segments of the market that are not well addressed even by the current medicines.
Operator: Our last question will come from Gary Nachman from Raymond James.
Gary Nachman: So shifting to TEPEZZA. When do you think we'll see more of an acceleration in the low CAS patients? How has reimbursement been improving for those patients? And describe how much the Japanese opportunity could help next year? And then just talk about the overall resources you're putting behind TEPEZZA and the rest of the rare disease portfolio that obviously, a much bigger focus for you now, if that continues to ramp up at what pace and when you might get more operating leverage from that rare disease business?
Bob Bradway: A lot of questions there, Gary, but why don't we take it in a couple of pieces. Go ahead, Vikram.
Vikram Karnani: Yes. So thanks for the question, Gary. Look, we're pretty pleased with how we've been executing on TEPEZZA this year and driving it towards growth. As you rightly observed, there are a significant number of low CAS patients or low clinical activity score patients that are suffering from this disease who are not being appropriately treated. And specifically, that's about 80,000 out of the 100,000 addressable patients in the U.S. What we have been doing is seeing significant momentum on expanding our prescriber base, which now in addition to oculoplastic surgeons also includes ophthalmologists and endocrinologists. And this is a really important element here. The strategic focus in endocrinology is really important so that we can serve those low C-A-S patients, the low CAS patients favorably. You asked about improving access. To date, we have achieved favorable medical policy changes for greater than 65% of U.S. covered lives. And if you compare that to 50% last quarter and just over 5% about a year ago, I think we've made pretty good progress in enabling patient access using our Phase IV data that have become available last year. So we continue to see a significant growth opportunity for TEPEZZA in the U.S. while also recognizing that as we make progress with a lot of our execution efforts, there continues to be a time lag between when we knock down barriers for access, expand our prescriber base and see patients get on therapy.
Bob Bradway: In Japan, Gary, we expect that they'll be, again, an attractive market and this will be well received in that country, and we'll talk about that once we've launched there during the course of next year. With respect to leverage, I think I would just offer that we're on track. With respect to our synergy targets there, and we'll begin to get even more leverage as we're able to take full control of the supply chain for the rare disease products. And then I would just further observe, as we've said many times, that feel fortunate that there's a good overlap between some of our existing capabilities in sales and marketing and the needs of those rare disease products. So all in all, we remain really excited about what we're able to do for rare disease patients, the position we have and the likelihood of that just improving over time. So with that, let me thank all of you. I know we've gone a few minutes over the set time but thank you all for participating in the call, and we look forward to regrouping with you after the third quarter. Thanks.
Operator: This concludes our 2024 Q2 earnings call. You may now disconnect. |
MELI | 2 | 2,024 | 2024-08-02 04:12:08 | Richard Cathcart: Hello everyone, and welcome to the MercadoLibre Earnings Conference Call for the Quarter Ended June 30, 2024. Thank you for joining us. I am Richard Cathcart, MercadoLibre's Investor Relations Officer. Today we will share our quarterly highlights on video, after which we will begin our live Q&A session with our CFO, Martin de los Santos; our Fintech President, Osvaldo Gimenez; and our Commerce President, Ariel Szarfsztejn. Before we go on to discuss our results of the second quarter of 2024, I remind you that management may make or refer to, and this presentation may contain, forward-looking statements and non-GAAP measures, so please refer to the disclaimer on screen, which will also be available in our earnings materials on our investor relations website.
Marcos Galperín: Tomorrow, August 2, 2024, marks 25 years since we founded MercadoLibre with the mission of democratizing commerce and financial services in Latin America. Over those 25 years, we have built a sustainable company that provides millions of small and medium-sized businesses with the tools they need to compete with larger players; we have enabled the shift to online retail by providing tens of millions of consumers with world-class levels of service; and we have included millions of people into the financial system across the region for the first time. These are notable achievements, but they are also just a baseline from which we think about our even bigger ambitions to deliver on our mission at an even greater scale. We are as optimistic as ever about the opportunities that are ahead of us and we are excited to pursue them with the culture of entrepreneurship, excellence and innovation that has served us well for the last 25 years. This is therefore a great moment to reaffirm our belief that the best is yet to come. Now, I will pass it on to Martín for more information on the second quarter of 2024.
Martin de los Santos: Thank you, Marcos. Hello, everyone. I am pleased to highlight MercadoLibre's outstanding performance in the second quarter of 2024, with strong growth across our key business units as well as solid bottom line financial results. In Commerce, we saw the highest growth in sold items and unique buyers since 2021, with both metrics accelerating sequentially. GMV performed well across geographies, particularly in Brazil where the 36% growth marks the highest level also since 2021. In Mexico, we maintained our momentum with successful Hot Sale once again. And in Argentina, we saw a positive growth in terms of items sold reverting the negative growth that we saw in Q1. This growth is a result of our commitment to improving the user experience through innovation and technology and the investments we continue to make in our key strategic initiatives such as fulfillment and MELI+. In Fintech Services, we saw strong growth in monthly active users which surpassed the 50 million mark for the first time and we also saw very solid engagement metrics demonstrating the traction that Mercado Pago has within our users. We continue to see a very positive adoption of our remunerated account in all of our major markets resulting in strong growth of asset under management. Our consumer and merchant credit books continue to scale while delivering strong profitability. During the quarter, we issued 1.6 million new credit cards and TPV grew by 3x compared to last year. The credit card is a critical component of our fintech value proposition, and we feel confident about scaling this product as a result of the improving accuracy of the underwriting models. Acquiring TPV grew also very strongly in Brazil, Mexico and Argentina and this was a result of the move up market strategy that we are implementing that enables us to reach larger merchants and also the continuous investments that we will make in the Online Payment segment. Our Consolidated Financial Results for the second quarter reflect the strong performance of our Commerce and Fintech operations with revenues of $5.1 billion growing above 40% year-on-year. We delivered income from operations of $726 million and net income of 531 million, resulting in a net income margin of 10.5%, which is the highest in the last eight years. For more information on our results, please refer to our shareholders letter. Now, I will pass it on to Richard for business news.
Richard Cathcart: Our logistics network plays a major role in enabling ecommerce in the region and driving more offline retail online. It has become a key competitive advantage for MercadoLibre. Innovation is a foundation of the success of our logistics network, and we are pleased to share some of our most recent innovations today. During the second quarter of 2024, MercadoLibre launched a fulfillment center in Texas in USA. This is the first fulfillment center outside of Latin America and it was opened to expand the assortment of products we offer to Mexican consumers by plugging U.S. sellers into our ecosystem. This is complementary to our existing cross-border business from China into Mexico. We are offering a great shipping service for our U.S.-based assortment. Buyers are receiving their packages from the USA within a couple of days in the north of Mexico, and within approximately three days in Mexico City. Shipping is free and we also offer interest-free installments. In June 2024, we took another major step in our innovation journey with the launch of robotics in our distribution center in Cajamar, just outside the city of Sao Paulo. A total of more than 300 robots will have arrived by the end of the year, with 100 of those already up and running. These robots will collaborate with the human workforce and will handle tasks such as transporting shelves containing products from storage areas. This optimizes processing time by 20%. It also enables us to automate repetitive tasks like product sorting, whilst reducing the distance that our workforce has to walk around the distribution center. It also increases total storage capacity by up to 15% per square meter. These robots operate autonomously, handling up to 20,000 items and 2,500 shelves per day, returning to charge stations when their batteries are low. This ongoing investment in technology and innovation reflects our commitment to creating an increasingly efficient logistics network. By building greater flexibility into our logistics operations, we have developed SLOW shipments which offer additional shipping options for buyers and efficiencies for MercadoLibre. SLOW shipments occur when a buyer chooses a slower shipping option than would be otherwise available to them because it may be more convenient or in some circumstances it may come with a lower shipping cost. This enables us to take advantage of moments of idle capacity in two key cost areas of our networks. Firstly, the processing in our fulfillment centers; and secondly, the line haul trucks that travel between cities. With SLOW shipments, the shipping window becomes larger and more flexible for MercadoLibre, which means we can choose the moments of greatest idleness to process products in our fulfillment centers and ship them between cities in line hauls to maximize network capacity utilization. MELI Delivery Day is another innovation, which has slightly different benefits to SLOW shipping. The main efficiency built into the MDD model is in the last mile, where several deliveries at a single address on a single drop means that last mile vans can drop more packages at fewer addresses. This helps us to dilute our last mile costs. Innovation and efficiency will continue to be key to the success of our shipping operations. For a more detailed discussion, check out the podcast on our Investor Relations website with the Head of Mercado Envios, Agustin Costa. From cross-border in Texas to robotics in Sao Paulo and MDD across Brazil, Mexico and Chile, we continue to innovate and will continue to do so because as always at MercadoLibre, the best is yet to come.
Operator: Thank you. At this time we will conduct the question-and-answer session. [Operator Instructions] The first question comes from the line of Andrew Ruben of Morgan Stanley. Andrew, please go ahead.
Andrew Ruben: Hi, thank you. So considering where you are the 25-year and congratulations for that. Can you talk about where we are in the interplay between commerce and fintech, it's a quarter we see the acceleration in GMV, also a number of fintech operating metrics picking up. So I'm curious how much you'd say is independent business drivers versus the two sides feeding each other. I'd be interested in the strategic update and maybe just honing in on the same topic near-term, you have the Brazil GMV accelerating to the 36% ex-FX. You also called out the higher remunerated account. We see growth in the credit business. So how much of that pickup would you attribute to these fintech initiatives versus something more commerce specific? Thank you.
Martin de los Santos: Hi, Andrew. How are you? It's Martin here. Thanks for your question. Obviously, as we have been saying over the years, being part of an ecosystems is both in the fintech side to commerce and vice versa, right? So I think in this particular quarter, credit is a good example to that. Our credit is fueling growth on our commerce side as we provide better payment solutions for users. Also, it's very beneficial to the fintech value proposition [indiscernible] credit cards very strongly this quarter. And in terms of growth in both on commerce side, we are very satisfied with growth that we're seeing in Brazil. I mean this is the second consecutive quarter, which we accelerate in Brazil. We are sustaining very solid growth rates in Mexico, gaining market share in both markets and also seeing a very strong recovery in Argentina both on commerce as well as on fintech side. So I think, for the most part, our strategy continues to perform extremely well, just like you said, 25 years after our – are – beginning our company, we continue to grow at rates of really at start-up rates, and we are super excited not only for what we have done so far over the past 25 years, but more importantly, to the many growth opportunities that we have ahead of us.
Osvaldo Gimenez: Let me complement that. I think that Andrew both businesses, we have always said that both businesses are very synergistic and we continue to believe that, and we have many, many examples of that. One is, for example, in order to grow how we can deploy products on the marketplace both to drive the growth of the marketplace, for example, in Mexico, a significant part of our GMV is paid either with Mercado Pago, with store balance of Mercado Pago or credit offered by us or by our own credit card on the one hand. On the other hand, how we can, for example, offer insurance products in the marketplace and grow the number of policies we sell. Both businesses that have been extremely synergistic. We have a huge user base on the marketplace and also on Mercado Pago and when we drive users from one platform to the other one. I think that we are very excited with that, that continues to work very well.
Andrew Ruben: Okay, thank you both.
Operator: One moment for your next question. The next question comes from the line of Irma Sgarz of Goldman Sachs. Irma, please go ahead.
Irma Sgarz: Yes, thanks for taking my questions. Congratulations also on 25th birthday tomorrow. You had a great quarter again in terms of operating leverage. And yet I can think of several items that can still contribute or unleash higher margins from here like scaling ads incrementally lower increases in provisioning, efficiencies in logistics, as you laid out. But before we all get ahead of our skis, are there any perhaps items or headwinds or areas of investment that we should think through especially into the back half of this year, perhaps related to carrier cost adjustments or higher deposit rates in Mexico, any marketing campaigns just to sort of level set expectations here a little bit in terms of what we should keep an eye on. Thank you very much.
Martin de los Santos: Hi, Irma, it's Martin here. Let me talk about this quarter. I think we – as you mentioned, we had a very strong quarter in terms of both EBIT results, but more importantly, net income, as you know, net income after the devaluation of Argentina has become a more – probably more relevant metric to look at, and we grew it by 100% year-on-year, and we delivered 10.5% of margin. In terms of the EBIT margin, specifically, you see on a comparable basis, you see a contraction this quarter. Most of that contraction is roughly 120 basis points of contraction. Most of it comes from bad debt provisioning and as you know, as we accelerated our credit book origination, we provisioned our expected losses upfront and that generates some pressure on margin, but we feel comfortable with that as we see very good performance in terms of NPLs and NIMAL margins continue to be very solid and with good profitability. So we are okay with scaling the book by increasing our credit card book as well. We issued more than 1.5 million – 1.6 million cards this quarter. We're in a credit card TPV by 3x compared to last year. So we should come with that kind of pressure on margins. In addition to that, we continue to invest in the strategic initiatives. We increased that penetration of fulfillment by 6 percentage points year-on-year we increased the penetration of shipping – free shipping also by 6 percentage points. So investments will continue to be, as we have been saying for several quarters at a similar pace, and there will be no change in our investors – investment strategy. We'll continue to invest in our investment strategic initiatives, minimize free shipping, credit and so on.
Irma Sgarz: Thank you.
Operator: One moment for your next question. The next question comes from the line of Robert Ford of Bank of America. Robert, please go ahead.
Robert Ford: Hey, thank you. Sorry about that. Happy birthday and congratulations on the quarter. I just had a few questions. And the first was, could you talk a little bit about Meli Más and MDD and how that's contributing to conversion and the acceleration you're seeing in GMV as well as the seller promotional tools that you call out today and particularly the ones that are resonating with consumers. And then how do you expect the end of tax withholding requirements for small businesses on their digital transactions to impact Pago in the marketplace in Argentina? And what's the timing for that? And then the third one I had was, we understand you've taken over 100,000 square meters of distribution space in Guadalajara [ph]. And we were curious as to the role that you envision for that space, particularly when it comes to centralizing inventory for Brazilian air cargo or processing cross-border transactions into Brazil. And where do you open up capacity in the rest of the network with the addition of that space in Guadalajara [ph]? And then how should we think about the implications of a Mexican banking license in terms of product enablers, funding and then the various frictions, whether they be regulatory tax or something else? And then lastly, and I apologize for all this. In the press release, you mentioned some downstream benefits of your more aggressive remuneration strategies and AUM strategies. And I was wondering if you could expand on those, please and that was it. Thank you.
Ariel Szarfsztejn: Hey, Bob, Ariel here. So I think on Meli Más, we are going through the same trajectory that we've been seeing over the last few quarters. Meli Más is successfully generating incremental engagement and incremental GMV. So users who enroll in the program have higher frequency, higher GMV, lower churn compared to the previous program, engagement KPIs are looking good. And to your point on MELI Delivery Day, we see adoption of MDD trending upwards. So general terms, we are extremely satisfied with the impact that the program is having in our business and particularly in the satisfaction of our users and we pretend to continue increasing the user base of subscriptor.
Robert Ford: And Ariel in terms of the MDD adoption coinciding with more packages per week or yet at a time?
Ariel Szarfsztejn: Yes. So in every single market, we see consumers choosing to get data packages from – with MDD trending upwards. And within MDD, we see consolidation also going up. In terms of capacity and distribution centers, I think you mentioned a couple of things that are different. So we did move our air cart in Sao Paulo. We just needed more space to deal with the volume that we are applying. But more on a general view, I think, as Martin was mentioning in the previous answer, we will continue building the capacity, linked the growth of our business and the increase in penetration of fulfillment, and that is true for every single market. This quarter or these few quarters, in particular, we have been expanding capacity in Mexico. At some point, we will continue expanding capacity in Brazil and the rest of the market as well, nothing changing or directionally radical with the way we've been operating so far. But in the end, we are compounding the growth of MercadoLibre as a whole with the increase in fulfillment penetration. I will let Osvaldo complement.
Robert Ford: Sorry, I was just going to ask you that facility is domestically oriented. Is that fair?
Ariel Szarfsztejn: Yes, we are not doing any international flights from Brazil to other countries, nor from any country of Latin America into another one. The only international connection that we do is from Texas into Mexico, which is not going through air.
Robert Ford: Great.
Osvaldo Gimenez: Bob, let me cover the two questions related to FinTech. One of them was how do we expect the end of tax footholding requirements in Argentina to impact Mercado Pago, and we are very excited about that. Today, electronic payments in Argentina had a drawback versus cash payments because were perceptions and taxes we need to rehold on behalf of the local IRS from every seller. So that was a detractor for further adoption of electronic payments in general and the lot of past Congress recently removed that at a federal level, not at a state level, but at a federal level. This, however, has not yet been implemented by the local IRS. So we need that to happen and then we will make the implementation. But that really will be a positive on all kinds of electronic payment. If I recall correctly, the second question was regarding implications of the Mexican banking license and I would say that, that is something that we believe there's a huge opportunity in Mexico to compete and further deploy financial services and that by having a banking license, we will be able to add products to – a stack of products. And for example, let people be able to collect salary season than the Mercado Pago account. And so we believe that the opportunity we see in the country is huge. We have been already growing our credit book very significantly. This will be a process that will be long, typically around two years, but it depends on the regulator. But we believe that we will continue growing our footprint in Mexico throughout that period. For example, recently, we increased the rate we have paying to the depositors in cuenta remunerada [ph], and we are very excited with the results we are seeing.
Robert Ford: And that's what triggered my question with respect to the benefits of – the downstream benefits of those AUM strategies. Could you expand a little bit on that further?
Osvaldo Gimenez: Yes. The reason for cuenta remunerada [ph] it really drives principality. We see that the two main drivers of principalities where people put their savings first. And together with that, where they get most of the credit. So we are driving those two up significantly. By having a very competitive cuenta remunerada and also be aggressive deploying our credit card strategy in Mexico.
Robert Ford: So these are not just opportunistic depositors taking advantage of the 15% rate. You're seeing some real adoption of the rest of the ecosystem.
Osvaldo Gimenez: Yes. Yes, Bob, we'll probably go to the next question and we can go into more detail on this on. But yes, the short answer is yes, it contributes to that.
Robert Ford: Thank you.
Operator: [Operator Instructions] The next question comes from the line of Marcelo Santos of JPMorgan. Marcelo, please go ahead.
Marcelo Santos: Hi good evening. Thanks for the opportunity for asking questions. I have two on my side. The first is, given that you launched your distribution center in Texas, could you please comment a bit on your broader ambition on cross-border, how relevant this could be? Where this like -- where do you think this could be in a couple of years? And the second question is regarding the net shipping. So dividing -- getting their shipping revenue, minus shipping cost divided by GMV, we see that it improved a lot on a quarter-over-quarter basis. If you could please dissect the drivers that led to the sequential improvement for one quarter to other. And if you see further room for more efficiency there. Thank you very much.
Ariel Szarfsztejn: He Marcelo, how are you? This is Ariel. So let me start with your first question related to cross-border. I think we've always said that cross-border is still a huge opportunity for MercadoLibre in general. Today, almost 15% of the GMV that we have in Mexico is coming from cross-border, mostly Chinese. But I would say that in the rest of Latin America, our cross-border business is still small, and we think we have an opportunity to generate some value there. Specifically about Texas, our introductory video was mentioning, we think that we can complement the selection that we have in Mexico from local Mexican sellers with inventory coming from North American sellers. And that is particularly relevant considering that there are certain thesis of that selection that we cannot get locally in Mexico or we cannot find at the right price. So in the end, our North American strategy is to complement the offering that we have in Mexico and be able to serve our consumers better. And eventually thinking about the strategic impact, we think this can be relevant. We think this could be multi-country in the future, but it's too early to tell. But signs of that operation are really, really positive. We see consumers getting extremely engaged with the products that we are offering, and we see our sellers from the U.S., also very satisfied with the sell-out that they have in the inventory that they are bringing to our warehouse. Going to the second part of your question about shipping margins and cost. I would say that we are pleased with the results that we are seeing from our logistics operation. So in terms of discipline with which we are managing the operation itself, but also with our ability to manage the -- our P&L while continuing to invest behind our strategic priorities. This quarter, as you were saying, we saw an expansion in shipping margin. That expansion is mostly coming from our ability to drive efficiencies in our operations, and that happened even with some headwinds coming from Mexico where we are operating at max capacity and where we have an extremely strong hot sale season. I would say, broadly speaking, we continue committed to running shipping with a very disciplined P&L. And you can see that clearly when you look back into a longer-term picture, right? So if you go back to 2019, you can see that our net shipping costs remained broadly flat or even improving, if you were to add our flat fee revenues into that one. And in that same period, we moved fulfillment penetration from 6% into 50%. We moved pre-shipping up 30 percentage points. We increased our square meters by 5x, all this across the region. So again, shipping is a key driver and a key strategic priority for MercadoLibre, and we are committed to executing what we need while managing costs and revenues with strong discipline.
Marcelo Santos: That’s very clear. Thank you very much.
Operator: The next question comes from the line of Maria Clara Infantozzi from Itaú. Maria, please go ahead.
Maria Clara Infantozzi: Hi everyone. Thanks for taking my questions. It's about your view on the implementation of GenAI in the ad business. So this has been a key topic of discussion in the earnings calls of some these sites during this test base. And can you please share your thoughts on the topic is now in the front and which opportunities of improvement in business do you foresee with the implementation of GenAI? And if I may add, can you please comment on how the AI business has been affecting your recommendation in time? Thank you.
Martin de los Santos: Hi, Maria Clara, this is Martin. I mean as you use -- can you mute the line on the other side please? We are hearing some noise. Thank you. Yes, as you mentioned, we have been -- put a lot of resources into AI and GenAI throughout the company, really. We don't have a centralized department of AI, but all of our different business units. And clearly, the IT team have been focusing on trying to find opportunities to improve our efficiency and deploy AI solutions, both in the way we manage the business as well consumer-facing. And some examples of that are on the commerce side, obviously, we are using AI to help us with recommendations, as you mentioned, but more important than that on reviews, for instance, that in the past, you have to -- if you were to review a product, you have to go through many different views, now we can consolidate that into a more efficient way of communicating the qualities, the prospects of a particular product pictures, as you know, our pictures that publish might not be the same quality that we are expecting from our merchants, and we can improve those with AI. Answers from sellers is another good example in the past, if you were to buy something at 2:00 AM in the morning, you'll have to wait until the next day to get an answer that obviously affected significantly the conversion of the product. Now we can respond right away with using GenAI models. On the -- obviously, on the developer side, we have 16,000 developers, which are also using AI tools to improve productivity and that also generating some improvements and efficiencies in the way we deploy products throughout the company. And I think one of the most important projects that we have is on CX, customer experience and customer support by which we are also applying AI tools that will help us to not only respond more efficiently in terms of cost, but also be more accurate in terms of the way we manage those issues. These are some examples, but there are many others. Osvaldo maybe also you can complement.
Osvaldo Gimenez: Yes. The only thing I was going to add, you asked about search and where you're seeing technical and bedding to power search that technical -- turn search into something more semantic. So it's easier to try to send the users to what they're looking for.
Operator: [Operator Instructions] The next question comes from the line of Kaio Da Prato of UBS. Kaio, please go ahead.
Kaio Da Prato: Hello everyone, thanks for the question. So two quick on my side, please. With all these good trends that we are seeing in the fintech business, I was wondering if you can share some idea about the profitability of the fintech business in your three main countries, Brazil, Mexican Argentina? And what levels do you think you can achieve in each of them? Just an idea of how it has been evolving over time? Would it be really helpful here. And additionally, you are mentioning that you would like to become the number one digital bank in Mexico. What do you think are your competitive advantages against the digital players in Mexico today as since that now you are with similar offerings compared to most of them nowadays. Thank you very much.
Osvaldo Gimenez: Hi Kaio. We don't share a lot of details regarding specific profitability in each of the three countries. Let me share with you that we are extremely, we are profitable in all three countries, in the three largest markets in Argentina, Brazil and Mexico. In the case of Brazil and Mexico is driven mostly on the fintech services side, driven mostly by our credit book and acquiring is profitable in all three markets. In the case of Argentina, the importance of credit is less relevant than in the other markets, but we have such a strong position as a wallet leveraging the payments every day users make that makes up for a lower credit volume at this point. And we are very profitable in all three markets. Regarding the second question was that we have claimed that we are applying for license and that will be – we want to be the number one digital bank in Mexico. We believe we have several competitive advantages. First of all is we already have a large user base given the importance of, on the one hand, the marketplace. And on the other hand, our acquiring business, which is very developed in Mexico. And furthermore, we have been doing aggressively. First, initially, our consumer credit book there for several years, but also recently, our credit card, and we are very excited with the kind of growth we are seeing. And we believe that this synergy we have between the marketplace acquiring business and the fintech services businesses is something that nobody else has. So we believe we have a very strong position in Mexico.
Kaio Da Prato: Okay, great. Thank you very much.
Operator: One moment for the next question. The next question comes from the line of João Soares of Citi. João, please go ahead.
João Soares: Thank you and congratulations on the results. Two quick ones on my side. The first one, is I wanted to dig a little bit deeper into the GMV performance in Brazil. We initially had the impression which is probably going to be more challenging. And actually, you had [indiscernible]. And not only do we see an acceleration, we saw volumes driving acceleration. So I just wanted to understand. I realize there's no silver bullet here at Super Bowl, but what you attribute this [indiscernible]? How much attribute this to – I mean, I just want to go at some point what are the main points that we would attribute this acceleration to it would be interesting to hear. And we also saw a good development of the ads penetration right now at 2%, right? So I just wanted to hear your thoughts on the broader retail media adoption. How much is this comes from the view involving your own capabilities? And also, any thoughts on the profitability on this business will be – also be interesting to hear. Thank you.
Ariel Szarfsztejn: Hey, João. This is Ariel. So thank you for your question on still I think it's a good thing. The fact that I am getting kind of the similar question on why we grew so much in Brazil quarter, but we must be doing some positive on that one. So the answer to your question is that there is no silver bullet performance. So it's not something specific that I can attribute that growth too. I would say several strategies and actions were executed across the business from improvements in selection, expanding our 3P selection complemented with more 1P, which is helping us strengthen MercadoLibre's position as they go to place to buy in Brazil, improvement in pricing, we are getting more and more obsessed with our price competitiveness. We continue also improving our shipping offering with faster deliveries, slower deliveries, more fulfillment, more free shipping. As we said in the past, we are putting a lot of effort in the averaging Brazil into regions, into categories, into different type of users as to find the right solution to push for growth in each of those segments, product and experience continues to be a key priority for us. We continue to deploy innovation in beauty, we deploy virtual trials we are expanding our compatibilities in out-of-park [ph] trading in consumer electronic presales. I mean we continue to improve our experience more and more. I think we also developed over time a good muscle to quickly identify and adjust our promotional calendars and marketing efforts as to capitalize the opportunities that appear in the market at every single point of time, and that's also helpful. And last but not least, as Osvaldo was saying before with the first question, our payments ecosystem. So Blue Money including Buy Now Pay Later, credit card, account money continues to gain share in our checkout, and that's definitely helping us increase conversion. So in summary, I would say that what you see today is probably the compounded effect of 25 years investing fully focused in Latin America. So the second part of your question related to advertising. So I would say, again, another good quarter or a great quarter for us. Our penetration reached 2% of GMV which is 40 basis points improvement year-over-year. The revenues grew 51% year-over-year in dollar terms, that's the eighth consecutive quarter with a growth rate above 50% particularly, we saw a great performance coming from cross-border sellers from 1P brands and that product continues to represent the majority of the business. I would also add to the ad thing, that a big milestone for us.
Operator: One moment for your next question. The next question comes from the line of Jamie Friedman of Susquehanna International Group. Jamie, please go ahead.
Jamie Friedman: Hi, good evening and congratulations on the 25th. I just wanted to briefly get your summary message about credit quality because I realize there's a lot of different inputs here. But the NIMAL did deteriorate on a year-over-year basis, about 500 basis points, though admittedly, it was roughly flat sequentially. The provision – that's Page 10. And then on Page 19, the bad debt provision, which I realize is also a function of growth math but that also increased about 300 basis points sequentially. So I know there's a lot of detail, but if you could just give us like the overall message about how you're thinking about credit quality, that would be helpful. Thank you.
Ariel Szarfsztejn: Hi. Sorry. We just got – we dropped, our line got dropped, so if you can give us one second we will try to.
Jamie Friedman: Okay, I can repeat it as well. You want me to say it again?
Ariel Szarfsztejn: Bear with me for a second, please. One second, please.
Operator: Please enter your dial in pin and press pound when finished.
Ariel Szarfsztejn: We are trying to dial-in once again. Hello.
Marcos Galperín: We can hear you. Okay. If you could please, Ariel if you listen to the last part of the answer from us, but we can move on to the next question, if needed, we can go in more detail on that. Please go ahead, please.
Jamie Friedman: So I was just asking – this is Jamie Friedman at Susquehanna. I was just asking for the one liner on credit quality. On Page 10, the NIMAL, though they were roughly flat sequentially. They did deteriorate about 500 basis points year-over-year. On Page 19, a 300 basis point increase in the bad debt provision. I realized that as growth math. But I noticed a lot of detail, but if you could just share us the one liners how you're thinking about credit quality, that would be helpful. Thank you.
Osvaldo Giménez: Absolutely. NIMAL was slightly down, but that compression was, I would say, fully explained by the growth of the credit card portfolio as percentage of the total portfolio. So it's mostly a change of mix. The credit card factory has a lower NIMAL because we will provision upfront but only a small portion of the portfolio generates revenue initially. Having said that, we are very excited with the evolution of all of our credit portfolios we are seeing very good results in the earlier cohorts of the credit cards. We continue to see that the improvement in our scoring models and shortening of the payback period for each cohort, that's why we have been growing the credit card portfolio. And beyond that, also the credit card is obviously strategically very, very, very important. And then when – the second part of the question is regarding, if I understood correctly regarding the NPL evolution. Again, we are comfortable with the results we are seeing, the spreads we have are very, very healthy. And I think overall, we are comfortable with the credit portfolio.
Martin de los Santos: Yes. And going back to NIMAL just to complement, we don't disclose specific NIMAL portfolio for countries, but as Osvaldo mentioned, this is a mixed issue. If you were to look at individual product portfolios, NIMAL are stable or improving year-on-year. So that's why we feel comfortable accelerating growth. Our credit book reached $4.9 billion, growing 51% year-on-year on the back of very strong profitability results.
Jamie Friedman: Okay, thanks Martin. Thanks, Osvaldo.
Operator: [Operator Instructions] The next question comes from the line of Geoffrey Elliott of Autonomous. Geoffrey, please go ahead.
Geoffrey Elliott: Hello, thanks very much for taking the question. There's clearly lots of growth, lots of acceleration, lots of positives in the numbers. Can you tell us what has been the biggest positive surprise for you over the last year? If you wound back to 12 months ago, you could see the numbers that you've just printed, which part of the business is it, which has exceeded your expectations.
Martin de los Santos: Hi Geoffrey, I think if you look at the results over the past year, we are super excited about all parts of our business. I mean on commerce side, as Ari mentioned, we are growing Brazil 36% on the back of – 30% last quarter and sustained growth in Mexico. This is the third consecutive quarter by which grew 30% year-on-year. So gaining market share in both markets, also very positively surprised about the turnaround of Argentina. We had a tough quarter, last quarter in Q1, and we regained growth once again on the commerce side of Argentina. Our fulfillment infrastructure continues to be deployed and great gain in penetration, which results in much better user experience. A number of users have been growing a number of buyers as well as monthly active users on the fintech side of the business. Then on the fintech side, we have tremendous opportunity ahead of us in Mexico. Assets under management are performing very well throughout the region. Our credit books as like Osvaldo mentioned earlier, performing very well, and we accelerated growth in the past two quarters. So very excited about all of our businesses and in particular, also the new businesses that are growing, Mercado Play, which is starting relatively new, showing some positive signs. So far, Meli Más, which we launched a year ago, performing very well. So we are very excited about both the commerce as well as the fintech side of the business.
Geoffrey Elliott: Okay. It sounds like the answer to that is everything. I'm tempted to ask you to pick one, but I won't just to follow up, the new customers, that the monthly active user group, who are those people? Are they people who have not used e-com before? Or are they coming from competitors, where are the new users coming from?
Martin de los Santos: Just to be fair with you, it's true that the answer was broad because we're really excited about the performance of the business. I think if I had to highlight one is probably the surprise of continuing to gain market share in Brazil for several quarters. For more than a year now, every quarter, we continue to grow at a faster rate than the market at a very large scale. So that's obviously something that we are very proud and very positively surprised.
Osvaldo Gimenez: If I were to pinpoint something on the fintech side, I'll say that several quarters ago, we restructured how our team is organized with a strong focus on fintech services and since then, we have seen very strong growth, both in Brazil and Mexico, not only in number of users, but in the frequency, the use of products how, for example, cuenta remunerada [ph] has grown and credit cards have grown. So I'd say the increased focus we put on fintech services clearly is paying off, and that is really according to the expectations we have.
Geoffrey Elliott: Great. Thanks very much.
Operator: [Operator Instructions] The next question comes from the line of Craig Maurer of FT Partners. Craig, please go ahead.
Craig Maurer: Yes, thanks. Again, congratulations on your 25. Most of my questions have been asked and answered. But I wanted to ask you a follow-up to Geoff's question on market share, if you could characterize for us where you think market share is for MercadoLibre and in each of the main markets? And how that's progressed year-on-year, that would be helpful.
Marcos Galperín: Yes. As you know, market shares are a lot of information – public information that it's not that accurate. I mean the reason why we believe we are gaining market share is because we are growing at a very rapid pace most likely for sure, above market. But in terms of specific market share numbers, those are numbers that we don't share, but its public information. I'm sure you can get. What we can say is that at a growth rate of 36% year-on-year in Brazil and 30% in Mexico, we are gaining share for sure.
Craig Maurer: Okay, thank you.
Operator: [Operator Instructions] The final question comes from the line of Marvin Fong of BTIG. Marvin, please go ahead.
Marvin Fong: Good evening. Thanks for taking my questions and congratulations as well on the anniversary as well as the strong quarter. I would just like to turn to the topic of the Brazil macro environment in terms of – it looks like inflation is kind of ticking up and the Central Bank is pausing. So just with respect to your fintech business, two parts on this. Does it factor at all or how does that trajectory factor at all into your willingness to lean into acquiring more – expanding more credit and acquiring more borrowers in that country? And then secondly, how might it affect your spreads. I think in the second quarter, you had some positive gross margin impact from credit spreads and credit funding. Just any thoughts on how you might pass or not pass on interest rate funding cost to your customers? Thanks.
Osvaldo Gimenez: Hi, Marvin, so mostly the decision of how to expand our credit books, our credit offerings is principally related to how we are seeing payments evolving, how we see the malls evolving and as long as we continue to see that our malls are working well and NPLs are coming down. We will continue being aggressive with expansion of credit. Our credits typically are very short, and therefore, we are very flexible to adjust to any change in interest rate policy that may come. And with regards to credit spreads and funding, I would say that today, we have spreads that are very healthy. We are in the – we're always looking for ways to continue growing the credit book we have. And in some cases, that will imply working with very positive spreads, but smaller than the one we have now because there's an opportunity to continue further expanding upmarket where in order to reach those customers would need to be even more competitive with vis-à-vis traditional banks.
Marcos Galperin: And just to complement on macro. I mean we've been operating in Latin America for 25 years, and we've seen many different macro situations, and we believe that in our industry, both on commerce and fintech a lot more important, stronger the secular trend of people moving online, both to commerce online as well as to bring their finances, digitalize their finances. So we are a lot more focused on continuing to improve our products, continue to offer faster shipping, better assortment on the commerce side, business credit book, as Osvaldo mentioned, and macro should not affect our performance or growth in the future, at least what we're seeing so far in Brazil, Mexico and Argentina.
Marvin Fong: I really appreciate the insight there. Thanks so much.
Operator: This concludes the question-and-answer session. I would now like to turn it back over to Martin de los Santos for closing remarks.
Martin de los Santos: Well, thank you, everybody, for joining. Once again, very excited about the results of the quarter, but more importantly, about the future of MercadoLibre, celebrating our 25th year tomorrow. But we're looking ahead, we see – we continue to see as many as big opportunities as we saw 25 years ago. So again, looking forward to the second half of the year and to reporting to you in three months. Thanks again.
Operator: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. |
BKNG | 2 | 2,024 | 2024-08-01 21:34:10 | Operator: Welcome to Booking Holdings' Second Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical facts are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the Safe Harbor statements at the end of Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com. And now I'd like to introduce Booking Holdings' speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen.
Glenn Fogel: Thank you and welcome to Booking Holdings' second quarter conference call. I'm joined this afternoon by our CFO, Ewout Steenbergen. I am proud to report second quarter results that exceeded the high end of our expectations for room nights and revenue. The upside on revenue, combined with lower-than-expected fixed OpEx growth, helped drive adjusted EBITDA above the high end of our prior guidance range. As expected, the travel market has continued to normalize and we are pleased with the strength of our underlying business. Moving to our key metrics in the second quarter. Our travelers booked 287 million room nights across our platforms, an increase of 7% year-over-year. Revenue of $5.9 billion and adjusted EBITDA of $1.9 billion, both increased 7% year-over-year. Finally, adjusted earnings per share grew 11% year-over-year, helped by our strong capital return program which reduced our average share count by 7% year-over-year. In line with our expectations, we saw that the booking window expanded less in the second quarter relative to the first quarter which negatively impacted room night growth compared to Q1. From a regional perspective, we observed a mild moderation of travel market growth in Europe. However, we believe we're continuing to perform well relative to the market in Europe. Looking at our other regions, we continue to see high growth levels in Asia and a slight improvement in growth in the U.S. As we look ahead to the third quarter, we believe room night growth will be impacted by a booking window that expands less than it did in Q2 as well as by the more moderate market growth we have seen in Europe, where our growth has remained stable from May through July. We expect that this will result in some deceleration in room night growth compared to Q2. Ewout will provide further details on our second quarter results and our thoughts about the third quarter. I remain confident in the attractive long-term growth profile of the travel industry, our competitive position over the long term and our long-term growth and earnings model. We remain focused on what is important for the business for the long term which means continuing to execute against our strategic initiatives while simultaneously taking actions to drive more cost efficiency in the business. We continue to see progress across several important initiatives which include advancing our connected trip addition, expanding our merchant offering at Booking.com, continuing to develop our AI capabilities, growing alternative accommodations and enhancing our Genius loyalty program. These initiatives all fit together in our ongoing effort to deliver a better planning, booking and travel experience for our travelers while also benefiting our supplier partners. We believe that continuing to drive benefits to our supplier partners is critical to successfully operating a growing 2-sided marketplace. We are encouraged to see healthy second quarter year-over-year growth in a number of supply partners working with us at Booking.com. We are focused on being a trusted and valuable partner by delivering incremental travel demand and developing products and features to help support these accommodation properties, the majority of which are small and independent businesses. We believe that improving the competitiveness and profitability of our smaller partners and supporting those partners across macroeconomic cycles contributes to the long-term economic health of our sector. Our alternative accommodation offering at Booking.com continues to benefit from having more listings available for travelers to choose from. At the end of Q2, our global alternative accommodation listings were about 7.8 million which is about 11% higher than Q2 last year. We believe this greater selection of listings is contributing to the increasing mix of alternative accommodation room nights booked on our platform. We continue to make incremental enhancements to our alternative accommodation offering for both our travelers and supply partners. For our travelers, we are focused on successfully delivering a better planning, booking and travel experience over time which we believe will lead travelers to choose to book directly and more frequently with us. At Booking.com, we are continuing to grow the number of total active travelers with repeat travelers growing at an even faster rate. In terms of direct booking behavior, we are pleased to see that the direct booking channel continues to grow faster than room nights acquired through paid marketing channels. As I've stated before, we think it's important for us to remain proactive in paid marketing channels in order to bring new travelers to our platforms so long as we're able to do this at attractive ROIs. In addition, I'm encouraged by the work our team at Booking.com is doing to increase our spend on social media in a disciplined manner which is an effort that helps to further diversify the channels we utilize while reaching our travelers on platforms they are actively using. Our Genius loyalty program at Booking.com plays an important role in helping to drive more travelers to choose to book directly with us over time. We see a meaningfully higher direct booking mix for Genius users versus other users. And that direct mix percentage steps up at each higher level of Genius status. So we are encouraged to see continued success and more of our travelers moving into the higher Genius tiers of levels 2 and 3 which now represent nearly 30% of our active travelers. In addition to a higher direct booking rate, we also see higher booking frequency from our Genius Level 2 and 3 travelers when compared to our overall business. In Q2, we drove more Genius benefits to our travelers with a 15% year-over-year increase in benefits. This is primarily driven by accommodation bookings. However, we are seeing growth in benefits and the other elements of travel as well with triple-digit growth in Genius discounts for car rental off of a small base last year and continued testing of Genius benefits for flights. In addition to these benefits, bookings in travel verticals outside of combinations contribute to a traveler's Genius level tier. We will continue to explore opportunities to enhance our Genius loyalty program and deliver more benefits to our travelers. And we know that Genius is a win-win with our supplier partners, enabling them to get incremental demand when they want it which is one reason more of our supplier partners are electing to participate. On the connected trip, we continue to take steps towards our long-term vision to make the planning, booking and travel experience easier, more personal and more enjoyable, while delivering better value to our travelers and supplier partners. In order to achieve the easier, more personalized experience of the connected trip, we have always envisioned AI technology at the center of this vision. Our teams of AI experts continue to draw on their valuable experience from using AI extensively for many years as they work to further incorporate this technology into our platforms. We believe our proprietary data, along with our resource and scale, position us well to build compelling AI-powered offerings over time. Another foundational element of the connected trip is the merchant offering that we continue to expand at Booking.com. Merchant capabilities will help bring different elements of travel together in a seamless booking experience while also unlocking the ability to merchandise across verticals. The mix of merchant gross bookings reached 58% of total gross bookings at Booking.com in the second quarter which is an increase of 10 percentage points year-over-year and is higher than our prior expectations. We are pleased to see that processing transaction through Booking.com's merchant offering generated incremental contribution margin dollars in the quarter, though this was still a small percentage of our total adjusted EBITDA. We continue to see growth in transactions that are connected to another booking from a different vertical in a trip. These connected transactions increased by about 45% year-over-year in the second quarter and can change or represent a high single-digit percentage of Booking.com's total transactions. We believe by providing a better overall booking experience, travelers may choose to book more trips with us with a higher likelihood of booking directly in the future. Flights are an important component for many of the connected trips that our travelers are booking. In the second quarter, air tickets booked on our platform increased 28% year-over-year, driven primarily by the growth of Booking.com's flight offering as well as strong growth in Agoda's flight business. We continue to see a healthy number of new customers coming to Booking.com through the flight vertical and are encouraged by the rate that these customers and returning customers see the value of the other services offered on our platform. In conclusion, we continue our work to deliver a better offering experience for our supply partners and our travelers. We remain confident in our long-term outlook for the travel industry, we are positive about our future and we believe we are well positioned to deliver attractive growth across our key metrics in the coming years. I will now turn the call over to our CFO, Ewout Steenbergen.
Ewout Steenbergen: Thank you, Glenn and good afternoon. I will now review our results for the second quarter and provide our thoughts for the third quarter and the full year. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. Now let's move to our second quarter results. Our room nights in the second quarter grew 7% which exceeded the high end of our guidance by 1 percentage point. As expected, we saw room nights growth moderate from the first quarter as we saw less year-over-year expansion of the booking window in the second quarter. Looking at our room night growth by region, in the second quarter, Europe was up mid-single digits. Asia was up mid-teens, rest of world was up high single digits and the U.S. was up mid-single digits. We continue to grow our alternative accommodations business faster than our overall business. For our alternative accommodations at Booking.com, our second quarter room night growth was 12% and the global mix of room nights was 36% which was up 2 percentage points from the second quarter of 2023. We continue to see encouraging progress in strengthening direct relationships with our travelers and increasing loyalty on our platforms. Over the last 4 quarters, the mix of our total room nights coming to us through the direct channel was in the mid-50% range and when we exclude our B2B business was in the low 60% range. We've seen both of these mixes continue to increase year-over-year. Mobile ad mix of our total room night was about 53% which was up 6 percentage points from the second quarter of 2023. We continue to see that the significant majority of bookings received from our mobile apps come through the direct channel. For our Genius loyalty program at Booking.com, we continue to see a year-over-year increase in the mix of room nights booked by travelers in the higher Genius tiers of levels 2 and 3. These members booked more than half of the room nights over the past 4 quarters. Outside of accommodations, we saw airline tickets booked on our platforms in the second quarter increased 28%, about in line with our expectations, driven by the continued growth of flight offerings of Booking.com and Agoda. Second quarter growth in bookings increased 4% which was approximately 3 percentage points lower than the 7% room night growth due to about 2 percentage points of negative impact from changes in FX and about 1% lower constant currency accommodation ADRs. The year-over-year ADR decline was negatively impacted by a higher mix of room nights from Asia. Excluding regional mix, constant currency ADRs were about flat versus 2023. While room night growth was above the high end of our guidance range, gross bookings growth came in at the midpoint of our range due to about 2% lower constant currency accommodation ADRs versus our expectation. In addition, our gross bookings were negatively impacted by lower flight ticket prices in line with the recent trends we have heard from many airlines. Second quarter revenue of $5.9 billion grew 7% year-over-year which exceeded the high end of our guidance by 1 percentage point. Revenue growth was negatively impacted by about 2 percentage points from the change in Easter timing and 2 percentage points from changes in FX. Adjusting for these two items, revenue would have grown about 11%. Revenue as a percentage of gross bookings was 14.1% which was slightly higher than expected due to a timing benefit as we saw gross bookings growth decelerate in the quarter and a less expanded booking window than expected. Additionally, revenue associated with payments was higher than expected. Marketing expense which is a highly variable expense line increased 8% year-over-year. Marketing expense as a percentage of gross bookings was 4.7%, about 15 basis points higher than the second quarter of 2023, due primarily to the timing of brand marketing spend as well as increased spend in social media channels. Second quarter adjusted sales and other expenses as a percentage of gross bookings was 1.9%, about 15 basis points higher than last year due to a higher merchant mix and higher transaction taxes. Our more fixed expenses on an adjusted basis were up 5% and were below our expectation across all three line items: personnel, G&A and IT. We're very focused on carefully managing the growth of our more fixed expenses and are taking actions to help improve our operating leverage in future quarters. Adjusted EBITDA of $1.9 billion was above our expectations, largely driven by higher revenue and lower-than-expected fixed expenses. Adjusted EBITDA grew 7%, despite approximately 5 percentage points of pressure from Easter timing and 2 percentage points from changes in FX. Adjusting for these two items, adjusted EBITDA would have grown about 14%. When looking at our adjusted EBITDA margins, for the first half of 2024 which neutralizes the impact of the Easter timing shift, we're pleased to see 160 basis points of margin expansion versus the first half of 2023. Adjusted net income of over $1.4 billion was up 3%, slower than the growth in adjusted EBITDA, due primarily to higher income tax expenses which was impacted by some discrete items. Adjusted EPS of $41.90 per share was up 11% and benefited from a 7% lower average share count than the second quarter of 2023. On a GAAP basis, net income was over $1.5 billion in the second quarter. Now on to our cash and liquidity position. Our second quarter ending cash and investments balance of $16.8 billion was up versus our first quarter ending balance of $16.4 billion due to about $2.4 billion of free cash flow generated in the quarter, partially offset by about $1.9 billion of capital return, including share repurchases and dividends. Moving to our thoughts for the third quarter. We expect third quarter room night growth to be between 3% and 5%, a sequential deceleration as we expect the third quarter to benefit less from a year-over-year expansion of the booking window than we saw in the second quarter. For the third quarter, we expect the booking window to be more similar to last year. Additionally, we have seen a mild moderation in the market growth in Europe over the last couple of months, though our growth in Europe has remained stable from May through July and we believe we continue to perform well relative to the market. We expect third quarter gross bookings growth to be between 2% and 4%, slightly below room night growth due to about 1 percentage point of negative impact from changes in FX. We expect constant currency ADRs to be down slightly year-over-year and for this to be offset by a slight benefit on flight bookings growth. While we continue to expect growth in flight bookings, we believe this will be less than previously expected due to lower flight ticket prices. We expect third quarter revenue growth to be between 2% and 4%. We expect third quarter adjusted EBITDA to be between about $3.25 billion and $3.35 billion, about flat year-over-year at the midpoint of the range. We expect adjusted EBITDA to grow slower than revenues due to deleverage from sales and other expenses and from growth in IT expenses related to higher software license fees and increased cloud cost. We expect third quarter revenue and adjusted EBITDA growth to also be negatively impacted by 1 percentage point from changes in FX. In terms of our outlook for the full year, we're adjusting our gross bookings growth expectation to faster than 6% which is a bit lower than our prior expectation due to less growth in flight growth bookings as a result of the lower flight ticket prices I previously mentioned. While flight prices have come down, we still expect strong growth in flight tickets for the year as we continue to expand the flight offerings at Booking.com and Agoda. We expect accommodation ADRs will be about flat to down slightly on a constant currency basis. For revenue, we now expect revenue growth of more than 7% which is a bit higher than our prior guidance, based on the outperformance in the first half of the year and our expectation for higher revenue associated with payments. Revenue is impacted to a much lesser extent than gross bookings from the decline in flight ticket prices. We continue to expect about 1 percentage point of negative impact from changes in FX on our topline growth rates while reducing our fixed OpEx growth expectation to low double digits as we continue to focus on bringing this growth rate down over time. We expect adjusted EBITDA to grow in the high single digits which is slightly faster growth than our prior expectation, given our outlook for increased revenue growth and lower fixed OpEx growth. We continue to expect adjusted EBITDA margins to expand year-over-year by a bit less than 8 percentage point. Finally, we're increasing our adjusted EPS growth expectation to above 15%. In conclusion, we continue to expect 2024 to be a strong year for the company. We remain focused on executing against our strategic initiatives while taking actions to drive greater operating leverage. We're excited about our long-term vision for the connected trip and enhancing our offering through technology innovation like generative AI. And with that, we will now take your questions. Operator, will you please open the lines?
Operator: [Operator Instructions] Our first question comes from the line of Mark Mahaney with Evercore.
Mark Mahaney: I was just asking about the European travel conditions, Glenn and Ewout. It sounded like that market may be slowing a little bit but if I'm capturing it right, your performance there seems to have been pretty steady, that sort of indicates market share shifts, market share gains. Any more color on that? Why you would be -- why your performance would be relatively unchanged, I guess, in a slowing European travel market environment?
Glenn Fogel: Mark, it's Glenn. I agree with what you say. I'm very pleased with where we're sitting right now. We've talked in the past about normalization and we're happy with the numbers that we're seeing so far. Your question sort of assumed a softening of the travel business overall. Let's talk about how much and to what extent. Our goal always is to gain share. Whether the market goes up or the market goes down, I can't control demand. I can't control economies. What I can control is how well we can provide value to the travelers and to the suppliers. And as long as we continue to do that, as long as we continue to provide a reason that people should come to us as a traveler or use us as a way to distribute somebody's travel suppliers, we'll continue to gain. And we've seen this in the long run here and I expect to continue to see it in the long run going forward. I can't really give more than that right now.
Ewout Steenbergen: And Mark, if I may quickly build on the answer that Glenn just gave, it's also important to point out that actually our growth in Europe has been quite steady and stable in the period from May through July. So yes, we are seeing some mild moderation but it has been relatively stable over the last couple of months.
Operator: Your next question comes from the line of Kevin Kopelman with TD Cowen.
Kevin Kopelman: Great. Could you maybe give a little bit more color on some of the moderation you're seeing, like other indicators, like length of stay or any trading down activity that you might be seeing? And given that things have started to slow, how do you gain confidence that they're not going to continue to slow both in room nights and rates?
Ewout Steenbergen: Kevin, if you look at the overall conditions of the market, we're not really seeing a trade down on a global basis. So both in terms of the star ratings as well as in the length of stay, it's relatively stable to what we have seen in previous periods. Maybe with one exception is a really mild indication of some trade down in the U.S. but otherwise, globally, we see a very steady picture.
Kevin Kopelman: And a quick follow-up on ad spend dynamics with the deleveraging expected in the third quarter. Is that more of the same in terms of brand and social spend?
Ewout Steenbergen: If you look at deleverage in the third quarter, that mostly relates to SNO and fixed OpEx. Marketing, actually, we expect leverage -- to see leverage in the second half of this year and also from a longer-term perspective because we expect to continue to see some benefit from the expansion in the direct mix. I also would like to point out and we think it's a really positive message for this call, that we are spending more on social media channels. That's a very attractive channel for us where we are expanding now and where we're investing more and we can do that at very attractive incremental ROI. So really an important point to really highlight with respect to our marketing leverage and the success we're gaining there.
Operator: Your next question comes from the line of Justin Post with Bank of America.
Justin Post: Great. Glenn, I'd love to hear your perspective on the travel market, bookings growing 3% to 5%. We know Europe has a really tough comp against reopening last year. Is that kind of how you're thinking about longer-term market growth? Or do you think it's kind of depressed right now on really difficult comps? And then love to hear about alternative accommodations, really, really strong growth there, an increasing percentage. Are you featuring that more on your website? And do you really like the economics of accommodations? How do you feel about those economics versus hotel?
Glenn Fogel: Justin, so two separate questions. One, just going back to the general sense of the travel market. And we talk about this a lot over many, many, many calls about how much we believe that the travel market is best influenced by GDP and that in the long run, GDP goes up, more people travel, more people couldn't travel, get wealthy enough that they can travel, that's a tailwind for us. And we talk about other things. You mentioned the 3% to 5%. I mean, lots of people can come up with whatever way you want in terms of global, what's global GDP? What's it going to do to travel? Numbers aren't that different or some are probably in that neighborhood, then how much additional can we get out of increasing share because we provide a good service. And then, of course, there are the other tailwinds of the off-line to the online, another one that's a point in our favor. All these things together blew the -- the growth algorithm that we've talked about in the past is totally intact. There's going to be volatility, there's going to be variations, there's going to be events are going to happen globally, macro events that happen that can influence a quarter or a week or a day. But in the long run, we just continue to build what we've been trying to build for a long time which is a better service and that's how we do it. And one of the things we've been building and we've been working hard on and I've talked about it for a number of years, how important it is for us to build an alternative accommodations business that will rival anybody's. And we admitted that it was taking us time to build it. We started from behind. Another company may have had a bigger head start on us and building it bigger. We think we've done a really good job of catching up. I love the last call we did a few months ago when we came out and we talked about it, our homes business, our homes business, more than 2/3 of the biggest player in the industry. In that last quarter, we said how we had grown faster, 11 of the last 12 quarters. Now, I don't know if our 12% is going to win or not this time, I don't know. I'm pleased with that growth rate, given the size of the business. And how are we doing it? We're doing it by doing what we do with all things is provide a reason, I said this just to Mark earlier, is that continue to build out a product that gives a person a reason to come and use it. Now I don't really care whether the customer uses a home, or a hotel, or a villa or an igloo. I don't care. I care they get what they want. That's the important thing. And then come back. In terms of the profitability of one versus the other, we can go into that and talk about it but it's not really relevant. Because what's relevant is making sure that they use what they want. We don't try and steer them. We're trying to just make sure they have the best tools to choose what they need in the long run. That's the way we'll win and create a great business.
Operator: And your next question comes from the line of Doug Anmuth with JPMorgan.
Doug Anmuth: Glenn, just curious, first, how you're interpreting the relative tightening of the booking window and what does that tell you about the state of the traveler into the back half? And then just curious, in your outlook, how much are you contemplating? Any impact from the tech issues that we've seen over the last couple of weeks and their impact to airlines as well?
Glenn Fogel: Right. Sure. So the booking window is an interesting thing and we saw it expanding, expanding, expanding and at some point it has to stop, right? I mean, eventually, you can't keep getting bigger and bigger. One of the things I was wondering was why. Why was it expanding? Was it expanding because of inflation and people trying to book early to get that price locked up, afraid that was going to be more expensive down the road. And then now maybe they're thinking well, maybe rates aren't going to keep on increasing, so I can wait. Maybe I'll get a lower price later. I don't know and I haven't done any data to analyze and come up with what the reason is. The fact is, window gets bigger and the window gets smaller. That, of course, influences any particular quarter but in the long run, it all averages out. So I'm not going to worry too much about that. What we do make sure though is make sure that we're spending the right amount of marketing money to try and get the right conversion, do it the right ROI and that's what we continue to do and we're very careful with that. But again, another thing, just like the economies, I can't control what people are going to decide when they want to book. In regard to the tech thing, the tech issues, if you assume you're talking about the horrific events that disrupted travel throughout the world but particularly hit some of our supplier partners significantly. Delta, horrific event and I saw the CEO's interview on Squawk Box and read about what they're planning to do. It's a problem when you have critical infrastructure breaks down and then disrupts millions and millions of people's lives. That's really unfortunate. And hopefully, it won't happen again. Hopefully, people test their products before they put them out into the market. And hopefully, there are backups. Things happen but in travel, we know happens a lot. Certainly, weather happens an awful lot. This is something though that wasn't weather which you can't control, this was making sure that your infrastructure works and will be interesting how that lawsuit turns out. I will point out, it didn't affect us very much though. So we're very pleased about that.
Operator: Your next question comes from the line of Eric Sheridan with Goldman Sachs.
Eric Sheridan: Maybe two questions, if I could. First, following up on sort of the demand environment. When you think about the shift from goods to services that has played out in the economy more broadly in the last couple of years, do you think elements of stability or maybe re-acceleration in terms of demand, it might be down to price? Or do you think it's just time and duration that might have to sort of find a new footing for demand and maybe elements of a potential to return to growth? So will this come down to sort of suppliers and pricing or elements of a new normal and finding a new level. I'm just curious for your perspective there, Glenn. And then in terms of the broader marketing messages, you've been on this journey to sort of rejigger the way you're approaching marketing funnel and driving more direct traffic. What do you see as the key investment priorities built on some of the learnings in the last 12 months that you want to share in terms of how the marketing focus for the company might continue to evolve beyond just 2024?
Glenn Fogel: So the first more generic question about goods versus services and I think your question, I'm trying to narrow it down to, I think what we're really talking about is we saw a change in people's behavior where they seem to value services significantly more than good which, of course, helps someone like us. And I think the question is, is this a permanent change or appears to go back to a balance that they had a few years ago, maybe pre-pandemic. And I think that in the end, again, this is one of those things that I believe but I don't have proof of is that as people get wealthier, you end up spending more money on services. And it ends up a lot because people generally have one home, you got one couch. You don't keep buying more and more but as your wealth increases, you want to do things, you want to enjoy things. And we see that happening. There's also -- there could be something of the Instagram effect where -- and this is a human nature that you want to show off to your friend, to your friends, all the great things you're doing, I think that definitely has some impact because we certainly -- certain parts of the world that people never used to travel to, now they are being overrun and I think that is the Instagram effect there. So that's all good for our business. I don't know how much further it will go, though, because you need to buy homes and you need to buy couches, et cetera. And I don't see that as a big swing but I'm not concerned that it's going to flip back and we're going to end up with lower; that's one. In terms of the marketing, let's talk a couple of these. I just want to repeat this point I made earlier about. One of the things that we -- I'm happy to see is seeing us making some progress in using social. We have a long problem getting that to work for us for many, many years, just didn't seem to work. But now we're seeing, okay, starting to work, getting some good ROIs. Putting more money into it like that and I think they will continue doing that. Another thing we saw that we don't talk a lot about it, I won't get too specific but we saw ourselves using money that we thought was producing a good ROI and we turned out, it really wasn't. And we shut some of these things down. I won't go into exactly what they were. And we said, that's really not hurting us. We said, "Well, that's great." And that's something that over last year or so that we saw some of the benefit in terms of our marketing leverage is coming from that. So, two good things and I'll let Ewout anything else to say about marketing there.
Ewout Steenbergen: Yes, Eric, maybe to give you another perspective. So I'm now 4.5 months with the company. A lot of joy, a lot of pleasure to be here and a great honor. But I'm also, of course, looking at some of the perceptions of the company. I think it's still very much an outdated perception out there that we are largely dependent in terms of sales in our business on the paid channels. Actually, we're emphasizing a lot as you have heard in our calls around the direct mix and being now in the low 60% level for B2C which is really a game changer from my perspective for the company. Also we're very much diversifying our paid channels which is very important because this is a very dynamic world. The paid channels are changing all the time. They are changing their algorithms. But I'm really impressed about the science that the company has behind its paid channels, the algorithms that we are adjusting to optimizing all the time, the way how we spend our paid marketing dollars and how we're investing that. And so it's -- there is not a silver bullet. It's all the time really the details about the optimization, how to get to the highest number of new customers coming to us through the paid channels in the most optimal way with the most attractive ROIs and super impressed how the company is doing that. And I think that gives us really an edge in terms of how we can deal with paid channels also in the future. Operator, I think you are ready for the next question.
Operator: And our next question is from James Lee with Mizuho.
James Lee: Two here. First, on loyalty program. It seems like one of your major peers is having mixed success with their loyalty program. And maybe, Glenn, you can once again talk about how your program is differentiated and that would allow you to have very high rate of repeat bookings? And secondly, on advertising, I noticed that your ad revenue seem to be under monetized at only 0.7% of gross booking. Is that a source of opportunity as you're looking to give -- to take advantage of scale or your reach? And if so, maybe help us understand what areas are you looking to expand?
Glenn Fogel: Yes. Sorry about that. Thinking of the answer. I'm going to let Ewout handle the ad opportunity. I'll talk about our loyalty program, Genius which is the Booking.com program which we talked a little bit about in our prepared remarks. We really haven't talked about it much in terms of numbers in the past but I was just really pleased to be able to talk about our Level 2 and Level 3 players. 30% of our active users -- active travelers are Level 2 or Level 3. And we talked about that gives us more than half of the Booking.com business which is really great. That -- and we talk about how they come back more frequently and they come back more direct. That's the point that it works. And one of the great things about it is, for the most part, we're not paying for it. Our partners are supplying almost all the benefit right now but we talk about we are also putting some benefits at a time. We're going to experiment putting more in ourselves. But it's a great thing. You think why do the suppliers do it? They do it because it gets them incremental demand. It gets them demand when they need it, when they want it. It's very flexible. We work together with them, with these partners, so they can get the demand and the reason they get the demand is because our high Genius level people, our high-spending people and they are going to come and they're going to use those services. It's really a win-win-win. Win for our travelers, win for our partners and win for us. There aren't a lot of people who are doing a program like that. So we think it does differentiate. And I'm really happy to see car rental now doing a lot more of it and we're experimenting with flights. And part of the whole vision of the connected trip the Genius program fitting right into that comes with all different types of permutations of ways to provide better benefits to travelers and use it in a way, a scientific way, a data-driven way. A way using all of our AI capabilities, all the data we have so that we can come up with the best solutions for both sides of the marketplace. That is where -- that's what we're driving to. And I see it happening now in some of the numbers we said, I think gives a little indication. And then, of course, there will be the other thing which is really [ph] advertising opportunities are great. And I'll let Ewout talk a little bit about that.
Ewout Steenbergen: James, thank you for pointing out the advertising revenues because it is indeed a very attractive potential line that gives us an opportunity in terms of growing our revenues in the future. Today, this line is mostly coming from KAYAK and OpenTable but there are opportunities, of course, to think about more advertising income from particularly the apps and the active app use that we're having mostly with Agoda and Booking.com. But as everyone knows, this is a very fine line because if you get too many advertisement as a traveler on an app, where you're interested in something else that can ultimately also become quite annoying. So finding there the optimal point is really important. But overall, you're right, that is an opportunity to help to drive further growth with the company in the future, next to many other opportunities we have because I think that's actually -- the exciting part for us as a business, are not just growing with the market. We have so many opportunities to grow faster if it is alternative accommodations we discussed or the multiple verticals around the connected trip we discussed or growing geographically in Asia, in the U.S. around payments, around generative AI and many other opportunities. So definitely, I would put this on the same list as well.
Operator: Your next question comes from the line of Stephen Ju with UBS.
Stephen Ju: All right. Great. So Glenn, I think I heard you talk in the prepared remarks about connected trips bookings up, I think it was 45% and accounting for a high single-digit percentage of the mix. At this point, is there anything you can share about how the basket size of a particular trip could be moving around and presumably it's up a lot because people are attaching more things. And I guess what the impact to your customer acquisition strategy may be as a result as customer lifetime values go up?
Glenn Fogel: Sure. Well, I won't give specifics but I'll confirm what you say is true, is that somebody buys two things. It's definitely going to be bigger than one thing. And also because they bought more things, as we use the science, as we use our data, as we use all the capabilities we have to come up with, what is the value for that customer? Well, how much should we spend to attract that person is going to change, obviously. And it's also the question is in terms of loyalty. We found and it does make sense, a more satisfied customer is going to come back more often. And people in the connected trip, people who use the connected trip, we do see a higher repeat rate for a connected trip person. And we see them coming direct. And the great thing about the connected trip too is that in the past, with just one vertical which was the hotel business, we were missing on customers who wanted to start with flights and now with flights, people are starting at flights and they come and they buy something else too. And also, it's the convenience factor and that goes into the whole reason why the connected trip. I've heard from people say, "Well, what makes you different?" And the truth is right now, we're semi-different because we don't have the full connected trip done yet, the way I want it to be. But at the end of the day, we all know how frustrating travel is. And we know how much easy it would be if there was just one place, one person who would handle everything for you, put it all together in the way that was the optimal way with all the different things you have to decide upon. And then if anything went wrong, that it would all get fixed. And now with the benefits of GenAI coming out and the progress I see being made with it, I talked to our people in customer service and what we're putting together there, I believe we will create something that truly is differentiating and that will create a reason that people will want to come to us. The more people who come to us, more opportunities we have to work with our partners to provide them opportunities to help build their businesses. Again, I'll get to use it again, I could say win-win-win again, because that's really what we're trying to achieve here.
Operator: And your next question comes from the line of Lee Horowitz with Deutsche Bank.
Lee Horowitz: So the modestly softer travel environment that the industry seems to be expecting in the second half of the year seems to be working through models by way of pricing pressures. I guess, Ewout, can you comment some on how you think about flexing your cost structure going forward to the extent that, say, hotel ADR has become a bigger headwind for the industry and by extension, your adjusted EBITDA margins?
Ewout Steenbergen: Lee, thank you so much for asking the question because we are, at this point in time, really putting much more emphasis on this particular area and looking for more operating leverage for the company in the future. And we should particularly be well positioned to do that because we have the scale. So we should be able to run much more volume over the same fixed infrastructure that we have as a company in the future and take advantage of that. And take advantage of that in the way that we can reinvest in new growth initiatives as well as, of course, also benefiting EBITDA margins and return of capital to our shareholders. So let me give you a couple of examples what we are doing at this moment. We have already done a couple of reorganizations in some of our businesses. We have been looking very carefully at head count, in some places, put a head count pause in place. We are looking at some expense benchmarking in some other brands and businesses, looking at procurement in real estate and many other areas. So more to come on that over the next couple of quarters that I can give you more details. But definitely, this has become a really big focus area. And we are pleased that, therefore, we can also say to you that for the full year guidance, we are now reducing the outlook with respect to fixed OpEx from low to mid-teens to now low double digits. As well as we continue to focus on growing our fixed OpEx at a lower level than the topline growth in 2025.
Lee Horowitz: Really helpful. And then, Glenn, maybe on alternative accommodations, you continue to deliver very healthy supply growth here. Do you feel like you are reaching a point of supply parity relative to your peers in the U.S. specifically, where you can perhaps lean in more aggressively investing against marketing and discounting within this vertical to sort of accelerate share gains?
Glenn Fogel: I have to admit, I don't believe we are at that level at all right now. But that, to me, is an incredible opportunity. The fact that we are performing as well as we are in terms of our overall number but we still do not have anywhere near the number or the type of home accommodations in the U.S. to be fully competitive is, well, it's a disappointment to me that is not done yet. It's an opportunity where we have all this upside still to come. And we won't be spending huge amounts of money on a subpar product. So not to fear. We're not going to do that. What we're going to do instead to spend the money that we're spending now to make sure we get the properties we need, get the things up and running the way we want the product, the way we want it to be. So nobody ever comes to our site and feels disappointed because it wasn't as good as X. That's what we're working on right now. Clearly, the numbers show that we're doing a good job in many parts of the world but the U.S. is, to me, something that is great opportunity. And for people who live in the New York area, you know if you were looking for -- I use this example all the time because I live in the New York area. If you are looking for a rental, you wanted a home in the Hamptons this summer, you came to our site. You probably said, "Jesus, there's not a lot here compared to some other people." I don't want that to be. I want us to have as many, if not more and I want it to be easier for them to come. I want the trust that coming to Booking is a better way to get that summer rental. And we're going to work on that and that's good for us, an opportunity for us. But your answer is correct. We're not there yet.
Operator: Your next question comes from the line of John Colantuoni with Jefferies.
John Colantuoni: You mentioned direct bookings were mid-50% of total and low 60%, excluding B2B which I think implies your B2B mix decreased from last year, if I'm doing the math correctly. In general -- but in general, B2B is a smaller offering relative to your biggest competitor. And I imagine this was a strategic decision but I'm curious why you're less excited about the opportunity in the B2B relative to some of the other players in the space?
Ewout Steenbergen: John, we are not really recognizing that math. And actually, we are really encouraged by the growth of our B2B business as well. You're right that overall, it's a smaller business than some other players in our industry but we have a couple of propositions that are really strong and all of our brands are actually active in the space. Booking.com is active in this space. Priceline with Getaroom, Agoda with Rocket Travel and many other propositions that we have in the market. So it is an important part of our commercial strategy but it is definitely something that is a bit smaller than other players.
John Colantuoni: Great. And maybe a second one on alternative accommodations. I think just broadly speaking, marketing intensity in the alternative space appears to have escalated a bit year-to-date. Talk about Booking's offering and positioning in the vertical and how that positions you to sort of continue delivering impressive growth if the competitive environment continues to ramp over time?
Ewout Steenbergen: John, I think actually, our proposition is unique with respect to alternative accommodations because we are putting both traditional and alternative accommodations on our same platform. So we have the benefit of all our brand marketing spend, all our paid market spend coming together on the same platform and giving the traveler an opportunity to pick and select their best option. Maybe they're coming in and looking for 2 hotel rooms for their family and ending up by booking an apartment with 2 bedrooms and they're very happy with that outcome. As Glenn said earlier, we are actually agnostic about which direction this is taking customers because it is important that they are finding the best option for them, ultimately, how to travel. We're agnostic from an economics perspective about this. And it is all about making sure we have the most attractive proposition in the market. But this is, from our perspective, a differentiator because we are able to bring all of those supply opportunities together on our platforms as a company.
Operator: Your next question comes from the line of Naved Khan with B. Riley Securities.
Naved Khan: Maybe just on this commentary on booking window kind of not expanding as much. Can you maybe just talk about if you're seeing any mix in your cross-border versus domestic bookings and if that might have anything to do with it. And the second question I have is on the U.S. online growth. It seems like it picked up a little bit versus the last quarter. I'm wondering if it was driven by alternative lodging or if that is not the case?
Glenn Fogel: Ewout, why don't you take that first one and then I'll talk a little bit about the U.S. and the increase we saw in the second quarter versus the first quarter.
Ewout Steenbergen: Naved, the way how we look at booking window is, as Glenn actually commented on a couple of minutes ago, to some extent, it doesn't matter for us. It doesn't matter when a traveler actually books because they will travel at a certain point in time. When they travel, they have the experience. And at that point, we will recognize the revenues and the economics to the company. So if you look at the performance of the business over multiple quarters, this is averaging out. If bookers booked earlier or later, ultimately for the same trip and that can really depend on many factors. It can depend on assumptions what will pricing do over time or locking in certain flights or locking in certain accommodations or other factors why bookers might come to us earlier or later for the same trip. But it is important if any investor looks at us from a medium- and long-term perspective, it doesn't matter because over time, it's averaging out and we will deliver the same results for our shareholders and continue to build our business over time with all the opportunities we have.
Glenn Fogel: In regards to the U.S. and trying to distinguish, is it because we did better in homes or we did better hotels or -- I really try and stay away from that a little bit. We're trying to provide a traveler with what they need and provide all the different opportunities, whenever. But I'm very happy in the second quarter, accelerated versus the first quarter for our U.S. business. That's very good, I'm pleased by doing better over the long run. But I'm not going to say it's because we did X, Y or Z. In the end, we have to do well in every single part of this business. That means we've got to provide the homes. Absolutely, I talked about that. We got to be a good partner to the hotels and provide them with the incremental demand they need, when they need it. In addition, the connected trip, we got to make sure we're getting all the inventory we can in terms of flights, to making sure we have that ground transportation. And as I always say, nobody goes on a holiday to hang out in the accommodation. They want to do stuff. So we got to make sure we get our attraction things working well and that we're putting up the right offers to the person that they want, when they want at the right time. And of course, there's all the other things, provide the insurance and tying it all together in our merchant platform which we put in our prepared remarks some of the numbers, very pleased about the increase in that. Glad to see it continuing to go up. Glad because it provides a great convenience. It makes it easier to do a lot of things in the connected trip. All working together to provide the ultimate thing which is having a better experience for the traveler and providing more opportunities for our supplier partners. Glad that we're seeing that we did better in America, I'd like to do even better in the long run. I think America, the U.S. is a great opportunity. We continue to under index there which means for me, that's a place that we can do better.
Operator: This concludes the Q&A session. Yes. That was our last question. Thank you so much. And with that, I will hand the call back over to you, Mr. Fogel for closing remarks.
Glenn Fogel: Thank you. So I want to thank our partners, our customers, our dedicated employees, our shareholders. We greatly appreciate everyone's support as we continue to build on the long-term vision for our company. Thank you very much and good night.
Operator: Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect. |
AMZN | 2 | 2,024 | 2024-08-01 20:24:08 | Operator: Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Second Quarter 2024 Financial Results Conference. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's call is being recorded. And for opening remarks, I will be turning the call over to the Vice President of Investor Relations, Dave Fildes. Thank you, sir. Please go ahead.
Dave Fildes: Hello, and welcome to our Q2 2024 financial results conference call. Joining us today to answer your questions is Andy Jassy, our CEO, and Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2023. Our comments and responses to your questions reflect management's views as of today, August 1s, 2024 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic and geopolitical conditions and customer demand and spending, including the impact of recessionary fears, inflation, interest rates, regional labor market constraints, world events, the rate of growth of the internet, online commerce, cloud services, and new and emerging technologies, and the various factors detailed in our filings with the SEC. Our guidance assumes, among other things, that we don't conclude any additional business acquisitions, restructurings, or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance. And now, I'll turn the call over to Andy.
Andy Jassy : Thanks, Dave. Today, we're reporting $148 billion in revenue, up 11% year-over-year, excluding the impact from foreign exchange rates. Operating income was $14.7 billion, up 91% year-over-year, and trailing 12-month free cash flow adjusted for equipment finance leases was $51.4 billion, up 664% or $44.7 billion year-over-year. As I think about what matters to customers long-term and, therefore, to Amazon, there's a lot to like about what we're seeing. Starting with AWS, year-over-year revenue growth accelerated again from 17.2% in Q1 to 18.8% in Q2. We're continuing to see three macro trends drive AWS growth. First, companies have completed the significant majority of their cost optimization efforts and are focused again on new efforts. Second, companies are spending their energy again on modernizing their infrastructure and moving from on-premises infrastructure to the cloud. This modernization enables builders to save money, innovate at a more rapid clip, and drive productivity in most companies' scarcest resources, developers. This is the flip I've talked about in the past, where the vast majority of global IT spend today is on-premises, and we expect that to keep inverting over time. With the broadest functionality, the strongest security and operational performance, and the deepest partner ecosystem, AWS continues to be customers' partner of choice and the biggest beneficiary of this flip from on-premises to the cloud. And third, builders and companies of all sizes are excited about leveraging AI. Our AI business continues to grow dramatically with a multi-billion dollar revenue run rate despite it being such early days, but we can see in our results and conversations with customers that our unique approach and offerings are resonating with customers. At the heart of this strategy is a firmly held belief, which we've had since the beginning of AWS, that there is not one tool to rule the world. People don't want just one database option or one analytics choice or one container type. Developers and companies not only reject it, but are suspicious of it. They want multiple options for flexibility and to use the best tool for each job to be done. The same is true in AI. You saw this several years ago when some companies tried to argue that TensorFlow would be the only machine learning framework that mattered, and then PyTorch and others overtook it. The same one model or one-chip approach dominated the earliest moments of the generative AI boom, but we have a lot of data to suggest this is not what customers want here either. And our AWS team is determined to deliver choice and options for customers. You can see this philosophy in the primitive building blocks we're building at all three layers of the Gen AI stack. At the bottom layer, which is for those building generative AI models themselves, the cost to compute for training and inference is critical, especially as models get to scale. We have a deep partnership with NVIDIA and the broadest selection of NVIDIA instances available, but we've heard loud and clear from customers that they relish better price performance. It's why we've invested in our own custom silicon in Trainium for training and Inferentia for inference. And the second versions of those chips, with Trainium coming later this year, are very compelling in price performance. We're seeing significant demand for these chips. These model builders also desire services that make it much easier to manage the data, construct the models, experiment, deploy to production, and achieve high-quality performance, all while saving considerable time and money. That's what Amazon SageMaker does so well, including its most recently launched feature called HyperPods that changes the game and networking performance for large models. And we're increasingly seeing model builders standardized on SageMaker. While many teams will build their own models, lots of others will leverage somebody else's frontier model, customize it with their own data and seek a service that provides broad model selection and great generative AI capabilities. This is what we think of as the middle layer, what Amazon Bedrock does and why Bedrock has tens of thousands of companies using it already. Bedrock has the largest selection of models, the best generative AI capabilities in critical areas like model evaluation, guardrails, RAG and agenting, and then makes it easy to switch between different model types and model sizes. Bedrock has recently added Anthropic's Claude 3.5 models, which are the best performing models on the planet. Meta's new Llama 3.1 models and Mistral's new Large two models. And Lama's and Mistral's impressive performance benchmarks in open nature are quite compelling to our customers as well. At the application or top layer, we're continuing to see strong adoption of Amazon Q, the most capable generative AI powered assistant for software development and to leverage your own data. Q has the highest known score and acceptance rate for code suggestions, but it does a lot more than provide code suggestions. It tests code, outperforms all other publicly benchmarkable competitors on catching security vulnerabilities and leads all software development assistants on connecting multiple steps together and applying automatic action. It also saves development teams time and money on the muck nobody likes to talk about. For instance, when companies decide to upgrade from one version of a framework to another, it takes development teams many months, sometimes years, burning valuable opportunity costs and churning developers who hate this tedious, though important work. With Q's code transformation capabilities, Amazon has migrated over 30,000 Java JDK applications in a few months, saving the company $260 million and 4,500 developer years compared to what it would have otherwise cost. That's a game changer. And think about how this Q transformation capability might evolve to address other elusive but highly desired migrations. During the past 18 months, AWS has launched more than twice as many machine learning and generative AI features into general availability than all the other major cloud providers combined. This team is cooking, but we're not close to being done adding capabilities for our customer's usage base. For perspective, we've added over $2 billion in advertising revenue year-over-year and generated more than $50 billion in revenue in the trailing 12 months. Sponsored ads drive the majority of our advertising revenue today and we see further opportunity there. Even with this growth, it's important to realize we're at the very beginning of what's possible in our video advertising. In May, we made our first appearance at the upfronts and were encouraged by the agency and advertiser feedback on the differentiated value we offer across our content, reach, signals, and ad tech. With ads and prime video, the exciting opportunity for brands is the ability to directly connect advertising that's traditionally been focused on driving awareness, as is the case for TV, to a business outcome, like product sales or subscription signups. We're able to do that through our measurement and ad tech, so brands can continually improve the relevance and performance of their ads. While ads have become the norm in streaming video, we aim to have meaningfully fewer ads than linear TV and other streaming TV providers. And of course, for customers preferring an ad-free experience, we offer that option for an additional $2.99 a month. In our stores business, we saw growth of 9% year-over-year in the North America segment and 10% year-over-year in the international segment. A few notes on our North America revenue growth rate. First, last quarter's leap day added about 100 basis points of year-over-year growth. Second, we're seeing lower average selling prices, or ASPs, right now because customers continue to trade down on price when they can. More discretionary higher ticket items, like computers or electronics or TVs, are growing faster for us than what we see elsewhere in the industry, but more slowly than we see in a more robust economy. And our continued faster delivery speed is earning us more of our customers' everyday essentials business. Third, our seller fees are a little lower than expected given the behavior changes we've seen from our latest fee changes. While some of these issues compress short-term revenue, we generally like these trends. While consumers are being careful on price, our North America unit growth is meaningfully outpacing our sales growth as our continued work on selection, low prices, and delivery is resonating. So far this year, our speed of delivery for prime customers has been faster than ever before, with more than 5 billion units arriving the same day or next day. As more customers experience our fast delivery, they look to Amazon for more of their shopping needs, and the continued acceleration of our everyday essentials business is an example of this phenomenon. On seller fees, lowering apparel fees has spurred substantial year-over-year unit growth in apparel. And the incentive we've given sellers to send their items to multiple Amazon inbound facilities so they can save money where they save us effort and money is getting more traction than we even hoped. These collective developments will benefit customers in the form of better selection, lower prices, and faster delivery speed. There's no shortage of ideas aimed in improving the experience for stores' customers. For instance, we're adding even more value to Prime, recently introducing free restaurant delivery in many of our geos, expanding Amazon's PharmacyRx pass to Medicare members. This is a benefit that gives subscribers all you can consume access to the most common generic medications for just $5 a month, and offering a grocery subscription to help save on grocery items when shopping our U.S. and UK fresh stores. As we pursue these initiatives, we remain focused on lowering our cost to serve. We have a number of opportunities to further reduce costs, including expanding our use of automation and robotics, further building out our same-day facility network, and regionalizing our inbound network. With more optimal inbound inventory placement, we expect to enable faster speeds, consolidate more orders in one box, and reduce inventory transfers once items reach a fulfillment center. These cost improvements won't happen in one quarter or one fell swoop. They take technology and process innovation with a lot of outstanding execution, but we see a path to continuing to lower our cost to serve, which as we've discussed in the past, has very meaningful value for customers in our business. As we lower our cost to serve, we can add more low ASP selection that we can support economically, which coupled with our fast delivery, puts Amazon in the consideration set for increasingly more shopping needs for customers. A few other comments about areas in which we're investing. We remain very bullish on the medium to long-term impact of AI in every business we know and can imagine. The progress may not be one straight line for companies. Generative AI especially is quite iterative, and companies have to build muscle around the best way to solve actual customer problems. But we see so much potential to change customer experiences. We see it in how our generative AI-powered shopping assistant Rufus is helping customers make better shopping decisions. We see it in how our AI features that allow customers to simulate trying apparel items or changing the buying experience. We see it in how our generative AI listing tool is enabling sellers to create new selection with a line or two of text versus the many forms previously required. We see it in our fulfillment centers across North America where we're rolling out Project Private Investigator, which uses a combination of generative AI and computer vision to uncover defects before products reach customers. We see it in how our generative AI is helping our customers discover new music and video. We see it in how it's making Alexa smarter. And we see it in how our custom silicon and services like SageMaker and Bedrock are helping both our internal teams and many thousands of external companies reinvent their customer experiences and businesses. We are investing a lot across the board in AI, and we'll keep doing so as we like what we're seeing and what we see ahead of us. We also continue to like the progress in Prime Video. Our storytelling is resonating with our hundreds of millions of monthly viewers worldwide, and the 62 Emmy nominations Amazon MGM Studios recently received is another supporting data point. We recently debuted titles like Fallout, the second most watched original title ever for Prime Video, The Idea of You, which attracted nearly 50 million viewers worldwide in the first two weeks on Prime Video, and Season 4, The Boys, which reached number one on Prime Video in 165 countries in its opening two weeks. And we continue to see momentum in live sports. We recently announced 11-year landmark deals with the NBA and the WNBA. When combined with our original films and shows, partner streaming services, licensed content, and rent or buy titles, Prime Video continues to evolve into the best destination for streaming video. And for Project Kuiper, our low-Earth orbit satellite constellation, we're accelerating satellite manufacturing at our facility in Kirkland, Washington. We've announced a distribution agreement with Vrio, who distributes direct TV Latin America and Sky Brazil to offer Project Kuiper's satellite broadband network to residential customers across seven countries in South America, and we continue to feel significant demand for the service from enterprise and government entities. We expect to start shipping production satellites late this year and continue to believe this could be a very large business for us. I could go on, but we'll stop here. There's a lot to feel optimistic about over the next several years and the team collectively remains focused on continuing to invent and deliver for our customers in the business. With that, I'll turn it over to Brian for a financial update.
Brian Olsavsky : Thanks, Andy. Let's start with our top line financial results. Worldwide revenue was $148 billion, an 11% increase year-over-year, excluding the impact of foreign exchange. This equates to a $1 billion headwind from foreign exchange in the quarter, which is about $300 million higher than we'd anticipated in our Q2 guidance range. Worldwide operating income nearly doubled year-over-year to $14.7 billion, which was $700 million above the high end of our guidance range. Across all of our segments, we remain focused on managing costs in a way that allows us to continue innovating and investing in areas that we think could move the needle for our customers. Starting with the North American international segments, customers continue to respond positively to our focus on low prices, broad selection, and fast shipping offers. We delivered at our fastest speeds ever so far this year, which helps drive strength in areas like our everyday essentials. These include items like non-perishable foods, as well as health, beauty, and personal care items. And Prime members continue to increase their shopping frequency while growing their spend on Amazon. Overall unit sales grew 11% year-over-year, which is consistent with our growth rates in Q1 after you adjust for the approximately 100 basis point impact of leap year. North America segment revenue was $90 billion, an increase of 9% year-over-year. And international segment revenue was $31.7 billion, an increase of 10% year-over-year, excluding the impact of foreign exchange. North America segment operating income was $5.1 billion, an increase of $1.9 billion year-over-year. Operating margin was 5.6%, up 170 basis points year-over-year, and down 20 basis points quarter over quarter. If we look at profitability of the core North America stores business, we actually improved our margin again quarter-over-quarter in Q2. The overall North America segment operating margin decreased slightly due to increased Q2 spend in some of our investment areas, including Kuiper, where we're starting to manufacture satellites we'll launch into space in Q4. We saw improvements in our cost to serve, driven by our efforts to place inventory more regionally, closer to where our customers are. This resulted in more consolidated shipments, with higher units per box shipped. We also saw packages traveling shorter distances to customers, and this also led to better on-road productivity in our transportation network. Our international segment was profitable again in Q2, with operating income of $300 million, an improvement of $1.2 billion year-over-year. Operating margin was 0.9%, up 390 basis points year over year. This increase is primarily driven by our established countries, as we improve our cost structure with better inventory placement and more consolidated shipments. Additionally, our emerging countries continue to expand their customer offerings, leverage their cost structure, and invest in expanding prime benefits. We are pleased with the overall progress of these countries as they make strides on their respective paths to profitability. Advertising remains an important contributor to profitability in the North America and international segments, and we saw strong growth on an increasing larger revenue base this quarter. We continue to see opportunities that further expand our offering in areas that are driving growth today, like sponsored products, as well as newer areas, like Prime Video ads. Moving next to our AWS segment, revenue is $26.3 billion, an increase of 18.8% year-over-year, excluding the impact of foreign exchange. AWS now has an annualized revenue run rate of more than $105 billion. During the second quarter, we saw continued growth across both generative AI and non-generative AI workloads. We saw companies turn their attention to newer initiatives, bring more workloads to the cloud, restart or accelerate existing migrations from on-premises to the cloud, and tap into the power of generative AI. AWS operating income was $9.3 billion, an increase of $4 billion year-over-year. It's driven by our continued focus on cost control, including a measured pace of hiring. Additionally, AWS operating margin includes an approximately 200 basis point favorable impact from the change in the estimated useful life of our servers that we instituted in Q1. As we've long said, we expect AWS operating margins to fluctuate over time, driven in part by the level of investments we're making at any point in time. We remain focused on driving efficiencies across the business, which enables us to invest to support the strong growth we're seeing in AWS, including generative AI. Now let's turn our attention to capital investments. As a reminder, we define these as a combination of CapEx plus equipment finance leases. For the first half of the year, CapEx was $30.5 billion. Looking ahead to the rest of 2024, we expect capital investments to be higher in the second half of the year. The majority of the spend will be to support the growing need for AWS infrastructure as we continue to see strong demand in both generative AI and our non-generative AI workloads. For the third quarter, specifically, I'd highlight a few seasonal factors to keep in mind. First, we hosted another successful Prime Day in mid-July. It was our 10th Prime Day and was our largest ever. Prime members globally saved billions of dollars on deals across every product category. From a profitability perspective, we've historically seen a headwind to operating margin in Q3, driven by Prime Day deals, as well as the marketing spend surrounding the event. Additionally, in Q3, we also begin to ramp up our capacity to handle Q4 holiday volumes in our fulfillment network. And lastly, we expect an increase in digital content cost quarter-over-quarter from the return of our NFL Thursday Night Football. We remain heads down, focused on driving a better customer experience. We believe putting customers first is the only reliable way to create lasting value for our shareholders. With that, let's move on to your questions.
Operator: At this time, we will now open the call up for questions. [Operator Instructions] And our first question comes from the line of Eric Sheridan with Goldman Sachs. Please proceed with your question.
Eric Sheridan: Thanks so much for taking the question and thanks for all the detail and the prepared remarks. Maybe a two-parter on AWS. There's been a theme during the last couple of weeks of earnings of the potential to over-invest as opposed to under-invest in AI as a broad theme. I'm curious, Andy, if you have a perspective on that in terms of thinking about elements of capitalizing on the theme longer term against the potential for pace or cadence of investment on AWS as a segment. And the second part would be coming back to your comments on custom silicon. How do you feel about custom silicon, both from a pace of investment and then more broadly, how you think about it as a return profile on a pivot to more custom silicon in your portfolio over the medium to long term? Thanks so much.
Andy Jassy : Thanks, Eric. I'll take them in order. I think on the question about investment in AWS and on the AI side, I think where I'd start is, I think one of the least understood parts about AWS over the last 18 years has been what a massive logistics challenge it is to run that business. If you think about the fact that we have about 35 regions and think of a region as multiple -- a cluster of multiple data centers and about 110 availability zones, which is roughly equivalent to a data center, sometimes it includes multiple. And then if you think about having to land thousands and thousands of SKUs across the 200 AWS services in each of those availability zones at the right quantities, it's quite difficult. And if you end up actually with too little capacity, then you have service disruptions, which really nobody does because it means companies can't scale their applications. So most companies deliver more capacity than they need. However, if you actually deliver too much capacity, the economics are pretty woeful and you don't like the returns of the operating income. And I think you can tell from having -- we disclosed both our revenue and our operating income in AWS that we've learned over time to manage this reasonably well. And we have built models over a long period of time that are algorithmic and sophisticated that land the right amount of capacity. And we've done the same thing on the AI side. Now AI is newer. And it's true that people take down clumps of capacity in AI that are different sometimes. I mean -- but it's also true that it's not like a company shows up to do a training cluster asking for a few hundred thousand chips the same day? Like you have a very significant advance signal when you have customers that want to take down a lot of capacity. So while the models are more fluent, it's also true that we've built, I think, a lot of muscle and skill over time in building these capacity signals and models. And we also are getting a lot of signal from customers on what they need. I think that it's -- the reality right now is that while we're investing a significant amount in the AI space and in infrastructure, we would like to have more capacity than we already have today. I mean we have a lot of demand right now. And I think it's going to be a very, very large business for us. On the custom silicon point, yeah, it's really interesting what's happened here. And it's also -- our strategy and approach here has been informed by running AWS for 18 years. When we started AWS, we had and still have a very deep partnership with Intel on the generalized CPU space. But what we found from customers is that they -- when you find a -- an offering that is really high value for you and high return, you don't actually spend less, even though you're spending less per unit, you spend less per unit, but it enables you and free you up to do so much more inventing and building for your customers. And then when you're spending more, you actually want better price performance than what you're getting. And a lot of times, it's hard to get that price performance from existing players unless you decide to optimize yourself for what you're learning from your customers and you push that envelope yourself. And so we built custom silicon in the generalized CPU space with Graviton, which we're on our fourth model right now. And that has been very successful for customers and for our AWS business is it saves customers about -- up to about 30% to 40% price performance versus the other leading x86 processors that they could use. And we saw the same trend happening about five years ago in the accelerator space in the GPU space, where the products are good, but there was really primarily one provider and supply was more scarce than what people wanted. And people -- our customers really want improved price performance all the time. And so that's why we went about building Trainium, which is our training chip and Inferentia, which is our inference chip, which we're on second versions of both of those, they will have very compelling relative price performance and in a world where it's hard to get GPUs today, the supply is scarce and all the schedules continue to move over time. Customers are quite excited and demanding at a high clip. Our custom silicon, and we're producing it as fast as we can. I think that's going to have very good return profile just like Graviton has and I think it will be another differentiating feature around AWS relative to others.
Operator: And our next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question.
Brian Nowak : Thanks for the questions. I have two. So the first one I wanted to ask about in the second quarter, the retail gross margins that we're trying to do the monkey math, look a little weaker than expected. Was there any extra pressure on retail gross margins because of discounting? Or is that where Kuiper is? Or sort of how do we think about some of the drivers of retail gross margins in the quarter at shipping? And the second one, Andy, in the past, you talked about cost to serve improvement and sort of getting the North America margins back to pre-pandemic levels. Can you just remind us again sort of the internal philosophy about executing on that? Is there a time line to deliver on that? Sort of how are you sort of balancing showing that profitability improvement over the next couple of years versus pressing on new investments like Kuiper and perhaps reinvesting some of those profits over the next couple of years?
Andy Jassy : Brian, let me start with the first question on North America margins. So if you look at the segment operating margins, we did decrease 20 basis points sequentially from Q1 to Q2. I'll remind you that we have - see the annual step-up in stock-based compensation at the end of Q1 each year, and that added about $1.8 billion of stock-based comp expense in Q2 versus Q1. So that's impacting to some extent, all three segments. But even with that stock-based comp step up, the stores part of the North America segment, increase the margin again last quarter. So we're continuing to see strong improvements in cost to serve as well as improvement in speed, added selection, better safety. So a lot of the key areas that we're hitting on are strong. What you're seeing for the segment is that some of our investment areas had a tick up in expenses and investment in Q2 versus Q1. And that's not unheard of. Q1 is usually the lightest investment quarter, things like Prime Video and devices have less investment going on in those quarters. But the one thing I'd point out, I think we mentioned it is Kuiper stepping up a bit in Q2 versus Q1 as we start to build satellites that we'll launch in Q3 and Q4 this year. And your second question, Brian, I continue and the team continues to believe that we have the opportunity to expand the margin in our stores business. And as I've said on a number of the calls that we've done, it's not going to happen in one quarter, it's not going to happen in one fell swoop, it's going to take work over a long period of time. But I think that one of the silver linings, if you will, about year and half ago in the ricochet of the pandemic and all the growth that we had and the cost to serve challenges that we had was, it really forced us to reevaluate everything in the network. And really, even our most closely felt beliefs over a long period of time. And what it did was unveiled a number of opportunities that we believe we have to keep driving cost to serve down. And the first one that you've seen play out over the last year or so has been the regionalization of the U.S. network. And I think one thing to remember about that is that while it's had even bigger impact than maybe we theorized when we first architected it, we're still not done fully honing it. There's a lot of ways that we continue to optimize that U.S. regionalization that we think will continue to bear lower cost to serve. But at the same time, we found a number of other areas where we believe we can take our cost down while also improving the customer experience. One of the great things about regionalization was it not only took our cost to serve down, but it meaningfully changed the speed with which we're able to get items to customers. And so we have a number of those other opportunities. Another example of that is regionalizing our inbound network, which is also going to lower our cost to serve and get items more close to end users and diminish the amount of time it takes to get them to customers. We have a number of things that we're working on that allow us to combine more units per box, which lowers our costs as well and a lot of customers like that better because it's better for the environment, having more units per box. So I think we have a lot of opportunities to continue to take down our cost to serve. And strategically and philosophically, just two other things as you were alluding to that question. I think that from our perspective, as we're able to take cost to serve down, it means that we're able to afford to have more selection that we're able to offer to customers. And there are a lot of lower ASP items there, average selling price items that we don't stock because they're not economic to stock with our current cost to serve. But as we work hard to make progress like we are on lowering our cost to serve, that allows us to add more selection. And we see this time in and time out that we -- when we add more selection, customers actually consider us for more of their purchases and spend more with us down the line. I think the other thing, too, I would tell you is that I don't see it as being binary in any way, nor have I really ever seen it this way in the history of the company. I've been here 27 years. But we don't think of it as we can either be investing or we can be working on trying to take our cost to serve down. We believe we can do both. If you think about the examples you gave, the stores business and the Kuiper business are -- they're just different people working on those businesses. So our stores team is going to continue to work really hard on expanding selection and keeping prices low and speeding up our delivery times and driving our cost to serve down while our Kuiper team is working on how to figure out how to help the 400 million to 500 million households around the world who don't have broadband connectivity get that connectivity and allow them to do a lot of the things we take for granted today with broadband connectivity. So they're not going to be binary. We're going to work on them both at the same time.
Operator: And our next question comes from the line of Mark Mahaney with Evercore. Please proceed with your question.
Mark Mahaney : Hey, thanks so much. Two questions. AWS, those three factors that are causing that kind of acceleration in Q2 and recovery in growth rates from a year ago, those sound sustainable? Is there any reason that we shouldn't see sort of ongoing acceleration at some level through the back half of the year? And secondly, I just want to ask about a small segment of pharmacy. It seems to me like at least anecdotally I seem to lean more into marketing for that and survey work suggests to us that there's kind of greater consumer interest in that. Just talk about where that business is for you? And is it at a point where you feel like you move beyond early adoption and are leaning into kind of getting more mass Amazon customer adoption? Thank you.
Andy Jassy : On the AWS question, it's always hard to predict what the growth rates are going to be, and it's a relatively large business at $105 billion revenue run rate at this point. But I do think that we have seen the lion's share of the cost optimization happen. And I also do believe that pre-pandemic, we were on this March where most companies are trying to figure out how to modernize their infrastructure, which really means moving from on-premises to the cloud because they can save money and invent that more quickly and get better developer productivity. And then the pandemic happen and people were in survival mode and then a difficult economy came and people are trying to save money. And we just see people going back to asking themselves, why aren't we taking this low hanging fruit here. I mean it makes -- I don't want to run my own data centers. I can actually be more cost-effective and invent more quickly from my customers if I'm using the cloud. And AWS with just a lot more functionality, stronger operational performance and security, which really matters to customers as well and a deeper partner ecosystem continues to be the partner of choice as people are moving to the cloud. And I think the generative AI component is in its very early days. It's -- as I said, we kind of sometimes look at it and say that it's interesting that we have a multibillion-dollar revenue run rate already in AI, and it's so early. But if we look at the amount of demand that we have from customers right now, it's very significant. So I think all three of those things have a chance and will likely continue over time. And we'll see where that growth rate nets out over the next number of years. I think that -- the one other thing I would say about that, too, Mark, is that -- the business today, as I mentioned, it's a $105 billion revenue run rate business, about 90% of the global IT spend is still on premises. And if you believe that equation is going to flip, which I do, there's a lot of growth ahead of us in AWS as the leader in all those dimensions I mentioned. But I also think that generative AI itself and AI as a whole it's going to be really large. I mean it is not something that we originally factored when we were thinking about how large AWS could be and unlike the non-AI space, where you're basically taking all of this infrastructure that's been built on premises over a long period of time and working with customers to help them migrate it to the cloud, which is a lot of work, by the way. In the generative AI space, it's going to get big fast and it's largely all going to be built from the get-go in the cloud, which allows the opportunity for those businesses to continue to grow. On the pharmacy side, I think you're right that you're seeing that business continue to grow and to get more resonance with customers. And I think it was always a relatively natural extension for us to build a pharmacy offering from our retail business. But I think a lot of what you see in the business has grown really quickly, a lot of what you've seen is that the work that the team has done on the customer experience over the last 18 months has really paid off. Customers love the customer experience of Amazon Pharmacy. And especially, by the way, when you think about the experience and the speed and ease with which you can order versus walking into a pharmacy in a physical store, if you walk into pharmacies and -- in cities today, it's a pretty tough experience with how much is locked behind cabinets, where you have to press a button to get somebody to come out and open the cabinets for you and a lot of shop lifting going on in the stores. So the combination of what's happening in the physical world and how much improved we've made our pharmacy experience is driving a lot of customer resonance and buying behavior. I think also you see us continuing to expand there. We expanded our RxPass package and program to Medicare members, that program allows customers and members to be -- Prime members to be able to get up to 60 common medications for just $5 a month. And we continue to launch same-day delivery of medications to cities. We have them in 8 cities, including Los Angeles and New York today with plans to expand to more than a dozen cities by the end of the year. So we're seeing a lot of growth there, and we're very optimistic about it.
Operator: And our next question comes from the line of Brent Thill with Jefferies. Please proceed with your question.
Brent Thill : On AWS, I'm curious if you had a backlog number you could share for the quarter. And I guess, Andy, when you think about getting the data state ready, I know AI today is early, but when you see most of these companies are having to move to public cloud, are you seeing a step-up in return to workloads moving to get ready for this day to stay even if they're not ready to adopt AI? What are you seeing in those sales motions? Thank you.
Dave Fildes : This is Dave. I'll just start off just to give you the backlog figure. So at the end of the second quarter, it was $156.6 billion. So that's up about 19% year-over-year.
Andy Jassy : On the second part of your question, Brent, what I would say is that it's true in analytics, but it's even maybe more so true in AI, which is that it's quite difficult to be able to do AI effectively if your data is not organized in such a way that you can access that data and run the models on top of them and then build the application. So when we work with customers, and this is true both when we work directly with customers as well as when we work with systems integrator partners, everyone is in a hurry to get going on doing generative AI and one of the first questions that we ask is show us where your data is, show us what your data lake looks like, show us how you're going to access that data. And there's very often work associated with getting your data in the right shape and in the right spot to be able to do generative AI. Fortunately, because so many companies have done the work to move to the cloud, there's a number of companies who are ready to take advantage of AI, and that's where we've seen a lot of the growth. But also it's worth remembering that again, remember the 90% of the global IT spend being on premises, there are a lot of companies who have yet to move to a cloud, who will, and the ability to use AI more effectively is going to be one of the many drivers in doing so for them.
Operator: And the next question comes from the line of John Blackledge with TD Cowen. Please proceed with your question.
John Blackledge : Great. Two questions. First, the AWS op income margins were strong, again, mid-30% area. Just kind of what were the key drivers? And how should we think about AWS margins in the back half of the year? And then the international op income margin stepped down a bit Q-over-Q. Just curious about that. Thank you.
Brian Olsavsky : Yeah. Thank you, John. Let me start with AWS profitability. So yes, the margin is in the mid-30% range in Q2. It's up from the mid-20% range last year. So you're seeing the impact of a number of cost reductions that we've made and efficiencies we've driven in the business. There's also an adjustment that we made to the useful life of servers that happened in Q1. Talked about last quarter, that contributed about 200 basis points of margin year-over-year. So we continue to work on the cost structure. But again, as we've said in the past, these operating margin will fluctuate and be lumpy quarter-to-quarter. We are -- continue to work to build new products that attract new customers and work on our efficiencies. Second question was?
John Blackledge : International segment margin.
Dave Fildes : Yeah, this is Dave. Just real quick on that. You mentioned we're about $300 million profit for the quarter. That is up about 390 basis points year-on-year from a margin perspective. And as we talked about in the past, there's a number of countries that different stages of existence and maturity there. And so I think you're seeing continued progress, certainly on a year-over-year basis with both our established countries. So the UK, Germany and Japan in particular, being sizable contributors to that business, continued improvement and build out there, similar to the factors we talked about with the U.S., focused on operational efficiency while expanding the customer experience. And then in the emerging countries, as we've said over the past several quarters, we launched about 10 countries over the last seven years really focused on, again, expanding that customer experience, building out the Prime member benefits while building scalable solutions for customers. And so I think in both that established and emerging areas, seeing good progress year-over-year in working for further improvement there.
Operator: And our final question will come from the line of Doug Anmuth with JPMorgan. Please proceed with your question.
Doug Anmuth : Thanks for taking the questions. You factored in some macro indiscretionary pressures into your 2Q guide, especially in Europe, and I think you called out computers, electronics and maybe TVs in 2Q as well. I’m just curious, were the macro trends generally as you expected? Or did you see softening through the quarter? And kind of how does that influence your 3Q outlook? And then separately, Brian, can you help us quantify the incremental investment around Kuiper that you talked about? Thank you.
Brian Olsavsky : Yeah, sure. Thank you, Doug. The macro factors, if I step back, I think Andy discussed it earlier as well. We're seeing a lot of the same consumer trends that we have been talking about for the last year. Consumers being careful with their spend, trading down, looking for lower ASP products, looking for deals. That continued into Q2, and we expect it to continue into Q3. We're seeing signs of it continuing in Q3. The difference in Q2 was that, again, we had very strong unit volume growth. We actually slightly accelerated when you adjust for leap year in North America unit growth in Q2. So the drop in revenue sequentially -- revenue growth sequentially was tied to ASP and both continuation of existing trends, but also as we talked about growth in our everyday essentials business and categories. So while we think we are selling a number of higher ticket items, certainly and holding up well in the market itself, certainly not as strong as it's been in a normalized economy. And -- so it's -- lower ASP products are more of the mix right now. And we like that because, again, our speed allows us to deliver, especially everyday essentials, quickly, and we'd like to be in the consideration set for consumers on those items. We're not going to quantify Kuiper today, but thank you for your question.
Dave Fildes : And thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website for at least three months. We appreciate your interest in Amazon and look forward to talking with you again next quarter. |
AAPL | 3 | 2,024 | 2024-08-01 19:36:04 | Suhasini Chandramouli: Good afternoon and welcome to the Apple Q3 Fiscal Year 2024 Earnings Conference Call. My name is Suhasini Chandramouli, Director of Investor Relations. Today's call is being recorded. Speaking first today is Apple’s CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation, and future business outlook including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed Annual Report on Form 10-K and the Form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks.
Tim Cook : Thank you Suhasini. Good afternoon everyone and thanks for joining the call. Today, Apple is reporting a new June quarter revenue record of $85.8 billion, up 5% from a year ago and better than we had expected. EPS grew double digits to $1.40 and achieved a record for the June quarter. We also set quarterly revenue records in more than two dozen countries and regions, including Canada, Mexico, France, Germany, the UK, India, Indonesia, the Philippines, and Thailand. And we set an all-time revenue record in services which grew 14%. At our Worldwide Developers Conference, we were thrilled to unveil game-changing updates across our platforms, including Apple Intelligence. Apple Intelligence builds on years of innovation and investment in AI and Machine Learning. It will transform how users interact with technology, from writing tools to help you express yourself, to image playground, which gives you the ability to create fun images and communicate in new ways, to powerful tools for summarizing and prioritizing notifications. Siri also becomes more natural, more useful, and more personal than ever. Apple Intelligence is built on a foundation of privacy, both through on-device processing that does not collect users' data and through private cloud compute, a groundbreaking new approach to using the cloud, while protecting users' information powered by Apple silicon. We are also integrating ChatGPT into experiences within iPhone, Mac, and iPad, enabling users to draw on a broad base of world knowledge. We are very excited about Apple Intelligence and we remain incredibly optimistic about the extraordinary possibilities of AI and its ability to enrich customers' lives. We will continue to make significant investments in this technology and dedicate ourselves to the innovation that will unlock its full potential. Recently, we've also been excited to bring Apple Vision Pro to more countries, giving customers the chance to discover the remarkable capabilities of this magical device. Vision Pro users are customizing their own workspaces, watching movies on 100-foot screens, and exploring entire worlds with just a pinch of their fingertips. With more than 2,500 native spatial apps and 1.5 million compatible apps for Vision OS, the developer community continues to pioneer stunning spatial experiences that are only possible with Vision Pro. Last month, we announced that we're bringing some amazing new immersive content to Vision Pro, including new series, concerts, films, and more. And we've seen great interest for Vision Pro in the enterprise, where it can empower companies large and small to pursue their best ideas like never before. With each innovation, we're unlocking new ways of working, new ways of learning, and new ways of tapping into the unlimited promise of human potential. We are doing that across every product and every service. Now let me share more detail in our June quarter results, beginning with iPhone. iPhone revenue was $39.3 billion, down 1% year-over-year. On a constant currency basis, we grew compared to last year. Customers continue to praise the iPhone 15 lineup for its incredible battery life, exceptional cameras, and unmatched power and performance. And we are excited to bring incredible new features to the iPhone with iOS 18, making it more personal, capable, and intelligent than ever before. This update includes the biggest redesign of the Photos app, new customization options for the home screen, messages over satellite, and the introduction of Apple Intelligence. Apple Intelligence utilizes the power of our most advanced iPhones, the iPhone 15 Pro and Pro Max, offering a transformative set of capabilities. Mac revenue was $7 billion, up 2% from a year ago. Customers are loving the latest M3-powered 13 and 15 inch MacBook Air. With back-to-school season upon us, MacBook Air is the perfect companion for students on campus and small business owners, developers, and creatives of all kinds depend on Mac to do more than they ever could before. Powered by Apple silicon with its neural engine and privacy built in at the chip level, Macs are simply the best personal computers for AI. And every Mac we've shipped with Apple silicon since 2020, is capable of taking advantage of Apple Intelligence with Mac OS Sequoia. We also know the importance of security for our users and enterprises so we continue to advance protections across our products. Turning to iPad, revenue was $7.2 billion, 24% higher year-over-year. During the quarter, we had an incredible launch where we unveiled the all-new 11 and 13 inch iPad Air, the perfect device for education, entertainment, and so much more. And With the new iPad Pro, we pushed the boundaries of power-efficient performance with the remarkable M4 chip, the engine behind this incredibly thin device. By leveraging the latest in Apple silicon, Video Editors and Musicians can take advantage of the cutting edge AI features in Final Cut Pro and Logic Pro. And we're very excited that iPad Pro and iPad Air models powered by the M series of Apple silicon will be able to utilize the powerful capabilities of Apple Intelligence. In wearables, home, and accessories, revenue was $8.1 billion, down 2% from a year ago. Apple Watch is empowering users to live a healthier day with a range of tools to take charge of their wellness journeys. At the core of Apple Watch, are powerful AI features that are helping users get help when they need it most, from irregular heart rhythm notifications to walking steadiness to crash detection and fall detection. I've heard time and again how meaningful these features are for users and their loved ones, and their stories motivate us to keep pushing forward on this vital work. As I mentioned earlier, in services, we set an all-time revenue record of $24.2 billion with paid subscriptions climbing to an all-time high. We achieve revenue records in the majority of the services categories with all-time revenue records in advertising, cloud, and payment services. Apple TV+ productions are delighting audiences on screens large and small. We're sharing powerful works of imagination with series and movies like Presumed Innocent, the Upcoming Disclaimer, and The Instigators starring Matt Damon. And we can't wait for returning fan favorites with new seasons of The Morning Show, Slow Horses, and Severance. Apple TV+ productions also continue to earn accolades with nearly 2,300 nominations and 500 wins to-date. That includes 72 Emmy Award nominations across 16 programs our best ever showing for the upcoming awards event. During the quarter, we also expanded Tap to Pay on iPhone to more markets including Japan, Canada, Italy, and Germany, enabling more businesses to use the power of iPhone to accept contactless payments. And we announced new updates to our services coming this fall, including US national park hikes and custom walk routes and Apple Maps, the ability to pay with rewards using Apple Pay, collaborative listening with Apple Music, and a redesigned Apple Fitness+ experience to help users make the most of our library of workouts and meditations. Turning to retail, we continue to expand in emerging markets with our first ever location in Malaysia. Customers from all over the country came together with our team members to celebrate this special moment. Elsewhere in the world, our teams have been sharing the magic of Apple Vision Pro and demos that delight, inspire, and deeply move customers exploring the wonders of spatial computing for the first time. At the heart of all of our innovations are the values that guide everything we do. We believe fundamentally that the best technology is technology that works for everyone. And in honor of Global Accessibility Awareness Day, we introduced all new capabilities to give users more ways to take advantage of all our products can do. These include eye tracking for users to control iPhone or iPad visually, music haptics to give those who are deaf or hard of hearing a tangible way to experience music, and vocal shortcuts that tie task to a user's voice. And we are committed as ever to shipping products that offer the highest standards of privacy for our users. With everything we do, whether it's offering a browser like Safari that prevents third-parties from tracking you across the internet or providing new features like the ability to lock and hide apps, we are determined to keep our users in control of their own data. And we are just as dedicated to ensuring the security of our users' data. That's why we work to minimize the amount of data we collect and work to maximize how much is processed directly on people's devices, a foundational principle that is at the core of all we build, including Apple Intelligence. And we continue to make significant progress on the environment. We are proud to say that all of our data centers, including those that will run private cloud compute, operate on 100% renewable energy. At Apple, we're constantly accelerating our pace of innovation. We are a company in relentless pursuit of big ideas. Time and again, we've seen how a spark of creativity can reach breakthrough velocity, reach across previously unexplored dimensions, and ultimately take flight in ways that can change the world. It's why we're going to keep investing in the meaningful innovation that enriches the lives of all of our customers. We have a busy time ahead of us, and I couldn't be more excited for all the amazing things yet to come. With that, I'll turn it over to Luca.
Luca Maestri : Thank you, Tim, and good afternoon, everyone. We are very pleased to report a new June quarter revenue record of $85.8 billion, up 5% year-over-year, despite 230 basis points of negative foreign exchange impact. We achieved growth in the vast majority of our markets, with June quarter revenue records in the Americas, Europe, and rest of Asia Pacific. Products revenue was $61.6 billion, up 2% year-over-year, driven by the launch of the new iPad Pro and iPad Air. Our installed base of active devices reach an all-time high across all products and geographic segments, thanks to our unmatched levels of customer satisfaction and loyalty and a large number of customers who are new to our products. Services revenue reached an all-time record of $24.2 billion, up 14% year-over-year, with an all-time record in developed markets and a June quarter record in emerging markets. Company gross margin was 46.3% near the high end of our guidance range and down 30 basis points sequentially driven by a different mix within products which was partially offset by a favorable mix shift towards services and cost savings. Products gross margin was 35.3%, down 130 basis points sequentially, primarily driven by mix, partially offset by favorable costs. Services gross margin was 74% down 60 basis points from last quarter. Operating expenses of $14.3 billion were at the low end of the guidance range we provided and up 7% year-over-year. Net income was $21.4 billion, diluted EPS of $1.40 was up 11% year-over-year and set a June quarter record. And operating cash flow was very strong at $28.9 billion, also a June quarter record. Let me get into more detail for each of our revenue categories. iPhone revenue was $39.3 billion, down 1% year-over-year, but grew on a constant currency basis. We set June quarter records across several countries, including the UK, Spain, Poland, Mexico, Indonesia, and the Philippines. And the iPhone Active installed base grew to a new all-time high in total and in every geographic segment. During the June quarter, many iPhone models were among the top selling smartphones around the world. In fact, according to a survey from Kantar, iPhone was the top selling model in the US, urban China, the UK, Germany, Australia, and Japan. Customer satisfaction on the iPhone 15 family continues to be extremely high, with 451 Research measuring it at 98% in the US in their latest reports. Mac generated $7 billion in revenue, up 2% year-over-year, driven by the MacBook Air powered by the M3 chip. We saw particularly strong performance in our emerging markets, with June quarter records for Mac in Latin America, India, and South Asia. The Mac installed base reached an all-time high with half of MacBook Air customers in the quarter being new to Mac. And customer satisfaction for Mac was recently reported at 96% in the US. iPad revenue was $7.2 billion, up 24% year-over-year, driven by the launch of the new iPad Pro and iPad Air. Customers are loving the latest iPad lineup for its new design and display, unparalleled performance, AI capabilities and much more. The iPad install base has continued to grow and is an all-time high, as half of the customers who purchased iPads during the quarter were new to the product. Also, customer satisfaction was recently measured at 97% in the US. Wearables, home and accessories revenue was $8.1 billion, down 2% year-over-year, a sequential acceleration from the March quarter. Watch and AirPods continue to face a difficult compare against prior year launches of the AirPods Pro second generation, the Watch SE and the first Watch Ultra. Apple Watch continues to attract new customers, with almost two-thirds of customers purchasing an Apple Watch during the quarter being new to the product, sending the Apple Watch install base to a new all-time high. And the latest reports from 451 Research indicate a customer satisfaction of 97% for watch in the US. In services, total revenue reached an all-time record of $24.2 billion, growing 14% year-over-year. We continue to have great momentum in services, as the growth of our installed base of active devices, sets a strong foundation for the future expansion of our ecosystem. And we see increased customer engagement with our services offerings. Both transacting accounts and paid accounts reach a new all-time high with paid accounts growing double digits year-over-year. Also, paid subscriptions showed strong double digit growth. We have well over 1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. And we are constantly focused on improving the breadth and quality of our services. From critically acclaimed new content on Apple TV+ to new games on Apple Arcade and the many latest features we previewed during WWDC for iCloud, Apple Pay, Apple Cash, Apple Music, and more. Turning to enterprise, we continue to see businesses, leveraging our entire suite of products to drive productivity and creativity for their teams and customers. USAA, a leading insurance and financial services company, recently expanded beyond their existing iPhone and iPad deployments to provide their employees with the latest MacBook Air. And American Express has continued to add to their fleet of over 10,000 Macs to enhance their employees' productivity, security, and collaboration. We're also excited to see leading organizations such as Boston Children's Hospital and Lufthansa using Apple Vision Pro to build innovative spatial computing experiences to transform the training of their workforces. Let me now turn to our cash position and capital return program. We ended the quarter with $153 billion in cash and marketable securities. We repaid $4.3 billion in maturing debt and increased commercial paper by $1 billion, leaving us with total debt of $101 billion. As a result, net cash was $52 billion at the end of the quarter. During the quarter, we returned over $32 billion to shareholders, including $3.9 billion in dividends and equivalents and $26 billion through open market repurchases of 139 million Apple shares. As we move ahead into the September quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. We expect foreign exchange to continue to be a headwind and to have a negative impact on revenue of about 1.5 percentage points on a year-over-year basis. We expect our September quarter total company revenue to grow year-over-year at a rate similar to the June quarter. We expect services revenue to grow double digits at a rate similar to what we reported in the first three quarters of this fiscal year. We expect gross margin to be between 45.5% and 46.5%. We expect OpEx to be between $14.2 billion and $14.4 billion. We expect OI&E to be around negative $50 million, excluding any potential impact from the mark to market of minority investments, and our tax rate to be around 16.5%. Finally, today our Board of Directors has declared a cash dividend of $0.25 per share of common stock payable on August 15, 2024, to shareholders of record as of August 12, 2024. With that, let's open the call to questions.
Suhasini Chandramouli : Thank you Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?
Operator: Certainly. We will go ahead and take our first question from Erik Woodring with Morgan Stanley. Please go ahead.
Erik Woodring: Great. Thank you very much for taking my question. Maybe Tim, if we start with you, you know, I thought some of the color you provided before the call about iPhone 15 performing better than the iPhone 14 was interesting. So just with that context, can you maybe help us understand where you see iPhone replacement cycles today, where you think the size of the base of iPhones that are aged and likely to upgrade are, and what that translates to in potential pent-up demand, as we enter a new iPhone cycle. And I have a follow-up, thank you.
Tim Cook: Yes, hi Eric. The installed base hit an all-time high during the quarter and so we were very happy about that. iPhone in general grew in constant currency. And the 15, as you point out, if you look at the same number of weeks of the 15 from launch and compare that to the 14, the 15 is doing better than the 14. And so that's kind of a state of where we currently are. In terms of upgrade rates, it's very difficult mid-cycle to call upgrade rates. I would just say that with Apple Intelligence, we are very excited about the level of value that we're going to provide to users. And we believe that -- that presents another reason for a compelling upgrade.
Erik Woodring: Okay, that's very helpful. Thanks, Tim. And then second, can you maybe dig into the China dynamics a bit? Sales down 6% this quarter, 3% in constant currency, an improvement from last quarter on a tougher compare that came on the back of some iPhone discounting. So can you maybe just share color on the China market as a whole how much you believe promotions helped in the quarter, how sustainable this improvement is, and if this performance really changes any of your approach to the China market as we look forward. Thanks so much.
Tim Cook: Yeah, Erik, as you point out, we decreased by 6.5% year-over-year for the whole of Greater China. And if you look at it on a constant currency basis, we declined by less than 3%. So over 50% of the decline year-over-year is currency related. That is an improvement from the first half of the fiscal year, and so we're happy to see the acceleration. If you look at iPhone in particular for Greater China, the installed base set a record. We also in Mainland China set a June quarter record for upgraders and so that's a very strong signal and in fact from Kantar -- the survey from Kantar this quarter showed that iPhones were the top three models in urban China. Also, if you look at -- one of the things we look at is the 15 family compared to the 14 family for the same number of weeks from launch. So this goes all the way back to the September of 2023. If you look at that, the 15 is outperforming the 14. And so those are some of the color I would provide. In addition, one of the things that we're very focused on is the level of new customers buying our products. And so if you look at this on the Mac and iPad, in Mainland China, the majority of customers buying or buying for the first time, buying that product for the first time and the watch, the vast, vast majority of people are buying a product for the first time. And during the quarter, I should say also that iPad returned to growth in Greater China, as it did around the world. And so we continue to be confident in the long-term opportunity in China. I don't know how every chapter of the book reads, but we're very confident in the long-term.
Erik Woodring: Great. Thanks so much.
Tim Cook: Yeah.
Suhasini Chandramouli: Thank you, Erik. Operator, may we have the next question, please?
Operator: Our next question is from Ben Reitzes with Melius. Please go ahead.
Ben Reitzes: Hey, thanks a lot. Appreciate it. Hey, Tim, you know, now that you've launched or announced Apple intelligence, do you have any ideas on how it may impact services. Would it – do you feel like it'll accelerate your Services business augmented? And maybe folks will need to buy more storage and some other things. How are you thinking about it as a catalyst for Services into next year? And I have a follow-up. Thanks.
Tim Cook: We started the rollout of Apple Intelligence this week with developers, so some of the features are out there as of Monday. And we couldn't be more excited about getting them out there. Obviously, this will enable developers to take their apps to the next level. And so we are taking the first step in getting the beta out there, and we can't wait to see what kind of amazing things they do with it.
Ben Reitzes: Okay. Thanks. And then Luca, with regard to gross margin, it's been -- there's been some component price inflation and mix. Do you mind just giving us a little more color on how you are managing that sequentially and how you feel about the current component environment as an impact on margins? Thanks.
Luca Maestri: Sure, Ben. I think I'll give you a bit of the walk for the June quarter and then get into the outlook that we provided for the September quarter. At the total company level, we've reported 46.3%. It is down 30 basis points sequentially, and it was really driven by a different mix. Within products, of course, we launched very important products like the iPad during the course of the quarter. But we had an offset from a shift in mix towards Services, and we got some good cost savings. And so when you look at it on a year-over-year basis, we are up significantly on the margin front. And keep in mind that foreign exchange continues to be a bit of a headwind for us. As we go into the September quarter, we are guiding 45.5% to 46.5%, which is kind of within the guidance that we provided last quarter. Again similar dynamics, we expect a slightly different mix. We expect foreign exchange to have a minimal impact sequentially, although a more significant impact on a year-over-year basis. On the commodity side, I think that is what you are referring to, yes we have seen some increases on the memory front, but the rest of the commodities, we see a continuous decline. So in general, we feel -- we're well positioned. And as you know well, these are very high levels of gross margin for us and we are pleased where we are.
Ben Reitzes: Okay. Thanks a lot.
Suhasini Chandramouli: Thank you Ben. Operator may we have the next question please.
Operator: Our next question is from Mike Ng with Goldman Sachs. Please go ahead.
Mike Ng: Hi, good afternoon. I just have two questions. First, I was wondering if you could talk about whether or not you've seen a shift in demand for iPhone 15 Pro, Pro Max models since WWDC that could potentially foreshadow consumer demand for Apple Intelligence enabled phones?
Tim Cook: We just announced the sort of the requirements at the system and the silicon level in June. And so we had very limited time during the quarter. So it's really too early to tell.
Mike Ng: That's fair. And then with the focus on upgrader potential over the next several years, I was just wondering if you could talk about what you are expecting from the US promotional environment from your channel partners, whether that's US wireless carriers, given the importance of device sales for those partners during an upgrade cycle. Or any retail support on what could be a very strong smartphone upgrade period? Thank you.
Tim Cook: We are very excited about Apple Intelligence and what it brings, and it is another compelling reason for an upgrade. I'd leave the promotional question for the sort of the carriers themselves to answer. But I believe it will be a very key time for -- and a compelling upgrade cycle.
Mike Ng: Great. Thank you Tim.
Suhasini Chandramouli: Thanks Mike. Operator, can we have the next question please.
Operator: Our next question is from Amit Daryanani with Evercore. Please go ahead.
Amit Daryanani: Good afternoon everyone. And I have two as well. I guess, Tim, maybe back to the Apple Intelligence dynamic. There's clearly a lot of excitement from consumers around what Apple Intelligence could mean for them. Can you just touch on your -- do you think the intent is to launch all the Apple Intelligence features at the same time to consumers, or do you think they end up getting staggered a bit? And if they are staggered, do you think it impacts how consumers come out and buy the next-generation iPhone?
Tim Cook: The rollout, as we mentioned in June, sort of -- we've actually started with developers this week. We started with some features of Apple Intelligence, not the complete suite. There are other features like languages beyond US English that will happen over the course of the year, and there are other features that will happen over the course of the year. And ChatGPT is integrated by the end of the calendar year. And so yes, so it’s a staggered launch.
Amit Daryanani: Got it. And then I guess your Services growth rates have been extremely impressive for several quarters and it seems like it is accelerated recently. Can you just touch -- talk about when you look at this double-digit growth, how much of that do you think is coming from the installed base growth versus better ARPU or better monetization of the installed base? And how do you kind of see that mix changing as you go forward?
Luca Maestri: Yes, Amit, it is Luca. It's a combination of a number of factors. The installed base growth is very important of course, because we have a larger pool of customers that uses the ecosystem and uses our Services. We are seeing and we've seen this consistently for many, many quarters now. We see continued growth in the level of engagement that our customers have with our ecosystem. We have more transacting accounts every quarter, so more people using the ecosystem both the free elements of the ecosystem and the paid elements. We see paid accounts growing double digits, and we've seen that for many, many quarters. Now we look at our paid subscriptions on our platform, and they are growing strong double digits as well. So obviously, the growing level of engagement helps us both from an ARPU standpoint and just a volume standpoint. Obviously, as you've seen over the last several years, we launched new services over time, and we've launched many new services, fairly recently. Obviously, our payments business is relatively new, Apple TV+, Apple Arcade, Fitness+, so many other services we've added. And so we are providing more and more opportunities for our customers to interact with the ecosystem. And we believe we are doing also a very good job at improving the quality of these services and improving the amount of content that we make available. We continue to make significant investments on TV+, on Apple Arcade. We are launching new shows, new games all the time. And I think you will continue to see that as we go forward. We are very, very happy with the 14% growth that we had this quarter because, particularly if you look at the performance that we had in Services a year ago, the compares for us tend to get a bit more challenging in the second half of our fiscal year. But in spite of that, we delivered a level of growth that was better than what we were expecting at the beginning of the quarter.
Suhasini Chandramouli: Thanks Amit. Operator we will take the next question please.
Operator: Our next question is from Wamsi Mohan with Bank of America. Please go ahead.
Wamsi Mohan: Yes. Thank you so much. Tim, you announced Apple Intelligence, but you also announced partnerships with OpenAI and presumably more coming down the road. How should investors think about the monetization models around these partnerships where the CapEx investments are clearly being made by these potential partners. But you're obviously -- they're leveraging your distribution to your very attractive installed base. So in the long-term, do you see the Apple Intelligence part -- the Services growth from Apple Intelligence being the larger contributor over time? Or do you see these partnerships becoming a larger contributor over time? And I have a follow-up.
Tim Cook: I think the way that I look at it is that Apple Intelligence is the on-device processing and the Private Cloud Compute. And a lot of that will be things with a personal context. And then for world knowledge, we are integrating with ChatGPT initially, and that will be focused on world knowledge as I said. And so the monetization model, I don't want to get into the terms of the commercial agreements because they are confidential between the parties. But I see both aspects as being very important. People want both.
Wamsi Mohan: Okay. Thanks. As a follow-up maybe for Luca. Just stepping back to the gross margin discussion again. If I look at calendar 2023, you had on average 150 basis points increase in product gross margins on a year-on-year basis. In 2024 so far, it had been more flat year-on-year. When we think about that, is the incremental headwind, I mean there was FX headwinds throughout the last several years. So ex-FX, are there other incremental headwinds that are either temporary or structural in nature that are perhaps limiting further upside to what are obviously very strong gross margins? Thank you.
Luca Maestri: Yes. Of course, as you said, the foreign exchange continues to be -- this is incremental on a year-over-year basis. And it is one of those things that is outside of our control. We try to hedge our exposures. But it is what it is. We know that when the dollar is strong, our gross margins are affected. The other element that I think it's always important to keep in mind is that within the Products business, our products have different margin profiles. And depending on the relative success in the marketplace, our products' gross margin tends to move. And so the mix of our products has an impact on gross margins, right? And so we need to pay attention to that. Of course, we just launched an iPad and that is one of the factors. But we want all our products to be very successful in the marketplace. And that's why we always look at gross margin dollars as the first order of priority, and gross margin percentage tends to follow from that. The other factor that obviously has an impact, a significant impact is the state of the commodity markets, and they tend to go in cycles. And so we will see how that plays out over time. But in general, we feel good about the level of gross margins that we have for our products business, and we think we are in a good position there.
Suhasini Chandramouli: Thanks Wamsi. Operator, can we have the next question please.
Operator: Our next question is from Krish Sankar with TD Cowen. Please go ahead.
Krish Sankar: Hi, thanks for taking my question. And congrats on the strong results. The first one for Luca or Tim. We keep hearing about these increasing silicon content for AI edge devices. And also, I think, Luca you spoke about increasing commodity costs. So I'm curious how to think about margins for these new AI devices. And Tim, do any of these Apple Intelligence features need more hardware updates than what we have today? And then I have a quick follow-up.
Tim Cook: Maybe I'll take the second one first and then pass it over to Luca. In terms of the requirements to run Apple Intelligence, there are system requirements and there are silicon requirements. And so from an iPhone point of view, the iPhone 15 Pro and Pro Max will run Apple Intelligence and the successor products obviously. If you look at the Mac, it starts with the M series of silicon that started in 2020. And the iPad is the same, and so it starts with the M series of silicon. And so there are system requirements and silicon requirements that go with each of those.
Luca Maestri: And from a gross margin standpoint, as you know, we don't provide any color past the current quarter, and we just provided guidance for the quarter 45.5% to 46.5%. It is essentially broadly in line with what we reported for the June quarter. So we'll take it quarter by quarter and we will report as the time goes by.
Krish Sankar: Got it. Very helpful. And then a quick follow-up for Tim. Thanks for the color on China. We also see many other consumer discretionary and luxury brands talk about a weak China. And I think Tim, you said half the details was FX related. I'm curious, the other half of the weakness, was that more China macro related or do you think it is kind of like specific to Apple with domestic competitors? Any other color you could give would be very helpful. Thank you very much.
Tim Cook: Well, certainly, the competitive environment there is the most competitive in the world. I've said that before and that remains to be the case. The macroeconomic factors have been in the press too, and I'm not an expert on those. I can only tell you what we're seeing. And we were pleased that the business showed improvement from the first half of the year.
Krish Sankar: Thanks Tim.
Suhasini Chandramouli: Thank you Krish. Operator, can we have the next question please.
Operator: Our next question is from David Vogt with UBS. Please go ahead.
David Vogt: Great. Two, if I may also. Tim, first one for you. I know it is early days, and you talked about the developers just getting their hands on Apple Intelligence. But when you think about the categories that are currently in the App Store and kind of what you think app developers could do with this new technology, what's your instinct say in terms of -- are these going to be iterative applications to currently available applications? Is there any sort of category that you think lends itself more naturally to Apple Intelligence? Is it games? Is it more creative? I'm just trying to get a sense of how you're thinking about it. And then I have a follow-up for Luca. Thanks.
Tim Cook: If you look at how we've deployed Apple Intelligence or are deploying Apple Intelligence, we've really thought about it at pretty much all of the apps that you use every day. And so we've thought about it from Notes to Mail to Messages and all the rest. And so there is been a deep level of thinking about how it affects those apps. And that's going to surface Apple Intelligence in a way that is natural to the user, in a way that will I think, get them very excited about it and get usage. Similarly, I think the developers will do that on a broad basis with their apps as well. And so I think, it is profound and we'll see what the developers do. But we're very excited to get the initial seed out there this week and see what they do. I think it will be amazing, yes.
David Vogt: Yes. No, that's helpful. I appreciate it. And Luca, just maybe -- I know you didn't give a full rundown of product categories in your prepared remarks. But if I kind of take your comments at face value, I guess what I'm trying to think about is for the next quarter, it sounds like with Services being relatively strong and FX easing a little bit. You are effectively saying that product revenue in the September quarter is going to basically be flat with the September quarter last year ahead of a product launch. And so I'm just trying to get a sense for, what are the puts and takes in that sort of outlook particularly as you have Apple Intelligence hopefully stoking the fire for demand going forward? Thanks.
Luca Maestri: Well, we have provided -- let me repeat what we provided. We think that we are going to be growing total company revenue at a rate that is similar to what we reported, so the plus 5%, right? In spite of the fact that we are going to have some foreign exchange headwinds, and we said about 150 basis points in the December quarter. And we said that we will grow Services double digits at a rate that is similar to what we've reported for the first three quarters of the fiscal year. We are not going into the other categories. I think there is a lot of good math that you can do from what we've given you here. Keep in mind on the Mac that we will have a challenging compare from a year ago, given the fact that we launched and we had the full quarter impact of the launch of the MacBook Air 15-inch a year ago. And also on the iPad, we reported 24% growth in the June quarter. Clearly we had the benefit from the launch in the June quarter of the new products, the iPad Air and the iPad Pro. So important to keep that in mind on a sequential basis.
David Vogt: Great. Thank you very much.
Suhasini Chandramouli: Thank you David. Operator may we have the next question please.
Operator: Our next question is from Atif Malik with Citi. Please go ahead.
Atif Malik: Hi, thank you for taking my question. The first one is for Tim. I know it's early days. The feedback on Apple Intelligence software features like notification summary and reduced interruption focus from the developers who have tried the iOS 18.1 beta version this week is very positive. My question is in response to an earlier question, you talked about a staggered launch on some of these software features. So are you expecting most of the features that you announced at WWDC to be part of iOS 18? Or we should be thinking that some of these features could potentially be part of iOS 19 next year?
Tim Cook: Our objective that we said in June is to roll out US English starting in the fall and that is to users, and then proceed with more functionality, more features, if you will, and more languages and regions coverage as we proceed across the next year. And so we sort of gave a time frame that -- and we're tracking to that.
Atif Malik: Understand. And the next one for Luca. Luca the Services growth momentum seems very strong. Are you seeing any impact from changes made to comply with the DMA rules?
Luca Maestri: Well, as you know we have introduced some changes to the way we run the App Store in Europe already in March. And we are seeing a good level of adoption from developers on those changes. We are on an ongoing basis, discussing with the European Commission how to ensure full compliance with the DMA. It is obviously early stage, but in general, our results for the Services business and for the App Store have been pretty good until now. Again to just provide you a frame of reference, the percentage of revenue that we generate from the European Union on the App Store is about 7% of the total.
Atif Malik: Very helpful. Thank you.
Suhasini Chandramouli : Thank you Atif. Operator may we have the next question please.
Operator: Our next question is from Samik Chatterjee with JPMorgan. Please go ahead.
Samik Chatterjee: Yes. Hi. Thanks for taking my question. I guess, Tim, if I can just ask you about Apple Intelligence as well. There is a regulatory aspect as well in certain geographies. You mentioned the staggered launch that you are aiming for and the timelines you're thinking. How are you thinking about the complexity of the regulatory process, in particular like EU and maybe China? And does -- in terms of your timelines of the rollout, are you sort of embedding in the regulatory aspect here? And how should we think about timing then including that? And I have a follow-up. Thank you.
Tim Cook: We are engaged as you would guess, with both regulatory bodies that you mentioned. And our objective is to move as fast as we can, obviously because our objective is always to get features out there for everyone. We have to understand the regulatory requirements before we can commit to doing that and commit a schedule to doing that. But we're very constructively engaged with both.
Samik Chatterjee: Okay, got it. And a quick one on the Wearables category, Luca. I know you mentioned the acceleration there on a sequential basis. Maybe you can just sort of parse that out in terms of what -- which categories drove the acceleration because that's been a category that has been lagging a bit in terms of revenue trends for the past couple of quarters. So just curious what is starting to sort of drive it to accelerate on a sequential basis? Thank you.
Tim Cook: Yes, I'll take that one. I think the important thing to remember when you look at the Wearables, Home and Accessories categories is that we have a difficult launch compare. And we've been running that for a few quarters and we still have that because last year had the continued benefit from the AirPods Pro second generation, the Watch SE and the very first Watch Ultra. And so it is important to keep that in mind. If you sort of take a step back, however and look at the business across the trailing 12 months, it is grown -- the Wearables, Home and Accessories business has grown to almost $40 billion, which is double what it was five years ago.
Samik Chatterjee: Thank you.
Suhasini Chandramouli: Thank you Samik. Operator, may we have the last question please.
Operator: Our last question is from Richard Kramer with Arete Research. Please go ahead.
Richard Kramer: Thanks. Thanks very much. Tim, you referenced the investment in innovation, and your R&D sales ratio reached what I think was a June quarter record even before launching Apple Intelligence. Do you see the rollout of these features requiring further increases in R&D or increases in OpEx or CapEx for cloud compute capacity? And is it even possible to forecast the Services usage as they roll out, given that they are so new for consumers? Thanks.
Tim Cook: Clearly, we have increased R&D over time. We have been investing in AI and ML for years. And in addition to investing more, we've also redeployed certain skills onto AI and ML. And so the growth in sort of embedded in our numbers that we've shared here, it is increasing year-over-year. On the CapEx part, it is important to remember that we employ a hybrid kind of approach, where we do things internally and we have certain partners that we do business with externally where the CapEx would appear in their respective businesses. But yes, I mean you can expect that there is -- we will continue to invest and increase it year-on-year.
Richard Kramer: Okay. And maybe a quick follow-up for Luca. When we look at the free cash flow margins for the first nine months, they are up materially. And given this year's product mix, can you describe to us what exactly in the Services mix or cost control is driving what seems to be structurally higher free cash flow margins across the business?
Luca Maestri: Yes, I'm glad you noticed that. We are pretty pleased with that fact. And I think you probably also noticed that we've increased our return of capital to shareholders this quarter. This one was a record quarter for us. Well, it's a combination of a number of things. Of course, an improvement in the top-line helps the margin expansion that we've had over the last several years and several quarters obviously has helped. And so that is driving better operating cash flow. On the CapEx front as Tim said, we employ a hybrid model. Some of the investments show up on our balance sheet and some other investments show up somewhere else and we pay, as we go. But in general, we try to run the company efficiently. We continue to think that capital efficiency is a good thing. And therefore, we are pleased with the fact that our free cash flow is doing well this year.
Richard Kramer: Okay. Thanks.
Suhasini Chandramouli: Thank you, Richard. A replay of today's call will be available for two weeks on Apple Podcasts, as a webcast on apple.com/investor, and via telephone. The number for the telephone replay is (866)-583-1035. Please enter confirmation code 1969407 followed by the pound sign. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at (408)-862-1142. And financial analysts can contact me, Suhasini Chandramouli with additional questions at (408)-974-3123. Thank you again for joining us today.
Operator: Once again this does conclude today's conference. We do appreciate your participation. |
ES | 2 | 2,024 | 2024-08-01 15:16:07 | Operator: Good morning and good afternoon ladies and gentlemen. Welcome to the Eversource Energy Q2 2024 Earnings Call. My name is Jaquita. I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with the opportunity for questions and answers at the end. [Operator Instructions] I would now like to pass the conference over to your host Matthew Fallon with Eversource Energy Director for Investor Relations. Matt please go ahead.
Matthew Fallon: Good morning and thank you for joining us. I am Matthew Fallon, Eversource Energy’s Director for Investor Relations. During this call, we’ll be referencing slides that we posted yesterday on our website. As you can see on Slide 1, some of the statements made during this investor call may be forward-looking. These statements are based on management’s current expectations and are subject to risk and uncertainty, which may cause the actual results to differ materially from forecasts and projections. We undertake no obligation to update or revise any of these statements. Additional information about the various factors that may cause actual results to differ and our explanation of non-GAAP measures and how they reconcile to GAAP results is contained within our news release, the slides that we posted last night and in our most recent 10-Q. Speaking today will be Joe Nolan, our Chairman, President and Chief Executive Officer; and John Moreira, our Executive Vice President, CFO and Treasurer. Also joining us today is Jay Buth, our Vice President and Controller. I will now turn the call over to Joe.
Joe Nolan: Thank you, Matt. Good morning everyone and thank you for joining us on the call. Let me begin with an update on offshore wind. I am very pleased to report that we have closed the sale of Sunrise Wind Project to Ørsted and that we anticipate closing the sale of our South Fork and Revolution Wind Projects to Global Infrastructure Partners in the third quarter. Closing these sales delivers on our commitment to exit the offshore wind business and focus our resources on being a pure play regulated utility with tremendous low risk regulated growth opportunities to enable the clean energy transition for customers. Turning to Slide 3. We continue to be a leader on delivering energy solutions for our customers with our focus on resiliency investments to address aging infrastructure and minimize customer outages on blue sky days and during storm events. We are also very busy preparing for the future of electrification to achieve our region's greenhouse gas reduction goals. Moving to Slide 4. Shown here are our state's near-term and long-term greenhouse gas reduction goals. To achieve these goals, we are planning investments to our grid to meet the demand growth from electrification of transportation in residential and commercial heating sectors. This effort requires us to upgrade and expand the electric system to handle the new demands that we will face, including more EV charging, more customers turning to heat pumps to warm and cool their homes, and expanded capacity needs to accommodate additional renewable energy resources. In addition, we must make our system smarter and stronger to withstand Mother Nature and the forces of climate change, which are resulting in more frequent and intense storms. We are continuing to invest in our electric system with smart technologies to help the grid automatically adjust to disturbances on the system and empower customers with more information to control their energy use. These increasing demands on the electric system make it critical for us to work together with our regulators to obtain timely cost recovery and maintain a solid financial position for the company. A strong financial position enables Eversource to plan for and meet these increasing demands while continuing to provide high levels of safe, reliable service to our customers. Turning to Slide 5. Our nearly $6 billion in transmission investments over the next five years is the largest program in our company's history and is key to achieving our collective greenhouse gas reduction goals. Based on system needs, our transmission investment program is moving from overhead line rebuilds in smaller reliability projects to much needed new substations to meet electrification demands and work toward a carbon free future. In our five year plan, these new substations and substation upgrades will equal approximately $1 billion of investment, and over $600 million of transmission projects are planned to enable clean energy resources. Our five year transmission investment program also includes over $3 billion for investments to replace aging infrastructure. We are also evaluating additional infrastructure requirements that could materialize during this forecast, and we expect incremental projects will be needed as we move forward. As we plan ahead, there are many areas of focus, such as advancing the electric sector modernization plan in Massachusetts, increasing import capacity into Boston, and enabling offshore wind and other renewables to advance regional decarbonization efforts that will drive transmission infrastructure investment for years to come. To give you an example of the magnitude of the incremental transmission investments we are seeing over the next ten years, we are planning for over a dozen new substations in Eastern Massachusetts alone to meet demand, compared to just four new substations constructed in that service area in the past decade. Moving to electric distribution on Slide 6, we are preparing for substantial growth in distribution investment. In Massachusetts, our current electric distribution investment plan is nearly double the previous five year plan. As we move forward to prepare for significant electric demand growth in Massachusetts to meet the state's clean energy goals, we are constantly evaluating solutions that will provide the right balance in outcomes for our customers. In order to determine our distribution system investments needs in Massachusetts, we have carefully evaluated the factors that drive the needs in each specific area, allowing us to plan efficiently and cost effectively for future system needs. Turning to Slide 7. We are very pleased with our progress of our Massachusetts AMI program, which we and other stakeholders know is critical for enabling a clean energy future. As part of the Massachusetts AMI program, we recently completed successful implementation of a new customer billing and information system, replacing a nearly 40-year-old system. This new customer system will provide a critical foundation for our AMI deployment. We are currently working on system design, building and testing of our meter management and communication applications, which we expect to conclude this summer. Network construction is anticipated to start early next year, with smart meter installation beginning in the third quarter next year. Our Massachusetts AMI program will deliver numerous day one benefits to customers, including improved grid management to enhance reliability and customer access to monitor electric consumption and control energy use. Further customer benefits include greater visibility on outages to enhance storm restoration response and dynamic rate design to enable customers to adjust electric use and lower their bills. Although we're very excited about the future transition to electrification, we are deeply committed to keeping the customer journey front and center. Affordability and fair and balanced rate design, along with a focus on environmental justice communities is top of mind for Eversource. A good example of Eversource's exploration of creative solutions to enable an equitable transition to clean energy is our first of its kind network geothermal pilot in Framingham, Massachusetts, which came online in June. We look forward to continuing our productive partnership with the state of Massachusetts as we deploy innovative technologies and pursue our carbon emission reduction goals. Turning to Connecticut, I want to thank the Lamont administration for its collaboration with utilities to provide regulatory clarity to continue the electric vehicle charging program. The solution that PURA is now preparing to put in place benefits our Connecticut customers while ensuring timely and adequate recovery of program costs. As I said before, it is critical to ensure that our customers receive safe, reliable and affordable service in a balanced regulatory environment is the best way to get there. Also, you may have heard that Governor Lamont has nominated David Arconti as the new PURA commissioner to take the place of Vice Chairman Betkoski, who is retiring this coming January. We are encouraged that David is a nominee with keen interest in energy policy and valuable experience as a former member of the Connecticut General Assembly. We are hopeful that this is a step forward in bringing Connecticut closer to its state policy goals with recognition that investment is needed to support these goals. Touching on New Hampshire, we continue to see positive momentum on the collaborative approach to plan for long-term energy needs with the signing of House Bill 1431 by Governor Sununu in July. This still requires utilities to file integrated distribution plans with the Public Utilities Commission every five years, a 10-year forecast of electric demand and an assessment of the distribution infrastructure needed to meet projected energy demands. Moving to Eversource's focus on our company's specific emission goals and employee development, I want to highlight the release of our 2023 Sustainability Report in our diversity, equity and inclusion report, as shown on Slide 8. Eversource has been a leader in these areas for many years, and it's a part of our DNA. In this year's sustainability report, we've submitted our specific greenhouse gas reduction targets to the science-based target initiative. We also highlight the progress made towards reaching our goals of carbon neutrality from our operations by 2030 with over 30% reduction in emissions from the 2018 baseline year. We are excited about the future. Eversource is uniquely positioned to leverage its skills, expertise and scale to build utility infrastructure. That will enhance system resiliency and transition to a clean energy future for our customers. We have a long runway of low-risk regulated investment opportunities and earnings growth potential, focused on delivering long-term value to our customers and our investors. Thank you for your interest in Eversource. I will now turn the call over to John Moreira to walk you through our financial results and progress made towards strengthening our balance sheet.
John Moreira: Thank you, Joe, and good morning, everyone. This morning, I will discuss our second quarter earnings results, provide a regulatory update and review our financing activity. As shown on Slide 9, our GAAP and recurring earnings for the second quarter were $0.95 per share as compared with GAAP earnings of $0.04 per share in the second quarter of 2023 and recurring earnings of $1 per share in the second quarter of last year. You will recall in the second quarter of 2023, we recorded the first of two impairment charges associated with our offshore wind investment of $331 million, or $0.95 per share. We also had other nonrecurring charges of $6.2 million, or $0.01 per share, in the second quarter of 2023. Both items are included in our GAAP earnings results for 2023. Breaking down the second quarter earnings results by segment, starting with electric transmission, which earned $0.54 per share compared with earnings of $0.46 per share in 2023. Electric transmission earnings increased due to rate base growth. Our electric distribution earnings were $0.42 per share for the quarter compared with earnings of $0.47 per share in 2023. The earnings decrease was due primarily to higher O&M expense, driven by higher storm restoration costs and the absence of a favorable prior year regulatory adjustment in New Hampshire, partially offset by higher revenues driven by NSTAR Electric's base distribution rate increase effective January 1 of this year. Electric distribution earnings are expected to be higher in the second half of the year, driven by capital cost recovery and New Hampshire's $61 million interim rate increase effective August 1. Our natural gas distribution business earned $0.08 per share for the quarter compared with $0.03 per share last year. The earnings increase was due primarily to higher revenues from NSTAR Gas' November 1, 2023 rate increase and lower O&M partially offset by higher depreciation, interest and property tax expenses. The Water Distribution segment contributed $0.02 per share for the quarter compared with $0.03 per share last year. The decrease in earnings was primarily due to higher O&M and interest costs. Eversource parent and other companies lost $0.11 per share in the quarter compared with recurring earnings of $0.01 per share last year. The main driver of this decrease was higher interest expense. Overall, our second quarter earnings results were in line with our expectations, and we are reaffirming our 2024 EPS guidance range of $4.50 to $4.67 as well as our longer-term 5% to 7% EPS growth rate. Turning to our regulatory update on Slide 10, starting with Massachusetts, as you may recall, we filed our electric sector modernization plan with the DPU in January, which is a roadmap to address growth from electrification needs. We expect a decision on our plan later this month. As a reminder, our electric sector modernization plan calls for $600 million of distribution capital investments for interconnection of clean energy resources and resiliency initiatives through 2028. This $600 million is incremental to our $23.1 billion five-year capital forecast we announced back in February. Next, I'm pleased to report that in early June, the DPU approved four additional capital investment projects to enable the interconnection of large-scale distributed generation resources on our system. Combined with the first project approved in December of 2022, these projects represent approximately $1 billion of total capital investment with $600 million of distribution investment and approximately $400 million of transmission investment. This $1 billion of investment is included in our five-year capital plan. In May, as per our settlement agreement related to the acquisition of EGMA, we filed our first rate base reset for rates to be effective November 1st of 2024. This filing reconciles our rate base, which has increased from $770 million to approximately $1.7 billion as of the end of 2023. This rate base reset is subject to a cap on the revenue change. With the application of this revenue cap, the proposed revenue increases are $78.7 million this year and $67.5 million effective November 1st of 2025. Closing out the Massachusetts regulatory items, we were pleased to receive final approval from the Massachusetts Energy Facility Siting Board for the Cambridge substation project. This is a $1.6 billion investment, of which $1 billion of investment is included in our five-year capital plan and the remaining balance in 2029 and 2030. This project consists of a new underground substation that will address the growing electricity needs of the city of Cambridge and the surrounding area. Turning to New Hampshire. PSNH filed a rate case in early June to recover more than $765 million of investment since our last rate case in 2019. The filing requests a rate range of $182 million in base distribution rates. That will take effect in two steps. The first rate adjustment will go into rates today, reflecting an increase of $61 million, with the remainder to go into effect on August 1st of next year. Interim rates will provide enhanced cash flows to the company until we receive a final rate decision next year. The filing proposes to recover investments made to improve reliability and includes recovery of increased costs associated with storm response and vegetation management due to the more frequent and more intense storm events. On blue sky days, the company's reliability investments in New Hampshire have certainly paid off for our customers. For example, banks in large part to investments in distribution automation technology, the percentage of New Hampshire customers restored in non-storm events in less than five minutes has improved from 30% in 2018 to over 50% in 2023. In addition, the company has rigorously controlled O&M costs since our last rate case. We have also proposed to implement a four-year performance-based ratemaking plan, including our capital support mechanism that would adjust rates annually to be approved by the commission. This mechanism enhances cash flow supports resiliency investments, replacement of aging infrastructure and investments for the integration of customer distributed generation while maintaining the additional transparency that comes with PBR. We anticipate a final decision in this case in 2025. In Connecticut, discovery is underway under storm cost prudency review for $634 million. We are also preparing to file for storm prudency review later this year for storm restoration costs related to events in 2022 and early 2023. As Joe mentioned, we received a decision from PURA allowing us to continue supporting the electric vehicle charging program for customers under a constructive cost recovery framework that will enhance our cash flow position. I'll now provide an update on some of the items shown on Slide 11 that will enhance our FFO to debt ratio from 2023 to 2025. First, the 2024 annual rate adjustment in Connecticut became effective July 1 of this year, recovering approximately $900 million of several costs, including public benefits related costs. The July 1st rate adjustment is recovering under collections from 2023 and has reset rates to a level matching recurred cost that we expect in 2024. Public benefit costs include the cost of energy supply contracts with the Millstone and Seabrook nuclear power plants and uncollectible hardship costs. Second, with the closing of our sale of Sunrise Wind to Ørsted, we received net proceeds of $152 million that will be used to pay down debt. Third, the closing of our sale of Revolution and South Fork Wind to Global Infrastructure Partners, we anticipate receiving gross proceeds of approximately $1.1 billion, subject to adjustments for capital expenditures. These proceeds will also be used to pay down debt. As a reminder, there is no impact to our financing plan from these capital expenditure adjustments. In addition, the filings for distribution rate increases at PSNH and at EGMA will provide additional cash flow enhancement. And lastly, regarding our equity issuances, we have raised approximately $250 million of equity through our ATM program and issued approximately 819,000 treasury shares in the first half of this year. We continue to anticipate equity means of up to $1.3 billion over the next several years, as shown on Slide 12. We are making progress on our effort to sell Aquarion Water Company. I'm happy to report that we have recently launched the initial phase of this process. All of the above actions give us a clear roadmap for improvement of our FFO to debt ratio in 2024 and give us confidence in achieving our 14% to 15% FFO to debt target at S&P in 2025. In summary, as you can see on Slide 13, we have a proven track record of earnings and dividend growth, and we are confident that our robust $23.1 billion five-year capital forecast and our forecasted financing plan will enable us to drive our 5% to 7% EPS growth rate through 2028 based off of our 2023 recurring EPS of $4.34. I'll now turn the call back to Matt for Q&A.
Matthew Fallon: Thank you. Jaquita, we are now ready for Q&A.
Operator: Absolutely. . We will now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Shah Pourreza with Guggenheim Partners. Your line is now open.
Shah Pourreza: Hi, guys. Good morning.
Joe Nolan: Good morning, Shah. Good morning.
Shah Pourreza: Good morning. Good morning. Joe, just maybe starting with Connecticut. I mean some constructive outcomes on the EV side. It sounds like the governor brought everyone together there. You're still kind of working through how to recover AMI. Are these like kind of green shoots in your view? Could we see some of that $500 million in capital you allocated elsewhere flow back into the state?
Joe Nolan: Yes. Well, thank you. As you know, I had committed to folks that we will work diligently on our relationships in Connecticut. This is one of the areas of focus. As you know, we talked about our exit from wind. I think you're seeing that we've successfully executing that strategy, working on Connecticut, the sale of Aquarion. With regard to Connecticut, I wish I could say that I had a high degree of comfort right now, the jury is still out. We are grateful for Governor Lamont's leadership. I think he's done a good job, and we'll continue to work at that. You have my commitment that I will continue to work on that relationship so that we get a stable regulatory environment for us to make any investments down there, especially on AMI because I've got to tell you, what's taking place in the energy markets, AMI today is more important than ever that we have a system that allows customers to make informed decisions around their use of energy. I think it saw what took place in the PJM markets, and this is the type of technology that we're going to need to deploy in our states in order to allow our customers to make those decisions around spending their dollars on energy.
Shah Pourreza: Got it. And sorry, Joe, just to PURA size, there's some noise there, like is 3 of the magic number? Or could we see the governor sort of expand to 5?
Joe Nolan: Yes, sure. So the governor is now at 4, but it will go down to 3 in January. I think the governor is committed. I mean, certainly, any discussions I've had with him, he wants to strike a balance, and that's what he has told me that he wants to strike a balance in Connecticut. So yes, he may go to 5. I think he's going to continue to work at it. It's a work in progress to make sure that he brings stability and regulatory certainty to the state of Connecticut. But again, it's -- we're taking a wait-and-see approach.
Shah Pourreza: Got it. Okay. Got it. And then just lastly, the Aquarion I mean, some data points around the Muni legislation this spring and trade press on the process. I guess any finer point you can put on the sale time line? Is it kind of your goal at this point to roll forward the plan next February without anything for Aquarion in it? Thanks, guys.
Joe Nolan: Yes. Well, I got to tell you, first, in terms of the legislative process, and there was a lot of discussion on that. That one particular piece of legislation was designed to allow a bidder that in the absence of that legislation would not have been able to participate in our sale process. So it doesn't give them any more of a leg up than anybody else. We have a very robust group. So that was encouraging that this is a player that wanted to be there. They are a known entity in Connecticut. So the process will move forward. And we -- John, if you want to talk about with respect to timing?
John Moreira: Sure, as I mentioned in my formal remarks, we recently have launched the process. Actually we're still working our way through finalizing some NDAs, In our forecasted financing plan, we assume that that transaction would wrap up by the -- by 2025 -- by the end of 2025. So that's our -- no change in that timeframe.
Shah Pourreza: Okay, guys, excellent. Thank you so much. We will see you soon. Appreciate it.
Joe Nolan: Thank you.
Operator: Thank you. The next question comes from the line of Jeremy Tonet with JPMorgan. Your line is now open.
Jeremy Tonet: Hi, good morning.
Joe Nolan: Good morning, Jeremy.
John Moreira: Hi, Jeremy.
Jeremy Tonet: Hi. I just want to go back to the FFO to debt slide, if I could. I just want to make sure that I've seen that right, specifically on the under recoveries in the bridge. It looks like the $600 million is listed twice. So I just want to kind of clarify what's happening there.
John Moreira: Well, the -- if you look at the table, Jeremy, the way this was designed is to highlight where it will end up in the FFO to debt calculation. So the $600 million is -- will be impacting the enhanced numerator of the math there and the $2.6 billion will offset debt. So that's -- that was the purpose of that table in there. So, sorry, if you add in any confusion. But that was the kind of the design.
Jeremy Tonet: Got it. And…
John Moreira: And keep in mind, Jeremy, just I think it's important to keep in mind that these numbers only reflect 2024 and 2025. Obviously, there are certain recoveries that will continue well beyond 2025.
Jeremy Tonet: Got it. That's helpful there. And then I just want to go back to the offshore wind sale timing. Could you just update us there on, I guess, when everything would close? And I guess the time line shifted a little bit just wondering if there's anything to note there.
John Moreira: Well, Jeremy, the time line has not shifted. We were guiding that this potentially will close late Q2 or early Q3. And what we've said is we've already closed Sunrise Wind. We did that on July 9, and we expect to close the GIP deal in this quarter.
Jeremy Tonet: Okay, I understood. I will leave it there. Thank you.
Joe Nolan: Thank you.
Operator: Thank you. The next question comes from the line of Nick Campanella with Barclays. Your line is now open.
Nick Campanella: Hi. Good morning. Hope you're having a great summer.
Joe Nolan: Good morning. Yes.
John Moreira: Yes, thanks.
Nick Campanella: Hi. Yes. So I just wanted to -- just to follow up on Jeremy's question on the offshore wind. Just can you just maybe give us a state of the construction status on Revolution, where you stand on those costs and capital expenditures? And then just how much does Eversource actually incur an offshore wind CapEx for this year before you sell the assets to GIP? Thank you.
John Moreira: Well, I would say, the construction activity is progressing very, very well. As of a week ago, when we connected with Ørsted, the monopiles or the foundations, they're probably at 50% installed, which is a remarkable task knowing that we had the time of year restrictions. From a capital deployment standpoint, Jeremy, obviously, that is sensitive information as you -- I'm sorry, Nick, as you know, we haven't really disclosed that.
Nick Campanella: Okay, no problem.
Joe Nolan: …but knowing that -- that the sale process is imminent. It may happen in the third quarter. So you'll have line of sight.
Nick Campanella: And you guys still feel good about that underlying IRR that you have to kind of deliver to GIP as per the contract?
John Moreira: Yes. Yes, we do. I mean it's -- as I just stated, Nick, the construction activity is going very well, thus far.
Nick Campanella: I appreciate that. Thank you. I appreciate it. And Jeremy and I are friends, so that's totally okay. So just on storm cost recovery, the $200 million that you have in the FFO to debt enhancements, I know you're in the discovery phase right now, and there's been some shift in that proceeding over the last year. But just mechanically, do you have to file a rate case to get that cash recovery ultimately back and get that regulatory asset wind down? Or what's the rate case outlook in Connecticut for you currently? Just maybe you can walk us through that. Thank you.
John Moreira: Yes, sure. Sure. So let me start with the $200 million, Nick. The $200 million it does not reflect any recovery of Connecticut storms, okay? The $200 million is more -- is all related to Mass and New Hampshire. And keep in mind, this is only two-year recovery in both of those jurisdictions, the recovery period is five years. As it pertains to $634 million request that we have in front of PURA from a prudency review. As the schedule currently is laid out, which we're hoping to have a bit more of an acceleration there will take us through September-ish timeframe of 2025. So that really would align with the expectation of potentially we could file a rate case around that time. The historical process is you do the prudence in Connecticut, you do the prudency review and then you file a rate case and then the -- once the rate case has been buttoned up, and those -- that new rate goes into effect, that's when we would roll in the storm costs.
Nick Campanella: That's super helpful. I appreciate the clarification, and thanks for the time.
John Moreira: Thanks, Nick.
Operator: Thank you. The next question comes from the line of Steve Fleishman with Wolfe Research. Your line is now open.
Joe Nolan : Good morning, Steve.
John Moreira: Good morning.
Steve Fleishman: Hi, good morning. Thank you. Just to kind of maybe close the loop on a prior question. Just whatever the latest cost estimate on Revolution is that still a good cost estimate?
John Moreira: As of right now, I mean, we always continue to work with Ørsted on further updates. But as of right now, yes.
Steve Fleishman: Okay. And then on -- just on the equity plan, so back at the beginning of the year, I think that was before you had the go-ahead on Sunrise and I think not only did you get this $230 million, but you avoided potential breakage costs. If I recall, when you kind of came up with the current plan?
John Moreira: That's correct. That's correct, Steve.
Steve Fleishman: And so kind of given that is now done and I just -- I guess, maybe like to get more color on how that plays into the up to $1.3 billion and obviously, you still have other things in flux. But maybe just a little more color since we now have that specific update.
John Moreira: Sure. Sure, sure. So I think you just nailed the answer to that question. We do have a lot of things in flux. Our forecast -- our financing forecast when we pulled it together and disseminate it as part of our guidance in February, had a lot of puts and takes. I had a lot of assumptions and we're still navigating our way through that. So I think it's a bit too early to give further guidance on our equity needs. Where we are today, as we stand here, $1.3 billion is the right number until certain things reach closure.
Steve Fleishman: And can you just remind me the $1.3 billion, like what the timeframe was for that? Was that over the whole four-year period or...
John Moreira: What was the guidance that we've said over the next several years.
Steve Fleishman: Several years. Okay. And yes, I think that's it for now. Thank you.
John Moreira: Thank you, Steve.
Joe Nolan: Thank you, Steve.
Operator: Thank you. The next question comes from the line of David Arcaro with Morgan Stanley. Your line is now open.
Joe Nolan: Good morning, David.
John Moreira: Good morning.
David Arcaro: Good morning. Good morning. Hi, thanks so much for taking my questions. I wanted to circle back on the FFO to debt enhancement slide. I was just wondering if -- like, have there been any changes in the underlying enhancements there? Or is this mostly just pulling in some of the known items, breaking them out more specifically here? Or has anything changed to the upside or downside?
John Moreira: Yes. These are the major, I would say, headlines, right? However, things always change -- one of the items that's not included in the slide that has materially developed is some of the tax benefits that we've been able to harvest has generated some cash refunds. So that -- the 2024 alone we had an inflow of tax refunds of about $120 million.
David Arcaro: So and that's not…
John Moreira: And the other thing that's noted that has not been quantified. But in my formal remarks, I did give you a lot of intel is the rate increases. We have EGMA going in with -- with a very sizable increase to start recovering the significant level of investments that we've made to that utility. And then we have the normal PBR rate mechanisms kicking in. And just yesterday, we got the approval to increase rates at PSNH, $61 million of interim rates. And within the next 12 months, we hope to have the final decision with another rate change effective August 1st of 2025. So that quantification would be further upside to this table that's shown, David.
David Arcaro: Great. That's helpful color. Thanks. And the $120 million that's not included in here currently, so that would be an upside.
John Moreira: Correct. That would enhance the numerator and enhance our operating cash flows.
David Arcaro: Okay. Awesome. Thanks for that. And then I was just wondering on EGMA, it's -- any issues that you would anticipate with this rate base step-up. It's a pretty big increase, obviously, given all the investment that you've made in that system. Just wondering what your expectations would be without challenging this case might be? And then subsequent to the extent you hit the cap, subsequent increases?
John Moreira: Yes, we do expect to hit the cap. And I would say what gives us comfort is the fact that this was all assumed as part of our settlement agreement when we acquired the company. We worked through with the regulators, the key stakeholders as to what that -- the investments that, that entity needed, and that's why we needed this rate base roll in. This is the first of two rate-based roll-ins that will kick in. The first one is we -- as I just announced on the call this morning, kicks in November 1st of this year and then the second one will kick in November 1st of 2027.
David Arcaro: Okay, great. Thanks so much. Appreciate it.
John Moreira: Thanks, David.
Operator: Thank you. The next question comes from the line of Julien Dumoulin-Smith with Jefferies. Your line is now open.
Joe Nolan: Julien, welcome back.
John Moreira: Welcome back, the prodigal son. What a pleasant surprise.
Julien Dumoulin-Smith: Thank you guys very much. I appreciate it. It's nice to chat with you guys again. It's -- look, let me follow up on a couple of the things have been flagged here speaking of returns here. How do you think about the green shoots in Connecticut? I want to talk a little bit more on that thesis for a quick second. I suppose, of the Yankee Gas filing at some point here, maybe late this year in December. How do you think about that foreshadowing any elements of that, call it, 4Q 2025 CL&P case? Anything that you'd be watching? Any items there? Again, I get it electric versus gas, but curious on that front. And then related, any items that you'd be watching on the PBR front, right, given that that's been kicked out here a little bit presumably a year or so. How do you think about the items that you'd be looking there for those presumed green shoots as well? So, thank you guys very much. Nice to chat.
Joe Nolan: Yes. Well, listen, I just will tell you that we have been spending a lot of time, significant outreach to over 100 communities that we serve there. We spent a lot of time down there. We continue to work it. I think it's important, and I think folks are beginning to understand just the type of impact Eversource has in Connecticut. I mean we employ over 5,000 people in that state, pay over $300 million in taxes. And our reliability numbers are extraordinary. When we first did that merger, our months between interruptions was in 12, now we're over 24 months between interruptions. We're probably best-in-class down there in terms of reliability. So I feel very good about that. But I wish I could tell you with certainty that everything is sanitary, but it's not. We are taking a wait-and-see approach on it, but I will commit to you that my efforts as we have exited the wind business, it's not only down to my focus is Connecticut. I spent a lot of time. I was there last week, had an opportunity to spend some time with key decision makers. I will continue to do that until such time as those relationships improve and that we can get some regulatory certainty on behalf of our customers and also our investors.
Julien Dumoulin-Smith: Excellent. All right. Fair enough. I hear you on that one. And then maybe related here, how do you think about just the amortization period, to the extent which you get that 600 change in Connecticut here, presumably in the next rate case, how do you think about the time period that, that recovery would entail? Again, I'm thinking with the FFO to debt to head on as you roll in out of that case.
John Moreira: Sure. So the historical amortization period in Connecticut has been six years.
Julien Dumoulin-Smith: Okay. So about $100 million a year of uplift after you get that approved…
John Moreira: Correct. As I mentioned in my formal remarks, we're also preparing to file our second prudency request for incremental storms that we've incurred. That's not part of the 634. So that -- we hope to goes in closing later this year.
Julien Dumoulin-Smith: Exactly. And presumably, that would be also trued up in the next case such that, that would be incremental for kind of a 2026 run rate?
John Moreira: That is correct.
Julien Dumoulin-Smith: Okay, excellent. Thank you. Hey, see you guys soon, all right?
John Moreira: Yeah, hope so. Thank you.
Julien Dumoulin-Smith: See you.
Operator: Thank you. The next question comes from the line of Paul Patterson with Glenrock. Your line is now open.
Joe Nolan: Good morning, Paul.
Paul Patterson: Good morning. How are you?
John Moreira: Great.
Paul Patterson: I wanted to follow up on the particle on Julien's question on Connecticut. The delay in the PBR case, what do you attribute that to? Is that just simply the complexity of the case? Or is there something else we should be thinking about?
John Moreira: Yes. I think the -- and we're glad that it did get pushed out -- it allows -- and we've been pushing for this. It allows for us to bring in key stakeholders and collaborate with these key stakeholders in Connecticut to reach a very constructive PBR structure. We are very familiar with the PBR, what we have in Massachusetts. And recently, as I mentioned on the -- in my formal remarks, we're looking to introduce the same type of structure in New Hampshire.
Paul Patterson: Okay. And then with respect to the transmission and everything, there's -- as you know, at FERC, the White House, et cetera, there's a lot of talk about the implementation of agreed enhancing technologies and a lot of law makers from New England what have you seen to be pushing for this as well, DLR, what have you. And I'm just sort of wondering how you think about that -- those technologies, I guess, and what kind of opportunities you see there or issues or any color that you might give with respect to that, given your build-out and everything that you're looking at doing?
Joe Nolan: Sure. I mean we've been active participants in these forums. And I think as you know the one attractive piece of Eversource is that over 40% of our business is FERC related and transmission. So we're very good at it. I think we probably have the best engineering talent in the industry and any type of technology or deployment of technology or opportunities. I can promise you that Eversource will be at the forefront of them.
Paul Patterson: Okay, But you don't see. Okay. Okay. I appreciate it. Thanks so much. Rest of my questions been answered. Thank you.
Joe Nolan: Thank you. Thanks, Paul.
Operator: Thank you. Next question comes from the line of Anthony Crowdell with Mizuho. Your line is now open.
Joe Nolan: Good morning, Anthony.
Anthony Crowdell: Hi, good morning, Joe. Good morning, John. Good. I feel like the prodigal son older brother that I got nothing. I guess just quickly apologize so just keep going back to Slide 11 and then just a clarification. Is the right way to look at this the 600, the top 4 plus 2, you're saying goes into numerator on FFO and what's on the bottom below that green line or the green table there, the 2.6 goes on the denominator?
John Moreira: Correct, which would be permanent because we offload our debt with that. And then on the numerator side, once again, as I previously mentioned, those numbers only reflect cash inflows to 2024 and 2025. Obviously, these deferrals will continue beyond that period.
Anthony Crowdell: Great. That's all I had. Thanks for taking my questions.
Joe Nolan: Thank you.
John Moreira: Thanks, Anthony.
Operator: Thank you. The next question comes from the line of Travis Miller with Morningstar. Your line is now open.
Joe Nolan: Hi, Travis.
John Moreira: Hi, Travis.
Travis Miller: Hi, there. Yes I'm just going to go one quick clarification here on Slide 11 again to the $200 million for the storm cost recovery that -- that primarily is the New Hampshire number, right? Or is it something else?
John Moreira: New Hampshire. No, it's both Mass.
Travis Miller: Okay, that's being debated. That's part of the prudency review right now.
John Moreira: No. Those -- the prudency review there's multiple things happening in Mass. So we do have a prudency review happening in Mass. These are what -- these costs have already been approved in rates -- so any -- for Massachusetts. The one in New Hampshire yes, a good chunk of that we filed for $240 million that's going through the prudency review there. That will kick in right around the time that permanent rates goes into effect, which will be in 2025. So there is a piece of that in here. And as I mentioned, both Massachusetts and New Hampshire has a five-year recovery window.
Travis Miller: Got it. Okay. So that kind of goes into that bucket of the filed rate increases to come?
John Moreira: Only, right..
Travis Miller: Correct. Yes. Okay. Okay. Very good. And then just high level, the New Hampshire legislation the IDP, what's your thought on how that changes your planning? How that might enhance growth CapEx, give us some high-level thoughts on how that could benefit either your financing plan or your CapEx grow over the next five-plus years?
Joe Nolan: Yes. We were very pleased. I mean, that legislation goes hand in glove with our entire operation. I mean, the integrated planning and the type of clarity that's needed as we begin to advance our investments. I think that was really a very, very positive step for us, and it's something that -- it's what we're all about. We're about collaboration. And that's what's still refreshing there in New Hampshire as well as Massachusetts around collaboration that we understand what's important to those administrations, and that's what we're delivering on.
Travis Miller: Okay, great. I appreciate the thoughts.
John Moreira: As I mentioned, Travis, our New Hampshire customers have experienced the benefit from those investments that we've made.
Travis Miller: Sure, sure. Okay, thank you.
John Moreira: Thank you.
Operator: Thank you. The final question comes from the line of Ryan Levine with Citi. Your line is now open.
Joe Nolan: Good morning, Ryan. They must have saved the best for wasp.
Ryan Levine: Thank you. Just two quick clarifying questions. In terms of the GIP deal, in your comments, should we assume that there's no earn out or callback that will be triggered based on the cost estimates that you laid out? And then in terms of the free cash flow metrics, a lot of disclosure talks about gross proceeds. Is there any material adjustments that we should be looking at to get to a net number that would actually reflect the actual FFO to debt metrics?
John Moreira: Yes. No, as I mentioned in my formal remarks, Ryan, as we saw with the Sunrise we have to reconcile to the CapEx that was embedded in the original purchase price. But that in and of itself will not have any impact on our financing plan. We spend less than what we thought the purchase price comes down. We spend more than what we had agreed to the purchase price increases. So really, no impact whatsoever. And as it relates to the revolution as we've been saying right along, there is a potential contingency that we would be subject to from a construction standpoint that we have to be mindful. But as I mentioned, so far, the construction activity has gone pretty well.
Ryan Levine: Okay. And then in terms of the gross versus net receipt disclosure in your FFO to debt targets for the next three years or three-year window there, is there any material adjustment to the gross proceeds that could be reflected?
John Moreira: Not as of right now. We don't see that. No. No, no, nothing.
Ryan Levine: Okay.
John Moreira: Because once we close the transaction, the funding obligation flips to GIP.
Ryan Levine: Okay. So there's no tax, taxes or anything along those lines. Appreciate it.
John Moreira: Okay.
Joe Nolan: Thank you.
Operator: Thank you. There are no additional questions waiting at this time. So, I would now like to pass the conference back over to Matthew for closing remarks.
Matthew Fallon: Yes. Thank you, everybody, for joining us this morning, and I know you had a lot of opportunities for the earnings call, and I'm grateful you join the Eversource earnings call, and I hope you all get a chance to recharge the batteries, and I get a chance to see all of you at EEI in the fall. Have a great day.
Operator: That concludes today's conference call. Thank you for your participation. You may now disconnect your lines. |
MRNA | 2 | 2,024 | 2024-08-01 12:58:02 | Operator: Good day and thank you for standing by. Welcome to the Moderna second quarter 2024 conference call. At this time, all participants are in listen-only mode. After the speakers’ presentation, there will be a question and answer session. To ask a question during the session, you’ll need to press star-one-one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star-one-one again. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Lavina Talukdar. Please go ahead.
Lavina Talukdar: Thank you Kevin. Good morning everyone and thank you for joining us on today’s call to discuss Moderna’s second quarter 2024 financial results and business update. You can access the press release issued this morning, as well as the slides that we will be reviewing, by going to the Investors section of our website. On today’s call are Stéphane Bancel, our Chief Executive Officer; Jamey Mock, our Chief Financial Officer, and Stephen Hoge, our President. Before we begin, please note that this conference call will include forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please see Slide 2 of the accompanying presentation and our SEC filings for important risk factors that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements. I will now turn the call over to Stéphane.
Stéphane Bancel: Thank you Lavina. Good morning or good afternoon everyone. Thank you for joining us today. I will start with a review our business, Jamey will present our financial results for the quarter and take you through our basic financial framework. Stephen will then review our clinical progress. I will then close by sharing our commercial progress and our outlook for major upcoming milestones. In the second quarter of 2024, our respiratory franchise has shown remarkable progress and is poised to positively impact millions of lives globally each year. This is why we started Moderna, to impact patients, and that is why the Moderna team is so focused on execution because of that profound impact on so many lives. Our mRNA-1273 vaccine, Spikevax, continues to play a critical role in combating COVID. Based on CDC data for the season just ending, October 23 to June 24, COVID continues to result in higher hospitalization than other respiratory viruses. We are pleased that our RSV vaccine, whose brand name is mRESVIA, our second respiratory product, has launched in the U.S. and has now shipped to U.S. customers. It is poised to impact public health in the U.S. this year and soon in many other countries for many years to come. Our flu vaccine candidate, mRNA-1010, has demonstrated positive Phase III results, meeting all immunogenicity end points in adults 18 and older. Our flu + COVID combo vaccine candidate, mRNA-1083, has also shown positive results in Phase III, underscoring our ability to innovate and [indiscernible] respiratory illnesses effectively. These achievements highlight the strength of our mRNA platform and our commitment to public health. We have now five out of five vaccines with positive Phase III data: COVID, RSV, flu, next-gen COVID, mRNA-1083 and our cold + COVID combo. We are very excited about these achievements and are very thankful for our teams. We believe our technology has the potential to significantly reduce the burden of these respiratory illnesses globally and save millions of hospitalizations around the world and thus impacting millions of families. Moving to business highlights for Q2, we manufactured the ’24 - ’25 season COVID vaccine targeting both the KP2 and GA1 strains of the virus. We are ready to meet the demand for the ’24 - ’25 respiratory season. In addition to RSV approval in the U.S, we are pleased that mRESVIA received a positive opinion from Europe’s regulatory agency, EMA CHMP. We are waiting for regulatory approvals in additional countries around the world. For pandemic flu, we recently announced a partnership in the U.S. with BARDA to address H5 influenza virus and future public health threats. The agreement awarded Moderna $176 million in funding to accelerate the development of mRNA-based pandemic flu vaccines. Lastly, our Japanese partnership with Mitsubishi Tanabe Pharma Corporation is an important collaboration. With this joint agreement, we will co-promote Moderna respiratory vaccines in Japan, extending our reach and impact in the Japanese market. In Q2, our revenues were up $241 million, [indiscernible] reflect the highly seasonal nature of our respiratory vaccine business. The net loss was $1.3 billion. We ended the quarter with $10.8 billion [indiscernible] strong cash and investment position. This progress [indiscernible] allows us to continue investing in our key programs and initiatives. Additionally, we continue to make considerable progress in reducing our operating expenses. Compared to Q2 2023, we have decreased our operating expenses by more than $600 million in Q2 2024. This reduction highlights our commitment to operational efficiency and financial discipline. Before I hand over to Jamey, I want to touch on the announcement we made last week. We are very pleased and proud to welcome David Rubinstein, the co-founder and co-chairman of Carlyle Group to the Moderna board, starting next week. David has decades of experience investing and growing businesses across a number of industries. He is also one of the most respected voices globally on matters related to international affairs and public policy. We are very excited to have him join us to help build Moderna to reach to the next level. With David joining the board, Stephen Berenson is stepping down from the board, and I would like to personally thank him for his many contributions during his tenure, including through the pandemic. We also announced that Bob Langer has informed the board of his intention to retire from the board. As one of our co-founders, Bob has made incredible contributions to Moderna and we would not the company we are today without his vision and insights. I am personally very grateful to Bob for his coaching and mentoring, especially during the early years of Moderna, where his [indiscernible] experience was so valuable to me. With that, let me turn to Jamey.
Jamey Mock: Thanks Stéphane, and hello everyone. Today I will walk you through our financial performance for the second quarter and also update you on our financial outlook for the remainder of 2024. Let me start with our commercial performance on Slide 9. Net product sales for Q2 were $184 million, down 37% year-over-year, mainly driven by lower sales volumes of our COVID-19 vaccine in regions outside of the United States compared to the second quarter of 2023, when we fulfilled orders from prior year contracts. Q2 sales were above our guidance of approximately $100 million primarily due to stronger than expected sales in the United States. We recognized sales from a number of other countries, including a small portion of the Brazil contract we announced last quarter. Year-to-date sales were $351 million, down 83% year-over-year, largely driven by the same Q2 year-over-year trends I just mentioned a moment ago. Moving to Slide 10, as I just explained, net product sales were $184 million. In Q2, we recognized $30 million of licensing revenue which is included in the other revenue line of $57 million. This revenue comes from a non-exclusive intellectual property out-licensing agreement with a leading pharmaceutical company in Japan announced in our Q1 earnings call. The deal includes an upfront payment and low double-digit royalties on net sales of their COVID-19 product in Japan. For the second quarter of 2024, our cost of sales was $115 million, which included $10 million of third party royalties, $55 million related to unutilized manufacturing capacity and wind down costs, and $14 million of inventory write-downs. This resulted in our cost of sales representing 62% of net product sales. As a result of our initiative to resize our manufacturing cost structure, cost of sales was down 84% from Q2 last year when cost of sales was 249%. R&D expenses were $1.2 billion in Q2, reflecting a slight increase of $73 million or 6% year-over-year. We purchased a priority review voucher during the second quarter which is included in our Q2 results. With first half R&D spending at $2.3 billion, we are tracking towards a full year expected spend of approximately $4.5 billion. SG&A expenses for Q2 were $268 million, reflecting a 19% decrease year-over-year. This reduction is a result of our continued strong focus on cost discipline and strategic investments driving productivity, on which I will provide additional detail in the upcoming slide. We reported zero income tax expense for the second quarter of 2024 compared to an income tax benefit of $369 million in the same period last year. This shift is primarily due to the continued application of a valuation allowance on a majority of our deferred tax assets, which we first established in the third quarter of 2023. Our net loss for the period was $1.3 billion, an improvement from the net loss of $1.4 billion recorded last year. Loss per share was $3.33 compared to a loss of $3.62 in the second quarter of 2023. We ended Q2 with cash and investments totaling $10.8 billion, down from $12.2 billion at the end of Q1, primarily due to ongoing research and development expenses and operating activities. Moving to Slide 11 and similar to Q1, I want to provide additional detail on the cost reductions we are driving across the company. You can see in our Q2 results that we had a 19% year-over-year reduction in SG&A spend due to efficiency gains. One of the main drivers for the year-over-year reduction in SG&A is from our commercial and medical affairs group. Over the past year, we have built our internal capabilities, which has allowed us to drive cost efficiencies by reducing our use of external consultants and other purchased services. We’ve also been more focused and targeted on how we invest in these areas to drive the strongest possible return on investment. As the endemic market has been more seasonal, we have shifted more of our commercial spend to the second half of the year. Additionally, our procurement team has successfully driven company-wide cost reductions in the first half of 2024. Their primary focus has been on reducing third party supplier rates, and we have seen strong progress in contract rates for raw materials, components, clinical, travel, and consulting services. We continue to see strong adoption in artificial intelligence by our employees which will allow us to scale the business in an efficient manner with a digital-first mindset. For example, in the second quarter our HR team launched benefits and equity GPTs. These AI-driven assistants are designed to handle frequently asked questions previously directed to the HR operations team and allow us to scale efficiently. Overall, we have built a solid foundation and made purposeful investments in people, processes and technology. We’ve highlighted some of the significant drivers of the Q2 SG&A savings, but we are also seeing additional efficiency savings in R&D and manufacturing. I’m very pleased with the cost savings results in the first half of the year and want to thank our Moderna teams. Now let’s turn to our 2024 financial framework on Slide 12. We are revising our expectation for 2024 net product sales to a range of $3.0 billion to $3.5 billion. There are three primary drivers for the updated outlook. First, we are now expecting very low sales in 2024 from EU member states based on recent feedback and discussions with country health officials. Second, in the U.S. we are seeing increased competitive pressures for our respiratory vaccines. While this has led to a slower RSV ramp than previously anticipated, we continue to believe and mRESVIA’s long term potential. Third, in the rest of the world we have provided for the potential risk of revenue deferrals from 2024 into 2025. We remain committed in our attempt to mitigate these risks, but believe it’s appropriate to adjust our guidance at this time. Finally, this revenue framework assumes a U.S. COVID vaccination rate similar to last season. Our second half sales mix will be dependent on timing of regulatory approvals across the world and the number of days available in the third quarter to ship. We currently expect a remaining sales lift of 40% to 50% in Q3, with the balance in Q4. We expect cost of sales as a percentage of product sales for the full year to be in the range of 40% to 50%, based upon our updated sales range. For R&D, we continue to expect full year expenses to be approximately $4.5 billion, down from $4.8 billion in 2023. For SG&A, we continue to expect full year expenses to be approximately $1.3 billion, down from $1.5 billion in 2023. Note that we expect SG&A to be higher in the second half versus the first half, primarily due to increased commercial activity, but still expect the second half to be down on a year-over-year basis. We continue to expect taxes to be negligible in 2024 and capital expenditures to be approximately $0.9 billion. Finally, we continue to expect that we will end 2024 with approximately $9 billion in cash. We have made strong progress in improving our working capital management, which is offsetting the change in our product sales outlook. With that, I will now hand the call over to Stephen.
Stephen Hoge: Thank you Jamey. Today I’ll review updates from our clinical programs in three of the four development areas in our portfolio. In the second quarter, we had important updates in respiratory vaccines, oncology and rare diseases. Starting with respiratory vaccines, we are very pleased by the approval and ATIP recommendation for our RSV vaccine, mRESVIA, in the U.S. for all unvaccinated adults 75 years and older and in unvaccinated adults 60 to 74 years of age who are at increased risk from RSV. This recommendation was the same as for the other two previously approved RSV vaccines. We also recently received a positive CHMP opinion from the European Medicine Agency for mRESVIA, and as Stéphane mentioned earlier, we are working towards approvals in additional countries. Turning to flu, we are in discussions with multiple regulatory authorities and intend to file in 2024. For our next-generation COVID vaccine, mRNA-1283, we announced positive Phase III efficacy results demonstrating non-inferior efficacy against COVID-19 compared to Spikevax in all trial participants 12 years of age and older. Efficacy was higher than Spikevax in adults 18 years and older. We are excited by the data and are sharing the results with regulators and intend to file for approval beginning in 2024. Rounding out the news in respiratory vaccines development, in the quarter we shared positive results from our Phase III trial with our combination flu and COVID vaccine. The trial met its primary immunogenicity end points with the combination vaccine eliciting higher immune responses against flu and SARS-CoV-2 than the licensed flu and licensed COVID vaccines given separately in adults 50 years of age and older in the trial. In the subset of participants 65 years of age and older, our combination vaccine also elicited higher immune responses than an enhanced flu vaccine that is recommended in the 65 and older age group in many countries, including the United States. These results are exciting, and we have begun sharing them with regulators and planning for the next steps. Turning now to oncology, in the quarter we share an update on our mRNA-4157 program, also known as INT, which elicits anti-tumor T-cell responses by targeting a patient’s unique tumor mutations, or neoantigens. INT is in multiple large randomized trials, including two Phase III trials, one in adjuvant melanoma and the other in adjuvant non-small cell lung cancer; one Phase II/III trial in adjuvant cutaneous squamous cell carcinoma, and two randomized Phase II studies, one in adjuvant kidney cancer and the other in bladder cancer. We and our partner, Merck expect to start additional studies in new tumor types. The development program was launched on the back of impressive randomized Phase II trial results in adjuvant melanoma. We recently shared the three-year follow-up data from that trial at ASCO this past June, and in the next few slides, I will quickly summarize the highlights from that presentation. The primary clinical end point for the Phase II adjuvant melanoma study is recurrence-free survival, or RFS. As presented at ASCO, there is a sustained improvement in RFS with the combination of INT plus Keytruda, versus Keytruda alone through three years of follow-up. 74.8% of patients receiving the combination treatment of INT plus Keytruda were alive and tumor-free at three years, which was 19 percentage points higher than Keytruda alone, and resulted in an impressive hazard ratio of 0.51. The combination of INT plus Keytruda also showed sustained improvement in distant metastasis-free survival at three years. 89.3% of patients in combination INT plus Keytruda treatment group were alive and without metastases or distant spread of their tumor at three years of follow-up versus 68.7% of patients in the Keytruda monotherapy group. This is an equally impressive and remarkable hazard ratio of 0.38. Lastly, we were pleased to share data showing an early favorable trend in overall survival at three years of follow-up. Finally on the safety side, INT continues to demonstrate a remarkable profile for a novel cancer therapy. Immune-related adverse events were not higher in the combination INT plus Keytruda arm despite the benefits than in the Keytruda monotherapy arm. This highlights the impressive emerging benefit-risk profile for our INT program. Moving now to rare diseases, I’m happy to share that our MMA candidate, mRNA-3705, was selected for the FDA START program. MMA is a rare disease in which patients cannot properly break down proteins from the food they digest; as a result, toxins build up in the bloodstream and cause recurrent episodes of life-threatening metabolic decompensation. The FDA START program is a program designed to accelerate development of new and promising therapies in rare diseases where there is a high unmet need. Our MMA candidate, mRNA-3705 is being evaluated in patients in a Phase I/II study with encouraging early results that we’ve previously shared, and we look forward to working with the FDA to accelerate the development of this promising potential medicine. With that, I’ll now turn it back to Stéphane.
Stéphane Bancel: Thank you Stephen and Jamey. Let’s start with COVID. With the start of the COVID season only a few weeks away, contracting for the season is almost completed as we speak. In the U.S., we have seen increased competitive pressure during the contracting season compared to last year, and we have not finalized most of the contracts. We are working closely with public health officials, healthcare providers, pharmacies [indiscernible] with these stakeholders are critical in driving widespread vaccination adoption. In the EU, we are in advanced discussions on the tender framework to provide market access; however, based on recent feedback from several large governments, we are now expecting very low sales to EU member states in 2024. Some large countries will not buy Spikevax for the ’24 - ’25 season. In the rest of the world, we have multiple signed contracts in place, some of which could be deferred into 2025. Contracting discussions are ongoing with some additional countries, but we do not expect this will have a significant impact on our updated sales framework. Moving now to launch preparation for the ’24 - ’25 season, our organization is fully prepared for the upcoming season thanks to the substantial efforts made by the Moderna teams to ensure the global availability of COVID vaccines. In North America, we are ready to supply Spikevax targeting the KP2 strain, as asked by the FDA, demonstrating our ability to quickly pivot and manufacture Spikevax for selected strains. In the rest of the world, we are supplying vaccine targeting the GA1 strain as requested by health authorities in those regions. Let me now take you through details on the U.S. COVID market. We’ll be ready to supply millions of Spikevax doses to all segments of the U.S. market upon regulatory approval. Our goal is to ensure that Spikevax is available to all customers - large retail pharmacies, independent pharmacies, healthcare professionals, [indiscernible] hospital network and public health entities at the same time, facilitating early and widespread vaccination. [Indiscernible] the world healthcare system to be ready to vaccinate is a key priority for us this season. To this end, we have implemented a real-time order tracking system which is available to all of our customers and provides detailed information on every order, including [indiscernible] timing, package size, and temperature status. Our supply chain is using AI tools to estimate the optimal order of distribution to locations within the U.S. market. These preparations highlight our commitment to ensuring the broad availability of Spikevax and meeting market demand. Let me now turn to our marketing efforts. We believe education and awareness campaigns will be important drivers to increase vaccination rates. We have started these efforts early. Ahead of the season, we have launched a back-to-basics campaign. This initiative is designed to raise awareness about how the SARS-CoV-2 virus works and why it is critical to get a new booster each year, like for flu. The virus mutates over time and we need to have a new tool to teach your immune system the new mutation to reduce infection, reduce hospitalization, and reduce deaths. Additionally, we are working with public health authorities to educate the public on the impact of long COVID, highlighting how vaccines can help reduce risk for young and middle age adults. Soon, we will start our in-season outreach to high risk groups. By collaborating with major retail pharmacies, we aim to effectively market our products during the season. This targeted approach ensures that our efforts are focused on those who are the most vulnerable, maximizing the benefits of vaccination for those groups. By leveraging media channels, we aim to reach a broader audience and emphasize the critical need for vaccination to mitigate [indiscernible] outcomes. Let me now turn to our RSV launch. We are very excited about the launch of our second product, mRESVIA. Following approval, [indiscernible] vaccine recommendation on par with competitor vaccines. Specifically, ACIP [indiscernible] recommended a single dose of RSV vaccine for all unvaccinated adults age 75 and above. ACIP also recommended a single dose for unvaccinated adults between the age of 60 and 74 who are at increased risk. Based on these recommendations, approximately 40 million people in the U.S. are eligible for vaccination. The RSV market size beyond the ’24 - ’25 season will depend on re-vaccination recommendations which are anticipated to be discussed by ACIP in future meetings. In RSV, our focus is to direct our efforts to the segments where the vast majority of vaccinations occur. In the U.S., we’re targeting the pharmacy segment, which includes both large retail chains as well as independent pharmacies. Together, the total pharmacy segment accounted last year for around 95% of RSV vaccine administration. We began shipping product in pharmacy in July, and as Jamey mentioned earlier, we are seeing a highly competitive environment. Additionally, larger competitor contracts will negotiate prior to approval and launch, resulting in lower 2024 share than we would have liked. Long term, we continue to believe our [indiscernible] will resonate well with customers, offering them the ability to use their time, maximize efficiency during the busy fall vaccination season, and also reduce potential medical errors. We look forward to some major upcoming milestones in the near term. In respiratory vaccine, we expect a COVID approval and will be ready to ship in the U.S. and rest of the world in the August-September time frame. In RSV, we expect to release Phase III data for high risk individuals 18 years of age and above. We are in discussions with regulators also on our flu program and intend to file in 2024. We also expect to present immunogenicity data in older adults for our flu vaccine, Fluzone HD. For our next-gen COVID vaccine, mRNA-1283, we are engaging with regulators and intend to file in 2024. In our combination flu -COVID vaccine, mRNA-1083, we are engaging regulators and hope to be able to give an update soon. [Indiscernible] fully enrolled and [indiscernible] we look forward to potentially Phase III vaccine efficacy readout in 2024. As Stephen just talked about, we are very excited about the INT program and we are looking forward to the completion of enrollment of our Phase III in adjuvant melanoma, which is of course a major milestone. We are keen to discuss with regulators the possibility of accelerated approval based on the Phase II study data. As we shared before, they are treating the review as necessary before we could consider pursuing accelerated approval for INT: first, durability of data which we believe that as Stephen presented, we are there; second, a substantially enrolled Phase III adjuvant melanoma study, and third, manufacturing readiness at our Marlborough site. Lastly, in our rare disease portfolio, we look forward to initiating a pivotal study for [indiscernible]. We are eager to achieve these milestones and to continue to progress towards our mission to deliver the greatest possible impact to people [indiscernible]. We expect these near term events combined with further advancement in our pipeline will confirm the power of our platform and its potential to serve patients for years to come. An important save the date for your calendar, our annual R&D day will be the morning of September 12 in New York City. Of course, a webcast will also be available. Thank you for listening to the call, and we would like now with the team to take your questions. Operator?
Operator: Thank you. [Operator instructions] Our first question comes from Salveen Richter with Goldman Sachs. Your line is open.
Salveen Richter: Good morning. Thanks for taking my question. A couple from me here. Can you help us understand the factors contributing to maintenance of the year-end cash balance guidance following the lowered product revenue guidance range? Then with regard to competitive pressures noted regarding contracts for COVID into second half, can you be more specific on the factors here, whether it’s contracting logistics or the clinical profile competitive dynamics, or what that might be? Third, how much visibility do you have on second half demand for the RSV vaccine based on contracting to date? Thank you.
Jamey Mock: Hi Salveen, I’ll take the first question regarding the year-end cash balance. I would say there’s a few factors in there. Number one, on the deferrals of revenue, some of which we have already collected the cash and ultimately we will collect the remaining balance that might push into 2025, but some of that is already a prepayment. Number two, as I mentioned in my prepared remarks, we have been working on working capital. We’ve got a whole team focused on it, and the teams are doing a great job from accounts payable, inventory balances, receivables and our collections progress. You can see our receivables balance on the balance sheet is relatively small at this point, so the team’s done a great job, which helps offset it. Then third, just coming into the year, we had a little bit of cushion to the $9 billion, so overall we remain confident in the $9 billion and are pleased with that kind of ending balance heading into 2025.
Stéphane Bancel: And Salveen, I’ll take the two or the question--it’s Stéphane. On the competitive pressure, I think on both products, COVID and RSV, we are seeing similar things, which is [indiscernible] from larger competitors with a portfolio of products, an ability, if you want, to also be much more aggressive on activities, whether it’s supply chain, whether it’s pricing, whether it’s co-marketing funding and dollars activity, so it’s really a mix at the customer level. We’ve just seen much more intensity and pressure on COVID versus last year, and on RSV, as you know, we’re entering a market where there’s two large established players, one with very large market share where of course [indiscernible], the other one who, as indicated, they want to gain market share because they are not pleased with their market share last year, and so we have been working really actively on that. In terms of visibility for RSV, we have some contracts that have already been signed and that we are actively supplying customers now that the product has shipped. We have some contracts that are being finalized with ability in season to demonstrate to the customer the value of PFS and to be able to move that into season, so we are working through all of those things. We’ll provide updates as the season goes, but we know this is very important for patients, it’s very important for the company, so we’re all hands on deck on COVID and RSV.
Operator: Thank you. Our next question comes from Terence Flynn with Morgan Stanley. Your line is open.
Terence Flynn: Great, thanks for taking the questions. Maybe two for me as well. Was just wondering on the guidance cut, if you can quantify how much was from COVID versus RSV, and then on the seasonal flu and the seasonal flu plus COVID combo, I might be parsing words here, but on seasonal flu, I notice the press release said intend to file in 2024, the combo said engaging with regulators on next steps, so maybe you could just help us think through the gating factors for each of those and the difference in language there. Thank you.
Jamey Mock: Yes, thanks Terence. I’ll take the first one related to guidance and what’s the split between COVID and RSV. What I would say is if you look at the three drivers, all of them are, first, similar in size. Then if I break them down, the deferrals are all related to COVID, the EU is all related to COVID, and then that last category of competitiveness in RSV vaccine--or in respiratory vaccines, there’s a split between COVID and RSV, so that should give you some understanding of the general split between COVID and RSV.
Stephen Hoge: Great, and for the question on the language, good pick-up. The 1083 flu COVID program is the most recent Phase III results, really quite fresh, and we have just begun the process of engaging with regulators, meaning sharing that data and discussing with them what their expectations would be on submission. For the other programs that you referenced, obviously we’ve had more time, had some of those discussions, and we’re obviously preparing for submissions, as we said in our prepared remarks.
Operator: Thank you. Our next question comes from Michael Yee with Jefferies. Your line is open.
Michael Yee: Thank you guys. Two questions from us. Looking forward on guidance, you obviously have revenue guidance this year, you have opex guidance which we see is around $6 billion of R&D and SG&A, and as you project out to the following years, you have already given cash flow guidance, so if things are generally staying along the same trajectory, I would think that cash guidance would be lower. Can you speak to the math there, and perhaps Jamey, who has said you could flex opex, is that of heightened importance and heighted priority more aggressively as you think about where things stand today in the change of guidance and talk to that, given cash guidance is a big concern for investors? The second question is going back to RSV - I appreciate the comments you just said, that was super helpful in breaking it down. Is that to say that the RSV projections you have are going to be perhaps in half, and is that due to lower share and lower price, and speak to that? Thank you.
Jamey Mock: Yes, thanks Mike. We are still--as I mentioned, we’re still expecting $9 billion in cash next year and don’t currently have any different change in our outlook for the $6 billion to $7 billion that we said we’d end 2025 with, and let me break that down. First, this year we went from the start of the year, $13 billion to $9 billion, so a $4 billion loss in cash. That included many prepayments coming into the year that will no longer repeat, so we’re not actually getting the cash from operations and that won’t be a drag year-over-year. Second, we plan to return to growth in 2025 and, as I mentioned earlier, some of that will also be buoyed by the fact that we have some deferrals heading into 2025, but more so we’ll have an entire year and operating experience on RSV, we hope to bring new products to market, and so we’re still expecting to return to growth. But yes, I mean, we continue to look at opex and understand what we want to do there, and we are always laser focused on our cash balance, and at this time we don’t think the $6 billion to $7 billion will change.
Michael Yee: Okay, and then on RSV, breaking it down, just a little more specifics on the impact of market share contracting and price, and how to think about that?
Jamey Mock: Yes, it’s a bit of both. We’re not breaking it down, nor have we given guidance on RSV, but I would say this year is not turning out as we expected, and I answered Terence’s questions in terms of how much is really split between COVID and RSV, so you can kind of get an understanding there. But again, we were third to market this year, some of the contracts were already negotiated, we only are participating in the second half, but I think our hope is that we get access across many of the retail chains, they start to get comfortable with us with the second product so that when we head into 2025, we can get a more fair market share on RSV.
Michael Yee: Perfect, thank you.
Operator: Our next question comes from Eliana Merle with UBS. Your line is open.
Elliott Bosco : Hi, this is Elliott Bosco from UBS on for Eli Merle. Two from us. Can you elaborate on the latest timing you expect for the Phase III CMV study, based on how event rates are tracking, and based on just the necessary 12 months of median safety follow-up, from a purely protocol perspective, what is the earliest we could potentially get the interim? Then second on international COVID revenues in future years, what do you see as the likelihood of potential deferral again in 2025?
Stephen Hoge: Great, thanks for the questions. I’ll take it first. First, we have enough data on case numbers for CMV. We may have an update at R&D day - I’m not sure, but we don’t have any change to our prior guidance, which is we do think that the interim analysis of efficacy could happen this year, and that would account for also median safety follow-up from a timing perspective, and so at this point, no new update, but we continue to stand behind the belief that the interim analysis for efficacy on the CMV program could happen this year.
Jamey Mock: Yes, and Elliott, on the deferrals, could they happen in 2025, the answer is yes, they can always happen. That said, some of this will push into next year, so, and if some of those push into the following year, those two would offset, but we’re not expecting that at that point. The only thing I’d say is we will come to market with our resilience contracts in the U.K., Australia and Canada, that provides us additional growth in those areas as well as potentially participating in additional public tenders as well, so there’s a little bit of risk but I think we can mitigate it with the deferrals from this year, as well as additional resilience contracts.
Operator: Thank you. Our next question comes from Gena Wang with Barclays. Your line is open.
Gena Wang: Thank you. I just have one question regarding the guidance for this year, particularly regarding the COVID revenue in the U.S. It seems contracting is mostly down, and you already also expect similar vaccination rates versus last year, and we know there is mainly only two players, so what could lead to the lower COVID revenue this year from prior [indiscernible] guidance?
Stephen Hoge: Yes, thanks Gena. We define competitiveness both in terms of share and in price, so we’re relatively pleased with our market share, there’s potentially some price pressure in there. But generally speaking, we think that the U.S. will perform pretty well compared to last year, but we are seeing a bit of a competitive--a more competitive market this year after a year where in the U.S., we had nearly or approximately 50% market share, so. We’re seeing the pressure but still confident in the overall performance of the U.S. business.
Gena Wang: Thank you.
Operator: Our next question comes from Luca Issi with RBC Capital. Your line is open.
Luca Issi: Oh, great. Thanks so much for taking my questions. Maybe Stephen, quick question - the recent ACIP meeting, it feels to me that the debate before that ACIP meeting was whether RSV was going to be either an annual vaccine or an every other year vaccine. However, ACIP clearly chose neither of them and simply said, this is one and done, so two questions. Were you surprised by that decision, and two, how should we think about the market potential for RSV long term, in light of the fact this is maybe a one and done vaccine versus obviously COVID and flu are annual vaccines? Any color there would be much appreciated, and then maybe quickly walk us through what’s the latest thinking on the opportunity for bird flu. Thanks so much.
Stephen Hoge: Great, thank you for both questions. Obviously first and foremost, our focus at the ACIP meeting was we were quite pleased with the parity recommendation, and I think we were all pleased with the clear recommendation for those over the age of 75 and those with higher risk from RSV, that they really should get vaccinated. As its only a year old is the market, the most important thing we can do is cover the large number of people who are now recommended, the 40 million-plus who are not vaccinated, and that’s quite a large increase in the number of folks who we hope to cover soon. Now, on the question--the specific question of revaccination, I think it’s also important to say that we are--you know, the ACIP is really just looking at one year of real-world data, and all three of the vaccines, but including mRESVIA, show significant second season protection, although it does decrease, and so there is the decline from season one into season two from a clinical trial perspective, but there’s still protection there in that year two. While you’re only one year into that public experience, public health experience, I think ACIP took a prudent choice and said there’s still a benefit, and maybe the focus should be on increasing vaccination coverage rates for those who are current unprotected because there clearly is some benefit, even still at that second year. I think if you fast forward a year, and this would be my perception, but if you fast forward a year, if you look at the rates of waning for the other two vaccines than ours, there is clearly a decline from year one to two, and from year two to three. The pace of that decline suggests that by year three, there really won’t be much protection for those people who have received vaccines in the first year. I think that’s when you probably need to start asking the question of, do we continue to leave those people unprotected or boost them again? Now, from a scientific perspective, you asked my view, you will be infected with RSV almost 20 times in your life, you will repeatedly get ill. In fact, many people who are at risk of severe complications over the age of 75 or otherwise with medical co-morbidities, they’ve seen RSV before. It’s the waning protection from that infection that ultimately is the reason why you need a vaccine, and because you get infected multiple times by that virus over life, even if you’ve seen it before, you probably will benefit from a booster in future. We continue to believe that as the public health story evolves, that recommending bodies and CDC and ACIP will look at the waning efficacy, the potential to boost people again and hopefully provide additional public benefit, and that eventually there will be recommendations for revaccination for those who are at highest risk of RSV, but it is not our choice. We are providing that data to obviously the regulators but principally to groups like CDC, and then they will determine the right moment, if ever, to recommend that revaccination in the United States. As it relates to bird flu, we continue to follow that very closely. It’s drifted a little bit out of the news more recently - I think that’s a good thing, but the most important news for us has been in the quarter, we executed an agreement with BARDA to advance into Phase III with our pandemic bird flu vaccine, which we’ll provide updates on as we move forward in the months and the year ahead. But we will be sure to be partnering with public health entities across the world, including the United States government specifically. We’re grateful for working with BARDA again in the event that bird flu does emerge as a pandemic or epidemic threatening this country.
Luca Issi: Thanks so much.
Operator: Our next question comes from Alexandria Hammond with BofA. Your line is open.
Alexandria Hammond: Hi, thanks for taking my question. Ahead of results for VX-522 in collaboration with Vertex for CF, if results provide positive proof of concept for the ability of mRNA and liquid nanoparticles to be aerosolized and cross the mucus barrier in the lung, can you walk us through additional indications you may be interested in, and should we expect you to develop these indications in partnership with Vertex? Thank you.
Stephen Hoge: Thanks for the question. We have--as you highlight, there is a large number of pulmonary diseases for which respiratory delivery could be quite impactful. We have not provided any updates on the preclinical programs that we’ve moved into development, and so I would describe those activities right now as still research and discovery phase, and not something for competitive reasons and for scientific reasons that we’ll talk about. They’re in the earlier stages. As it relates to whether we would partner with Vertex on it, we would of course always welcome partnering with Vertex given their expertise, but the partnership we have right now, the deal we have with them is limited to the cystic fibrosis program at this point.
Operator: Thank you. Our next question comes from Edward Tenthoff with Piper Sandler. Your line is open.
Edward Tenthoff: Great, thank you. Most of my questions have been answered, but I appreciate all the detail. I wanted to ask a little bit about the orphan disease program, and maybe you can provide a little bit of color on what the regulatory path might look like in MMA and PA. Thank you.
Stephen Hoge: Thanks Ted. They are somewhat different, and they are in early stages of those regulatory conversations, so. We just received the FDA START designation, but if you look at the data that we shared last R&D day, and we’ll obviously provide updates on this going forward, one of the clearer pictures that emerged was that in MMA, we are seeing good movement of a biomarker of methylmalonic acid that’s pathognomonic for the disease, and so you can imagine of the challenges very quickly when you have a good biomarker is how do you validate that biomarker and show that moving that biomarker is reasonably likely to predict benefit, and that’s a scientific question we will work on and ultimately engage with regulators, including FDA, as a key step for moving forward. We are evaluating in the clinical trial folks movement in their biomarker from baseline, so it’s a clear study to run. In the case of proprionic acidemia, there is not as clear a biomarker in the field because of the structure of that particular part of the metabolic pathway, and so there we’ve been following events, and as you know, we’ve previously shared in a single-arm study the pre and post treatment rates of metabolic decompensations. We have seen a favorable trend in that - we’re actually quite excited by that. That takes a little more time than a biomarker, but we obviously have been working on that a little bit longer, and so we’ll be engaging with regulators on that single arm approach and understanding the difference between internal controls or other controls to evaluate that. In any event, you may end up with a randomized study, you may be able to use a single arm study, and in the case of MMA, you may be able to use a biomarker, so those are the kinds of conversations we’re having, but as I said, they’re early days. The FDA discussion on MMA just started, and so we’ll provide updates as we have more clarity on those timelines.
Edward Tenthoff: Great, thanks. Looking forward to the R&D day.
Operator: Our next question comes from Jessica Fye with JP Morgan. Your line is open.
Jessica Fye: Hey guys, good morning. Thanks for taking my questions. For RSV, I’m curious your take on Pfizer’s comment that customers want to carry an RSV vaccine that could address both maternal and the older adult population. Then for INT, I saw it on the near term milestone slide, but to clarify, what’s your latest projection on when you expect to complete enrolment of the Phase III adjuvant melanoma trial, and what’s the latest you can share on manufacturing progress for that product? Are there any updates to share on how that’s going? Thank you.
Stephen Hoge: Sure, I’ll take that. Obviously the majority of the recommended population in this country continues to be the older adults. I wouldn’t comment on Pfizer’s competitive positioning on our quarterly call except to say that in the retail channel overwhelmingly and in many physicians’ offices overwhelmingly, the focus is on protecting older Americans. What’s happening with the younger population, maternal population is obviously smaller in terms of an overall market opportunity. We do recognize the need to try and provide the broadest potential label and, as we’ve previously updated, we are pleased that we’ve conducted our Phase III study in 18 to 59-year-old high risk populations, and we intend to file that this year with a goal of expanding that label for those who are at high risk for medical reasons and may benefit from an RSV vaccine, even if they are younger. I would say we agree that a broad label is valuable, but I think it’s important to cover as many people as possible, and that’s what we’re excited by moving forward with our 18 to 59-year-old filing. On the question of INT, we have not with our partner updated yet on where we are in enrolment. Obviously as we had said at ASCO, and there was quite some coverage of risk, we are pleased, very pleased with the pace of enrolment, and we do expect that to conclude quickly, but we have not yet provided any updates and we’ll obviously do so at the appropriate time with our partner, Merck. As it relates to manufacturing, we actually have made great progress there establishing our Marlborough facility, as well as demonstrating through the clinical trial our ability to manufacture at high volume, frankly commercially relevant volumes, and so we’re--we feel like we’re in a good place in terms of the manufacturing trajectory. It’s still a few months of work to go this year to get to where we want to be, but we’re starting to feel quite optimistic that the manufacturing will be online as and when we hope.
Jessica Fye: Thank you.
Operator: Our next question comes from Evan Wang with Guggenheim Securities. Your line is open.
Evan Wang: Hey guys, thanks for taking the questions. A few from me. Just first, just given the comments on the higher competitive environment, how are you thinking longer term about the outlook for RSV and COVID versus some of the [indiscernible] you made earlier in the year and historically, just given some of the pricing and market share dynamics there? Second, with COVID and the EU tender, what’s your level of confidence in the EU being a meaningful contributor in 2025, and what changes between now and then? You know, does having the combo or potentially having a combo add to competitiveness there? Lastly, I saw that you guys purchased a PRV - is that for use on the combo or the standalone flu, and are you comfortable in getting ahead of the potential June recommendation next year? Thanks.
Stéphane Bancel: Thanks, this is Stéphane. On the high competitive environment on COVID and RSV, what we believe is on RSV, our customers are going to experience the PFS product, and that’s going to be ability to really have full season, to be able to try and get the products to a channel that will have lots, so we anticipate in ’25 to have better share than in ’24 for the U.S. We’re going to be launching probably outside U.S. markets in ’25, that’s of course we’ll not have sales in ’24, so that’s all going to be important for growth. In COVID, we believe the portfolio in terms of next-gen COVID and then flu plus COVID, it’s going to be an important driver to kind of reset the expectation moving forward and the market dynamics. In terms of the EU, the current contract between Pfizer and the EU ends in 2026, so we think 2025 and 2026 are still going to be low. Some countries have actually used a lot of our vaccine and so we could see some countries in ’25 and more in ’26 needing COVID vaccine and then wanting to diversify their supply base [indiscernible] vaccine as well, given its performance, so as you mentioned the combo, it’s something that we have been discussing quite a lot with governments in Europe. They see the value of a combo given its strong performance, as we’ve shared, to be an important tool for public health in terms of compliance. In a world where governments are worried about people getting their flu shot and their COVID shot and their RSV shot, that’s just a lot of shots and nobody likes needles, nobody likes to go to the doctor or to the pharmacist, and so the combo is something that customers are really valuing, so that could be another opportunity in countries when this product is available to go back into growing Europe. The key priority for us in Europe now for 2025 is really launching RSV and growing the business on RSV until we see the flu mono or flu plus COVID launch.
Operator: Thank you. Our next question comes from Tyler Van Buren with TD Securities. Your line is open.
Greg: Hi there, this is Greg [indiscernible] from TD Securities. I am more interested in your thoughts on the magnitude of the RSV market. [Indiscernible] small in relation to last year during earnings, so do you agree, and what is your latest thinking on the overall sizes of the RSV market in elderly patients versus the prior that you built you’re your expectations?
Lavina Talukdar: You broke up a little bit during your question. I think we caught the tail end of your question, which is what is the size of the RSV market relative to what we though previously?
Greg: Yes, thank you. Just to reiterate quickly, I believe that GSK discussed the RSV market being smaller this year relative to last year [indiscernible]. Just didn’t know if you agree with that and what was your latest thinking on the overall size versus the prior $6 billion to $8 billion [indiscernible].
Stéphane Bancel: Yes, so let me try to take a stab at it. As Stephen stated, in the long term we believe that as real-world evidence data is gathered by public health leaders, that they will most probably be in for boosting. The current recommendation is what it is, but as Stephen said, we believe it will potentially evolve over time. For this year, I think what is interesting is on paper, it seems that it could be a smaller market. The thing that’s going to be interesting to see how it plays out in terms of market size and number of doses in arms is the guidelines are much more clear than last year, and as you know, sometimes in vaccinations, you get a better reaction from the doctors and pharmacists and consumers with clear guidelines versus not as clear guidelines with larger population potential. Because of those two factors, it’s going to be interesting to see how the season plays out.
Greg: Thank you.
Stephen Hoge: Then I would just comment on the current year market size as well. I think we talked about what we believe the patient population is, which is still sizeable, and we believe that the market will still be overall sizeable this year and similar to last year, if not a little bit more. I think there are other factors at play with those comments - you know, there was a lot of inventory that was--or a lot of sales that happened in the prior year, that customers may be sitting on some of that inventory, so from a revenue perspective that might be different, but from a vaccination rate perspective, we believe that it will still be similar, if not a little bit bigger this year.
Operator: Our next question comes from Cory Kasimov with Evercore. Your line is open.
Adi : Hi, good morning. This is Adi on for Cory. I have a question on has the recent summer COVID surge caused any concern for fall vaccinations as the infected population is usually recommended not to get vaccinated for six months post infection, and is the base case for the U.S. COVID revenue similar vaccination as last year, which I think per CDC tracking was 22.5 overall population and 14% for 65 and above?
Stephen Hoge: Yes, I’ll take it. First, the question on the summer wave and the epidemiology, we’ve seen this multiple years in a row now, and so in some ways, there is a move in certain geographies towards a little bit of a summer wave. It just highlights the fact that this virus is incredibly effectively at spreading, incredibly effective in creating disease even for folks many years after vaccination and other protection, and why we need to protect people for the winter season, because whatever we see in the summer, you see a dramatically higher wave in the November through February time horizon, and so that’s really where we’re trying to protect people for. But in terms of does the summer wave impact, the small summer wave impact the view of the fall wave, it really doesn’t change year-over-year that perspective, and that’s why we’re confident vaccination coverage rates will still be there, and as Jamey said, we see them the same. We hope to do better, but we see them minimally as similar to last year in the United States.
Operator: Thank you. Ladies and gentlemen, this does conclude the Q&A portion of today’s call. I’d like to turn it back to Stéphane Bancel for any closing remarks.
Stéphane Bancel: Well, thank you everybody for joining us, and we look forward to speaking to many of you in the coming days and weeks, and if not, seeing you for R&D day on September 12. Have a great day, bye.
Operator: Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day. |
QCOM | 3 | 2,024 | 2024-07-31 19:37:08 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Qualcomm Third Quarter Fiscal 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, July 31, 2024. The playback number for today's call is (877) 660-6853, International callers, please dial (201) 612-7415. The playback reservation number is 13747430. I would now like to turn the call over to Mauricio Lopez-Hodoyan, Vice President of Investor Relations. Mr. Lopez-Hodoyan, please go ahead.
Mauricio Lopez-Hodoyan: Thank you, and good afternoon, everyone. Today's call will include prepared remarks by Cristiano Amon and Akash Palkhiwala. In addition, Alex Rogers will join the question-and-answer session. You can access our earnings release and a slide presentation that accompany this call on our Investor Relations website. In addition, this call is being webcast on qualcomm.com, and a replay will be available on our website later today. During the call today, we will use non-GAAP financial measures as defined in Regulation G, and you can find the related reconciliations to GAAP on our website. We will also make forward-looking statements, including projections and estimates of future events, business or industry trends or business or financial results. Actual events or results could differ materially from those projected in our forward-looking statements. Please refer to our SEC filings, including our most recent 10-K, which contain important factors that could cause actual results to differ materially from the forward-looking statements. And now to comments from Qualcomm's President and Chief Executive Officer, Cristiano Amon.
Cristiano Amon: Thank you, Mauricio, and good afternoon, everyone. Thanks for joining us today. In fiscal Q3, we delivered non-GAAP revenues of $9.4 billion and non-GAAP earnings per share of $2.33, which was above the midpoint of our guidance range. Revenues from our chipset business of $8.1 billion reflect a sequential growth in automotive and IoT and continued traction of our Snapdragon mobile platforms across leading smartphones. Our automotive and IoT revenues were the result of ongoing execution of our diversification strategy. Licensing business revenues were $1.3 billion. Now I would like to share some key highlights from the business. In automotive, we secured more than 10 new design wins with global automakers during the quarter. These include next-generation digital cockpit connectivity and/or ADAS and autonomy. Our Snapdragon Digital Chassis continue to scale across virtually all OEMs and is now a key asset for the automotive industry. As we look forward, we're focused on extending our industry-leading on-device AI solutions to the Snapdragon Digital Chassis to enable automotive-centric Gen AI use cases and applications. It's important to note that our architecture with capabilities across all domains is uniquely positioned to enable sensor data to be utilized simultaneously for ADAS autonomy workloads and user-centric Gen AI experiences in the digital cockpit. A great example is our Snapdragon Ride Flex solution, which combines digital cockpit and ADAS on a single SoC. Future drivers for automotive growth include Gen AI experiences the software-defined vehicle transition, central computing replacing microcontrollers, expansion into 2-wheelers and core to cloud services. In handsets, we are pleased that all Galaxy Z Fold6 and Flip6 are powered by the Snapdragon 803 for Galaxy, delivering extraordinary AI capabilities premium level performance and power efficiency for foldable devices. Together with Samsung and our other partners, we continue to push the boundaries of own device Gen AI on mobile devices. To that end, we're pleased with the growth and trajectory of AI use cases on smartphones. This continued expansion of AI features is a precursor to next-generation smartphones which we believe will become AI-centric with pervasive on-device AI working across applications in the cloud. Qualcomm is very well-positioned to help drive this transformation across the industry in the coming years. At our upcoming Snapdragon Summit in October, we will reveal details of our next-generation Snapdragon 8 flagship mobile platform, the first to be powered by our custom Oryon CPU. This platform, combined with new and unparalleled NPU AI capabilities is already exceeding both our and our customers' performance expectations. In compute, we're very pleased that Copilot+ PCs powered exclusively by Snapdragon X Series platforms became available for purchase on June 18. This marks the start of one of the most significant transitions in personal computing since the launch of Windows 95 and is restoring performance leadership back to the Windows ecosystem. 20 Copilot+ PCs from Microsoft, Dell, HP, Lenovo, Acer, ASUS and Samsung are now available across 20 countries and 47 retailers. It's important to highlight the unique Copilot+ and Snapdragon ex-elite dedicated retail spaces in Best Buy, Costco, Curies, Harvey Norman and many more. We are very pleased with the initial response with several models sold out at retailers and online. Our retail presence is expected to expand to more than 60 retailers across 25 countries in the coming months. We're also working closely with more than 50 global commercial customers to drive Snapdragon readiness in their respective environments. Additionally, we added the Snapdragon X Series platforms to the Qualcomm AI hub, allowing developers to easily take advantage of optimized AI models to create responsive power-efficient and compelling on-device generative AI applications for Copilot+ PCs. As we look forward to 2025, we are already working with OEMs on the next wave of Copilot+ PCs. In addition to new design wins, our X Series product road map will expand to address PCs with retail prices as low as $700 without compromising NPU performance. Longer term, we believe the benefits of Snapdragon X Series platforms make it clear that the PC ecosystem has begun the transition to an ARM-compatible architecture. As we look forward, we're forecasting that at least of PCs will be AI capable by 2027. Given our clear technology leadership and competitive road map we expect to be positioned as one of the top silicon suppliers for these devices. We also remain excited about the continued positive momentum in XR, particularly the success of Meta's Ray-Ban smart glasses. Sales are exceeding our expectations due in part to the integration of Llama into the experience. We foresee an acceleration in demand for extended and mixed reality devices as new use cases enabled by Gen AI gain scale. Snapdragon XR remains the industry platform of choice, and we are engaged with major ecosystem players, including Meta, Google, Microsoft, and others. Most recently, at the Augmented World Expo will showcase 2 of the latest XR devices, NTT's augmented reality glasses and Sony's upcoming head-mounted mixed reality device. In industrial IoT, we're pleased to report that we're now collaborating with Aramco on connectivity, AI and advanced computing solutions for industrial and enterprise use cases in Saudi Arabia. This also includes accelerating development of the industrial 4G, 5G and non-terrestrial networks ecosystem, including the first significant wide area private cellular network for IoT. As the industrial sector is transformed by AI, we expect an increase in demand for more complex on-device processing. This trend aligns well with our core capabilities, especially the computing and AI road map we have built for Auto and PC. As high-performance processing and intelligence at the edge becomes critical for the next phase of enterprise digital transformation, we see a unique opportunity to build a leadership position in this space. In the next few months, we will announce our new dedicated product road map for industrial IoT and including support for multiple operating systems, ability to run multibillion parameter AI models in a comprehensive development platform. Finally, we're very pleased to share that we recently signed a key long-term licensing agreement with Honor, a leading Chinese smartphone OEM. We continue to be pleased with the company's diversification beyond mobile, and we're particularly proud of what we have accomplished to date in automotive and PC. We will provide additional updates on our diversification strategy at our Investor Day in New York on November 19. I would now like to turn the call over to Akash.
Akash Palkhiwala: Thank you, Cristiano, and good afternoon, everyone. I'll start with our third fiscal quarter earnings. We are pleased to announce strong non-GAAP results with revenue of $9.4 billion and EPS of $2.33, both of which were above the midpoint of our guidance. QTL revenues of $1.3 billion and EBT margin of 70% were in line with our expectations. QCT delivered revenues of $8.1 billion and EBITDA margin of 27%, which was at the high end of our guidance range, driven by upside in both IoT and automotive. QCT handset revenues of $5.9 billion were in line with expectations, reflecting our scale in premium Android handsets and greater than 50% year-over-year growth in revenues from Chinese OEMs. QCT IoT revenues increased 9% sequentially to $1.4 billion as we continue to see a gradual recovery in the industry environment. We delivered our fourth consecutive quarter of record QCT automotive revenues of $811 million, with sequential growth of 34%. Our revenue acceleration reflects content growth in new vehicle launches as we become the leading supplier of advanced computing and connectivity solutions to the automotive industry. Lastly, we returned $2.3 billion to stockholders during the quarter, including $1.3 billion in stock repurchases and $949 million in dividends. Before turning to guidance, I would like to outline 3 factors included in our forecast. First, Consistent with our long-term financial planning assumption of largely flat handset units, we continue to estimate global 3G/4G 5G units in calendar '24 to be flat to slightly up on a year-over-year basis. Second, our license to export products to Huawei, which was set to expire in late calendar '24 was revoked on May 7. This change will impact our revenues in both the current quarter and the first quarter of fiscal '25. Lastly, our fourth fiscal quarter includes an additional week as we align our fiscal reporting period with the calendar quarter end every 5 to 6 years. Now turning to fourth fiscal quarter guidance. We are forecasting revenues of $9.5 billion to $10.3 billion and non-GAAP EPS of $2.45 to $2.65. In QTL, we estimate revenues of $1.35 billion to $1.55 billion and EBT margins of 70% to 74%, reflecting normal seasonality for handset units. In QCT, we expect revenues of $8.1 billion to $8.7 billion and EBT margins of 27% to 29%. We expect QCT handset revenues to grow by low single-digit percentage sequentially. This forecast reflects an increase in purchases from a modem-only handset customer partially offset by seasonally lower Android revenue ahead of our new Snapdragon premium chipset launch in the first quarter of fiscal '25. We expect QCT IoT revenues will increase by low double-digit percentage sequentially, driven by growth across consumer, networking and industrial. Following our outperformance in the third quarter, we expect QCT automotive revenues to remain flat in the fourth fiscal quarter. We are on track to deliver approximately 50% year-over-year revenue growth in fiscal '24, providing confidence in our ability to execute to our long-term targets. Lastly, we expect non-GAAP operating expenses to be approximately $2.2 billion. In closing, we are pleased with our execution and financial performance in fiscal '24. Based on the midpoint of our guidance, we are on track to deliver strong non-GAAP EPS growth of approximately 20% relative to fiscal '23. Over the last quarter, industry support for our vision for on-device AI has accelerated and been validated by several key players. Beyond handsets and PCs, we expect on-device AI to drive competitive differentiation for us in industrial, networking, automotive and XR. Our leading technology and product portfolio has positioned us to continue to execute on our diversification strategy. And in the months ahead, we look forward to introducing new industry-leading products across all our end markets. Finally, as Cristiano outlined, we'll be hosting our Investor Day on November 19, where we'll provide an update on our IoT and automotive diversification strategy. This concludes our prepared remarks. Back to you, Mauricio.
Mauricio Lopez-Hodoyan: Thank you, Akash. Operator, we are now ready for questions.
Operator: [Operator Instructions] First question will come from the line of Matt Ramsay with TD Cowen.
Matt Ramsay: I have a couple of questions, guys, really highlighting some of the diversification the company is now starting to deliver on in the revenue. I guess the first one is in the automotive business, some pretty big upside there. And maybe you could talk a little bit about like the -- you're seeing some of this revenue come through now in OEM programs that no doubt you won 2 or 3 years ago. Do you think that continues as we roll through the next several quarters? I mean what kind of momentum could we see as some of these units start to roll out from, I guess, the programs you won a long time back? And then Cristiano on the second one, people keep asking lots of questions about AI PCs. As you know, you're getting really close here to when the holiday ramp period would start for you to sell in units. So maybe you could give us your current take on your expectations of what the PC market could bring in terms of units or revenue for your company as we look forward into the next fiscal year.
Cristiano Amon: Very good. Thank you, Matt. Thanks for asking the questions. Let me start with automotive. Look, we're very pleased with automotive performance. And I want to start by saying this is you continue to see signs of the pipeline translating into revenue. There are a couple of things we really like it. The first one is -- our automotive revenue is all about share of new cars being launched with our content, also is independent whether the industry is about internal combustion or EV because it's all about digital, would be the Snapdragon Digital Chassis really became a key asset for the automotive industry. And just within the quarter, we have not only the launch of 10 new models with our technology, but also we actually have 10 new design wins, which continue to add to the pipeline. So we're very excited about that. We will continue to see as new cars get launched with our technology from the pipeline, the revenue to grow. And as Akash said in the script, we're actually on track to the metric we provided for $4 billion in 2026. One side comment on your question. An upside is what Gen AI is doing in automotive. Gen AI use cases, especially using large language models for audio. It was a great user interface for were behind the wheel. We're starting to see a lot of interesting use case being developed. That upside to our model, it could be an upgrade of content in the digital cockpits that we have in. The second comment which is about PCs. I will start by saying we're very pleased is exceeding our expectations. We -- it's a new version of Windows, the Copilot+ is a new architecture with an ARM compatible. We expect that, that will ramp over a period of time. But what we have seen in the market right now with the 20 models that can launch is exceeding our internal targets. Some models, as I mentioned in my prepared remarks, had sold out. And I think we should expect that, that will continue to be a crescendo, slow and steady as the market transition. We will have new product announcements coming up at EFA, and you're going to continue to see more Copilot+ features coming from Microsoft we're very happy about that as the same thing we did with auto, we expect PC to be the next biggest driver of diversification for the company, and we'll continue to track every quarter.
Operator: Our next question is from the line of Samik Chatterjee with JPMorgan.
Samik Chatterjee: Congrats on the strong print here. I guess, Cristiano, if I start you off with those smartphone question here related to VI smartphones. One, can you share if you're seeing any depreciable difference in the demand for smartphones with AI features in them from consumers already. And as you look to the pipeline in terms of design wins for next year, how are you thinking about proliferation of the AI features and capabilities into more mid-tier or outside of the flagship to your phones that you work with, with your customers? And I have a follow-up.
Cristiano Amon: Thank you for your question, Samik. So on smartphones, I would start by saying one thing that we really like. And I think it was reflected by some of the metrics provided by Akash he talks about in his remarks, 50% growth within China with Chinese OEMs. So I has expanded the size of the premium tier. So even in a market which it's kind of flattish to low single-digits in growth. The premium tier is actually growing faster. And we've seen that. We're seeing a larger premium tier enabled by AI. And to your specific question, we are happy with the trajectory of AI features. We used to have a few. Now we have tens of AI features. And eventually, when they get to 100, we're going to start to see a change that -- a smartphone with AI feature will become an AI smartphone. We don't have any heroic assumptions in our model, but we actually like the direction this is going that could create an interesting upside if we have an AI-driven upgrade cycle. It's still early in the process, but the use cases are becoming more interesting. I pointed to the increase of use cases in the Galaxy Flip6 and Fold6. China has a number of use cases. They're going to be launched in the next flagship. And I know you asked about bringing AI to the master. We intend to do that. The same thing we're doing with the PC which is as we expand the road map, we're not compromising on AI capabilities. We're going to see us doing that within our mobile road map. But on the premium tier, I'm actually very excited given the upcoming launch of our next Snapdragon that has our custom CPU. And you're going to see the same shift in performance that we have done in the PC ecosystem restoring the performance back to the Windows ecosystem, you're going to see doing us something similar in phones. And AI is going to be a big part of the story.
Samik Chatterjee: Got it. And a quick one for Akash. Akash, the guide for September revenues, that looks pretty similar to what you were sort of soft guiding us to back sort of 90 days ago, although you now have incremental headwinds with the license to export to Huawei. How should we think about sort of where you're finding the offsets? Where is the upside to help you offset that incremental headwind?
Akash Palkhiwala: Yes. Thanks, Samik. Samik, we're pretty happy with the way the quarter has played out, right? If you look at our handset business, we are growing. We are -- we're guiding that will grow low single-digit percentage on a quarter-over-quarter basis. IoT, we're guiding low double-digit growth, and we're seeing strength across industrial edge networking and consumer. And then auto coming off of an extremely strong quarter in June, we're guiding flat revenue in the September quarter. And so all of these, both IoT and automotive are incremental to our previous expectations, and you're seeing that benefit show up in our guidance.
Operator: Our next question is from the line of Chris Caso with Wolfe Research.
Chris Caso: I guess first question is just a clarification on the extra week in the quarter that you referred to. Can you speak about what impact you might expect it to have on both revenue and cost? And if there's any implications on that the absence of the extra week, as you go into the following quarter, which is obviously a seasonally strong quarter.
Akash Palkhiwala: Yes. Sure, Chris. If you think about the 2 factors I outlined for the guidance, which is the extra week on one hand and then offset by the Huawei reduction, revenue reduction on the other side. Those 2 largely offset each other. And so the net impact on our overall guidance is pretty limited when you consider the impact of both factors. Specifically on the extra week, as you know, not all weeks are created equal as you think about the different parts of our business. So what we've factored in is incremental revenue on the QCT side, incremental OpEx on the OpEx side. And then within -- sorry, incremental revenue on the QTL side. And then within QCT, revenue forecast and the benefit that we have from a flagship phone launch that doesn't really change based on the number of weeks. So that remains largely consistent and these factors are already included in. But kind of the big message is when you step back and look at the 2 key factors I outlined, they're pretty much canceled out against each other.
Chris Caso: Okay. Understood. And then moving over to QTL. The guidance for the fourth quarter is -- it's outside of the range that you have been talking about before. You haven't changed your expectation for global handset units. So can you speak to the reason for the QTL guidance and if that's sustainable going forward because typically, the first quarter is a stronger quarter for that segment.
Akash Palkhiwala: Yes, sure. So the QTL guidance is relatively straightforward. If you look at June to September, we typically see very small growth on a quarter-over-quarter basis. So we factored that in. And then we have the extra week on top of it as well, which is also factored into our numbers. So that's how we got to the number we're guiding for QTL.
Operator: Our next question is from the line of Stacy Rasgon with Bernstein Research.
Stacy Rasgon: I want to ask the second half of Chris' question again that you didn't quite get to. The extra week, I should think about the implication for December quarter seasonality coming off of that. What are you guys thinking for December? If you could help us shape that a little bit?
Akash Palkhiwala: Sure, Stacy. So as you know, well, we typically grow into the first quarter into the December quarter, and we're expecting that it's a seasonally strongest quarter of the year going forward. And as we think about the quarter, there couple of factors we consider. First is the launch of our new Android premium tier chip, which is going to be a tailwind for us. We do go back from the 16 weeks -- 14 weeks back to 13 weeks within the quarter. And then relative to last year, we'll not have Huawei product revenue going forward, which we did have last year. So net of all of this, when you look at a year-over-year basis, we expect revenue to be largely -- revenue growth to be largely consistent with the year-over-year growth we saw in December quarter last year.
Stacy Rasgon: Got it. That's helpful. If you could also just give us any sort of incremental color. How much of the guide actually includes how much of the guide is PC revenue at this point for next quarter? I know you said the consumer piece sounds like it's growing in IoT, that's where it is, but how much of it actually is PCs?
Akash Palkhiwala: Yes. I mean Stacy and all candor, we're a few weeks into our launch. And so it's too early to kind of have either a bullish assumption or a specific assumption on PC. We do have indications from our customers and we've tried our best to factor it in as we usually do. But as Cristiano said, to us, this is about kind of the longer-term growth opportunity and being very specific on sell-through in the short term is not really something that we have insight into. But we will, as we get to Investor Day, we're going to give a lot more disclosure on our specific plans on revenue ramp.
Operator: Our next question comes from the line of Joe Moore with Morgan Stanley.
Joe Moore: I wanted to come back to the 50% growth in China handset. And it sounds like you talked about growth in the premium tier there. Can you kind of give us a sense of how much of that is price versus units? And is that -- is the market expanding? And then maybe market share commentary because your numbers seem better than your competitor.
Akash Palkhiwala: Yes. So if you look at the total handset market, our general assumption is that from '23 to '24, it's flat to slightly up. So the market is not growing. But within that, the premium tier, the trend has been very positive. We've gone from greater than $400 representing 21% of the market now to representing 31% of the market. And so that's very significant growth that we are benefiting from. And as you know, we are very strong at the premium tier. And as that market expands, we get to participate in that, not just from a revenue perspective, but content increase perspective as well.
Operator: Our next question is from the line of Christopher Rolland with Susquehanna.
Christopher Rolland: I guess in your latest Q, you talked about a bunch of new licenses coming up. I think they expire early fiscal '25, including Huawei. I guess, first of all, the 4G at Huawei would this might affect these negotiations? Do you expect everyone else to sign in those negotiations as well? And then lastly, do we think about Huawei that impact is roughly $150 million a quarter. Is that a fair number on the 4G stuff from Huawei?
Alex Rogers: Chris, this is Alex. Thanks for the question. So if you look at the licensing progress basically over the last year or so, we set out to execute on a number of renewals and extensions. And we've done actually a really good job doing that. The most recent was getting on or signed up to a long-term agreement. And then, as you know, Apple extended through '27. But we also noted recently that we have 2 major Chinese OEM signed long term. Well, we haven't named them, but they are significant handset manufacturers. And then we're working through negotiations with others that we still have optimistic expectations in terms of getting them signed up. We also recently announced that we signed up tranching to a 5G license, and we're still negotiating with them. There's some litigation ongoing, but I think the important thing is to focus on the 5G license with that company and the ongoing negotiations. So Huawei is a company that we've been engaged with, just like the others in terms of trying to move negotiations forward. We expect that to continue. We don't really have any news on that just yet.
Akash Palkhiwala: And then from a revenue breakdown perspective, as you know, we don't break down our QTL revenue by OEM, but a reasonable way of thinking about it is look at the scale of the market the number of units, any specific OEM contributes to the scale of the market and apply that to our overall revenue stream.
Operator: Our next question is from the line of Ross Seymore with Deutsche Bank.
Ross Seymore: One question, one follow-up. First one, probably more for Cristiano. I just wanted to see how you feel with your leadership position on both the modem and the apps processor side in your handset business. How do you feel about the relative market share that you'll have in the penetration at given customers? There's kind of perpetual debate about what you're doing with your lead Korean customer, year-to-year, gen-to-gen same thing with your modem only customer. So as you look forward over the next year or 2, how are you feeling about the penetration that Qualcomm can have at the major customers?
Cristiano Amon: All right. Thanks for your question, Ross, loaded question. So I'm going to have to unpack one by one. I think the first part of the question, how do we think about modem technology. We feel pretty good about our modem technology. I think this is one of the core competencies of the company. We continue to be the number 1 company in the country in a number of wireless patents and extended essential patents and continue to be the company pushing for the road map. As it relates to our business with Apple, we still operate with the framework that we provided to you all. I think when we extended the chipset agreement, and we expect to be operating within that. We have no new update to provide it everything above what we said before is an upside. So we don't have that in our financial planning assumptions above what we had disclosure. When we think about the application processor, I think the conversation is a little bit more interesting because we have always said the leadership in AI performance, we always had the leadership and sustained peak and sustained performance in mobile gaming in other applications with our Adreno GPU. And now for the first time in a while, we're going to have our own custom CPU, which will be announced at the Snapdragon Summit and will be in the flagship devices launching towards the end of the year, beginning of 2025. So I will argue that our application processor advantage is accelerating. And as I said in this earnings, I think the launch of the Copilot+ PC was really a graduation for Qualcomm as it used to be perceived as a communications company isn't really a computing company. To the point that now we become the benchmark for others to follow within the PC industry. And I think that is going to be reflected in -- in the handset as well as we have our own custom CPU. As it relates to relationship with Samsung, we have executed agreements with them. It's largely consistent to what you have seen with the launch of the GS24, how is that going to continue. We're pretty happy with the relationship. And I think we both have a lot of opportunity with the AI coming into premium smartphones.
Ross Seymore: I guess as my follow-up for Akash. One, in the answer to your prior question, you said that your year-over-year growth in December would be about the same as it was last December. Just a clarification. Was that just for QCT? And then I guess my bigger picture question, how should we think about gross margins in QCT going forward? Looks like you're implying them down a bit in the September quarter, but still flat year-over-year. Has the diversification process happens, automotive, PCs, et cetera? How should we think about that line in your income statement?
Akash Palkhiwala: Sure, Ross. So that comment was really focused on overall company, so not just QCT, but the overall Qualcomm metrics. From a gross margin perspective, we did slightly better than we expected. We had guided in the third quarter. And what we're doing is we're guiding fourth quarter in line with the guidance we had provided for third quarter. I think as you look forward beyond fourth quarter into fiscal '25 using fourth quarter as a way to model the going-forward path is a reasonable way of thinking about it.
Operator: Our next question is from the line of Tal Liani with Bank of America.
Tal Liani: Can you hear me?
Cristiano Amon: Yes, we can.
Tal Liani: Okay. Perfect. Sorry. So I need help to define your addressable market in compute, meaning. Is it mostly about consumer laptops, enterprise? How do you envision your addressable market in the compute segment? And the second thing is you talked a lot about AI, AI inclusion in handsets. When we talk to carriers, they seem to be far away from it in the sense that they can't find the applications yet. What do you -- what do you think is going to drive the deployment? What kind of applications and what's the timing of applications that will drive the deployment of AI in handsets?
Cristiano Amon: Tal, this is Cristiano. Thank you for your question. Let me take the first one. You should think about addressable market the follow way. First of all, it's Windows 11, addressable market. We're very focused right now on laptops, whether it's commercial laptops for enterprise, consumer laptops. We're ranging price points, I think, especially as we talked in the prepared remarks, extending the road map from $700 and above. That's -- and what is defined as AI PC, a metric that I can provide to you. And I think there has been a number of OEMs indicating their respective views, but we forecast about 50% of our computers sold in 2027 will be AI PCs. That's one way to think about it. And we continue to basically see the transition of as upgrades are happening to Windows 11 and Copilot+ PCs, an opportunity for us to participate with a highly differentiated solution. I think your second question...
Akash Palkhiwala: It was on AI applications.
Cristiano Amon: It was about AI applications for devices. So here's how you should think about it. AI is going to do on phones, whether you're going to text, whether you're going to talk, whether you're going to touch, it's going to be a very important part of the human computer interface. And this is going to start to change a lot of the user experience on apps. It's less of a carrier conversation. It's really more of an application conversation. And those are going to start to change a lot of the use case of existing apps or you're going to start to see as we see the development of new agents that become more relevant. For example, if you are like me, a user of WhatsApp, you're going to see the ability within WhatsApp for you to search with Llama for you to do different things with their model. And eventually, a lot of the models are going to have multiple functionality across multiple apps. The way to measure this is the number of use cases. And we're -- as I said before, we're actually very happy with the trajectory. I'd like to compare what happened with the smartphone. When the smartphone -- first, there were like 10 apps and then became 100 apps and became 1,000 of apps, became hundreds of thousands of apps and then it became very clear what was happening. I think we look at a little bit the same way. We're in the beginning, but we like the number of use cases increasing, and that's going to drive a lot more AI NPU performance in the silicon and hopefully continue to expand the premium and high tier.
Operator: Our last question is from Tom O'Malley with Barclays.
Tom O'Malley: I have one for Cristiano and one for Akash. Just very recently here, obviously, in the quarter, there's a huge step-up in the auto portfolio, and I think you guys did a good job of kind of describing what drove that. But you've also, in your deck and kind of in your commentary talking more about AI PC being a driver. Cristiano, if you look at kind of the next 12 months, you hosted an Auto Analyst Day and you kind of talked about the opportunity being back-end loaded, and I think the end date was kind of the late 2020s. But if you look at the next 12 months, what opportunity do you think is more exciting to you the automotive side or the IoT in terms of revenue growth? Obviously, the buckets are different sizes, but just breaking those 2 out as to what can drive some growth there. And then on the Akash side, if you look into Q4, you obviously have an extra week there, but you are seeing OpEx step down. Could you just walk through the moving parts that I would expect it to be up a little bit just given the extra week?
Cristiano Amon: Thank you, Tom. Actually, I appreciate the question. I really like the question to give me an opportunity to explain this. You should think of Qualcomm -- we're not just trying to build one big business of differentiation. Actually, we're building a number of business -- I'm sorry, of diversification. We're really focused on this. And when we talk about Auto Investor Day, that was actually in September 2022, we kind of outline how that is going to be turning into a big platform for Qualcomm and building into the financials. And then hopefully, you can see now, especially with this quarter, that's materializing. And that will continue. That's not going away. We expect -- given the size of our pipeline, we talk about $4 billion in '26. We talk about $9 billion towards the end of the decade. We're on track to do that. But the second one is PCs. And as we get -- it's early. As I said, we're very happy. It's exceeding our expectations. Some models sold out. We just launched. I think when we get to the Investor Day, we probably will feel comfortable putting a metric out there of what that's going to represent and how that's going to grow over time when we think about the total contribution to Qualcomm. That's one they're very excited. But we don't stop there. The next one, and I encourage you to so what we're going to do next quarter, I think AI and computing, it's driving the industrial road map towards Qualcomm. So we we're completely redesigning our industrial road map, and we're going to unveil that road map in the coming months. So we think about this as -- there are many markets that can benefit from technology. We're super focused on growth and diversification and it's about a number of bets, not just one bet.
Akash Palkhiwala: And Tom, on your second question on OpEx, we had some non-labor material-related spent and tape-out related spend in the third quarter, which is why third quarter OpEx was higher and it goes down into the fourth quarter despite the extra week. And so it's just timing of non-labor spend that drove it. But fundamentally, no change in kind of the way we are managing OpEx. We're very committed to operating discipline and hiring, even when we do it, it is very focused on specific new skills that are required for diversification. So you won't see a difference in the way we are managing the OpEx for the company.
Operator: That concludes today's question-and-answer session. Mr. Amon you have anything further to add before adjourning the call?
Cristiano Amon: No, I just want to just quickly thank all of our partners. Our suppliers, our employees for a great job on PC execution. I think we're very proud of what we accomplished. We will continue to drive AI across each one of our businesses. We feel we have a very unique position in the ability to run AI at the edge. We're very happy with the automotive traction, and we're actually looking forward to the next generation of products launching coming months, as I said, hopefully creating a new vector for growth of the company in the future in industrial IoT. Thank you very much.
Operator: Ladies and gentlemen, this concludes today's conference call. You may now disconnect. |
META | 2 | 2,024 | 2024-07-31 19:36:05 | Operator: Good afternoon. My name is Krista and I will be your conference operator today. At this time, I would like to welcome everyone to the Meta Second Quarter 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] This call will be recorded. Thank you very much. Kenneth Dorell, Meta's Director of Investor Relations, you may begin.
Kenneth Dorell : Thank you. Good afternoon and welcome to Meta Platform's Second Quarter 2024 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO, and Susan Li, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's earnings press release and in our Quarterly Report on Form 10-Q, filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The earnings press release and an accompanying Investor Presentation are available on our website at investor.fb.com. And now I'd like to turn the call over to Mark.
Mark Zuckerberg : All right, thanks Ken. And hey everyone, thanks for joining today. This was a strong quarter for our community and business. We estimate that there are now more than 3.2 billion people using at least one of our apps each day. The growth we're seeing here in the US has especially been a bright spot. WhatsApp now serves more than 100 million monthly actives in the US, and we're seeing good year-over-year growth across Facebook, Instagram, and Threads as well, both in the US, and globally. I'm particularly pleased with the progress that we're making with young adults on Facebook. The numbers we are seeing, especially in the US, really go against the public narrative around who's using the app. A couple of years ago, we started focusing our apps more on 18 to 29 year olds and it's good to see that those efforts are driving good results. Another bright spot is Threads which is about to hit 200 million monthly actives. We're making steady progress towards building what looks like it's going to be another major social app. And we are seeing deeper engagement, and I'm quite pleased with the trajectory here. The big theme right now is, of course, AI. And I'll focus my comments today on three areas. What AI means for our family of apps and core business. What new AI experiences and opportunities we see, and how AI is shaping our metaverse work. So let's start. Across Facebook and Instagram, advances in AI continue to improve the quality of recommendations and drive engagement. And we keep finding that as we develop more general recommendation models, content recommendations get better. In this quarter, we rolled out our full screen video player and unified video recommendation service across Facebook, bringing Reels, longer videos, and live into a single experience. And this has allowed us to extend our unified AI systems, which had already increased engagement on Facebook Reels more than our initial move from CPUs to GPUs did. Over time I'd like to see us move towards a single unified recommendation system that powers all of the content including things like people you may know, across all of our surfaces. We're not there yet. They're still upside, and we're making good progress here. AI is also going to significantly evolve our services for advertisers in some exciting ways. It used to be that advertisers came to us with a specific audience they wanted to reach, like a certain age group, geography, or interests. Eventually, we got to the point where our ad systems could better predict who would be interested than the advertisers could themselves. But today, advertisers still need to develop creative themselves. And in the coming years, AI will be able to generate creative for advertisers as well. And we'll also be able to personalize it as people see it. Over the long term, advertisers will basically just be able to tell us a business objective and a budget, and we're going to go do the rest for them. We're going to get there incrementally over time, but I think this is going to be a very big deal. Moving on to some of the brand new experiences that AI enables, last quarter we started broadly rolling out our assistant Meta AI, and it is on track to achieve our goal of becoming the most used AI assistant by the end of the year. We have an exciting roadmap ahead of things that we want to add, but the bottom-line here is that Meta AI feels like it is on track to be an important service and it's improving quickly both in intelligence and features. Some of the use cases are utilitarian like searching for information or role-playing difficult conversations before you have them with another person and other uses are more creative like the new imagine yourself feature that lets you create images of yourself doing whatever you want in whatever style you want and part of the beauty of AI is that it's general. So we're still uncovering the wide range of use cases that it's valuable for. An important part of our vision is that we're not just creating a single AI, but enabling lots of people to create their own AIs. And this week we launched AI Studio, which lets anyone create AIs to interact with across our apps. I think the creators are especially going to find this quite valuable. There are millions of creators across our apps, and these are people who want to engage more with their communities, and their communities want to engage more with them, but there are only so many hours in the day. So now they are going to be able to use AI Studio to create AI agents that can channel them to chat with their community, answer people's questions, create content and more. So I'm quite excited about this. But this goes beyond creators too. Anyone is going to be able to build their own AIs based on their interests or different topics that they are going to be able to engage with or share with their friends. Business AIs are the other big piece here. We're still in Alpha testing with more and more businesses. The feedback we're getting is positive so far. Over time, I think that just like every business has a website, a social media presence, and an email address, in the future I think that every business is also going to have an AI agent that their customers can interact with. And our goal is to make it easy for every small business, eventually every business, to pull all of their content and catalog into an AI agent that drives sales and saves them money. When this is working at scale, I think that this is going to dramatically accelerate our business messaging revenue. There are a lot of other new opportunities here that I'm excited about too, but I'll save those for another day when we're ready to roll them out. The engine that powers all these new experiences is the Llama family of foundation models. In this quarter we released Llama 3.1 which includes the first frontier level open source model as well as new and industry leading small and medium sized models. The $405 billion model has better cost performance relative to the leading closed models, and because it's open, it is immediately the best choice for fine-tuning and distilling your own custom models of whatever size you need. I think we are going to look back at Llama 3.1 as an inflection point in the industry where open source AI started to become the industry standard, just like Linux is. I often get asked why I'm so bullish on Open Source. I wrote a letter along with the Llama 3.1 release, explaining why I believe that Open Source is better for developers, for Meta app, and for the world more broadly. My view is that Open Source will be safer, will enable innovation that improves all of our lives faster, and we'll also create more shared prosperity. For Meta's own interests, we're in the business of building the best consumer and advertiser experiences. And to do that, we need to have access to the leading technology infrastructure and not get constrained by what competitors will let us do. But these models are ecosystems. They're not just isolated pieces of software that we can develop by ourselves. So if we want the most robust ecosystem of tools, efficiency improvements, silicon optimizations, and other integrations to develop around our models, then we need them to be widely used by developers across the industry. And once we know that we're going to have access to the leading models, then I'm confident that we are going to be able to build the best social and advertising experiences. Part of why I'm so optimistic about this is that we have a long track record of success with open source. We've saved billions of dollars with open compute project by having supply chains standardized on our infrared designs. Open sourcing tools like PyTorch and React has led to real benefits for us from all the industry's contributions. This approach has consistently worked for us and I expect it will work here too. Another major area of focus is figuring out the right level of infra capacity to support training more and more advanced models. Llama 3 is already competitive with the most advanced models, and we're already starting to work on Llama 4, which we're aiming to be the most advanced in the industry next year. We are planning for the compute clusters and data we'll need for the next several years. The amount of compute needed to train Llama 4 will likely be almost 10 times more than what we used to train Llama 3, and future models will continue to grow beyond that. It's hard to predict how this trend -- how this will trend multiple generations out into the future. But at this point, I'd rather risk building capacity before it is needed rather than too late, given the long lead times for spinning up new inference projects. And as we scale these investments, we're of course, going to remain committed to operational efficiency across the company. The last area that I want to discuss is how AI is shaping our metaverse work, which continues to be our other long-term focus. Last quarter, I discussed how advances in AI have pulled in the timelines for some of our products. A few years ago, I would have predicted that holographic AR would be possible before Smart AI, but now it looks like those technologies will actually be ready in the opposite order. We're well positioned for that because of the Reality Labs investments that we've already made. Ray-Ban Meta Glasses continue to be a bigger hit sooner than we expected, thanks in part to AI. Demand is still outpacing our ability to build them, but I'm hopeful that we'll be able to meet that demand soon. EssilorLuxottica has been a great partner to work with on this, and we are excited to team up with them to build future generations of AI glasses, as we continue to build our long-term partnership. Quest 3 sales are also outpacing our expectations. And I think that's because it is not just the best MR headset for the price, but it's the best headset on the market, period. In addition to gaming, people are increasingly taking advantage of Quest's capabilities as a general computing platform, spending time watching videos, browsing websites, extending their PC via virtual desktop, and more. Horizon also continues to grow across VR, mobile, and desktop, and I expect that it will become an increasingly important part of that ecosystem as well. We're hosting our Annual Connect Conference on September 25th, and we will have lots of exciting updates around all of our AI and Metaverse work, so I encourage you to tune into that. At the end of the day, we are in the fortunate position where the strong results that we're seeing in our core products and business give us the opportunity to make deep investments for the future. And I plan to fully seize that opportunity to build some amazing things that will pay off for our community and our investors for decades to come. The progress we're making on both the foundational technology and product experiences suggests that we're on the right track. I'm proud of what our team has accomplished so far, and I'm optimistic about our ability to execute on the opportunities ahead. As always, thank you to our teams who are pushing all this important work forward, and thanks to all of you for being on this journey with us. And now here is Susan.
Susan Li : Thanks Mark and good afternoon everyone. Let's begin with our consolidated results. All comparisons are on a year-over-year basis unless otherwise noted. Q2 total revenue was $39.1 billion up 22% or 23% on a constant currency basis. Q2 total expenses were $24.2 billion, up 7% compared to last year. In terms of the specific line items, cost of revenue increased 23% driven primarily by higher infrastructure and reality labs inventory costs. R&D increased 13%, primarily driven by higher headcount-related expenses and infrastructure costs which were partially offset by lower restructuring costs. Marketing and sales decreased 14%, due mainly to lower restructuring and headcount-related costs. G&A decreased 12%, mostly due to lower legal-related expenses. We ended the first quarter with almost 70,800 employees, up 2% from Q1. Second quarter operating income was $14.8 billion, representing a 38% operating margin. Our tax rate for the quarter was 11%. Net income was $13.5 billion, or $5.16 per share. Capital expenditures, including principal payments on finance leases, were $8.5 billion, driven by investments in servers, data centers, and network infrastructure. Free cash flow was $10.9 billion. We repurchased $6.3 billion of our Class A common stock and paid $1.3 billion in dividends to shareholders, ending the quarter with $58.1 billion in cash and marketable securities and $18.4 billion in debt. Moving now to our segment results. I'll begin with our Family of Apps segment. Our community across the Family of Apps continues to grow, with approximately 3.27 billion people using at least one of our Family of Apps on a daily basis in June. Q2 total Family of Apps revenue was $38.7 billion, up 22% year-over-year. Q2 Family of Apps ads revenue was $38.3 billion, up 22% or 23% on a constant currency basis. Within ad revenue, the online commerce vertical was the largest contributor to year-over-year growth, followed by gaming and entertainment and media. On a user geography basis, ad revenue growth was strongest in rest of world and Europe at 33% and 26% respectively. Asia Pacific grew 20% and North America grew 17%. On an advertiser geography basis, total revenue growth continued to be strongest in Asia Pacific at 28%. The growth was below the first quarter rate of 41%, as we lapped a period of stronger demand from China-based advertisers. In Q2, the total number of ad impressions served across our services and the average price per ad both increased 10%. Impression growth was mainly driven by Asia Pacific and rest of world. Pricing growth was driven by increased advertiser demand in part due to improved ad performance. This was partially offset by impression growth particularly from lower monetizing regions and surfaces. Family of Apps other revenue was $389 million, up 73%, driven primarily by business messaging revenue growth from our WhatsApp business platform. We continue to direct the majority of our investments toward the development and operation of our Family of Apps. In Q2, Family of Apps expenses were $19.4 billion, representing approximately 80% of our overall expenses. Family of Apps expenses were up 4%, mostly due to higher infrastructure and headcount related expenses, which were partially offset by lower restructuring costs. Family of Apps operating income was $19.3 billion, representing a 50% operating margin. Within our Reality Labs segment, Q2 was $353 million, up 28% driven primarily by Quest headset sales. Reality Labs expenses were $4.8 billion, up 21% year-over-year, driven mainly by higher headcount-related expenses and Reality Labs inventory costs. Reality Labs operating loss was $4.5 billion. Turning now to the business outlook. There are two primary factors that drive our revenue performance, our ability to deliver engaging experiences for our community and our effectiveness at monetizing that engagement over time. To deliver engaging experiences, we remain focused on executing our priorities, including video and in-feed recommendations. On Instagram, Reels engagement continues to grow as we make ongoing enhancements to our recommendation systems. Part of this work has been focused on increasing the share of original posts within recommendations so people can discover the best of Instagram, including content from emerging creators. Now, more than half of recommendations in the US come from original posts. On Facebook, we're seeing encouraging early results from the global rollout of our unified video player and ranking systems in June. This initiative allows us to bring all video types on Facebook into one viewing experience, which we expect will unlock additional growth opportunities for short-form video, as we increasingly mix shorter videos into the overall base of Facebook video engagement. We expect the relevance of video recommendations will continue to increase as we benefit from unifying video ranking across Facebook and integrating our next-generation recommendation systems. These have already shown promising gains since we began using the new systems to support Facebook Reels recommendations last year. We expect to expand these new systems to support more services beyond Facebook video over the course of this year and next year. We are also seeing good momentum with our longer-term engagement priorities, including Generative AI and Threads. People have used Meta AI for billions of queries since we first introduced it. We're seeing particularly promising signs on WhatsApp in terms of retention and engagement, which has coincided with India becoming our largest market for Meta AI usage. You can now use Meta AI in over 20 countries and eight languages, and in the US we are rolling out new features like Imagine Edit, which allows people to edit images they generate with Meta AI. Beyond Generative AI, the Threads community also continues to grow and deepen their engagement, as we ship new features and enhance our content recommendation systems. Now to the second driver of our revenue performance, increasing monetization efficiency. There are two parts to this work. The first is optimizing the level of ads within organic engagement. We continue to see opportunities to grow ad supply on lower monetizing surfaces like video, including within Facebook as the mix of overall video engagement shifts more to shorter videos over time, which creates more ad insertion opportunities. More broadly, we are continuing to get better at determining the best ads to show and when to show them during a person session across both Facebook and Instagram. This is enabling us to drive revenue growth and conversions without increasing the number of ads or in some cases even reducing ad load. The second part of improving monetization efficiency is enhancing marketing performance. We continue to be pleased with our progress here, with AI playing an increasingly central role. We're improving ad delivery by adopting more sophisticated modeling techniques made possible by AI advancements, including our Meta Lattice ad ranking architecture, which continued to provide ad performance and efficiency gains in the second quarter. We're also making it easier for advertisers to maximize ad performance and automate more of their campaign setup with our Advantage+ suite of solutions. We're seeing these tools continue to unlock performance gains, with a study conducted this year demonstrating 22% higher return on ad spend for US advertisers after they adopted Advantage+ Shopping campaigns. Advertiser adoption of these tools continues to expand and we are adding new capabilities to make them even more useful. For example, this quarter we introduced flexible format to Advantage+ Shopping, which allows advertisers to upload multiple images and videos in a single ad that we can select from and automatically determine which format to serve in order to yield the best performance. We have also now expanded the list of conversions that businesses can optimize for using Advantage+ shopping to include an additional 10 conversion types, including objectives like add to cart. Looking forward, we believe Generative AI will play a growing role in how businesses market and engage with customers at scale. We expect this technology will continue to make it easier for businesses to develop customized and diverse ad creatives. We've seen promising early results since introducing our first Generative AI ad features, image expansion, background generation, and text generation with more than 1 million advertisers using at least one of these solutions in the past month. In May, we began rolling out full image generation capabilities into Advantage+ Creative, and we're already seeing improved performance from advertisers using the tool. Finally, we expect AI will help businesses communicate with customers more efficiently through messaging. We're starting by testing the ability for businesses to use AI in their chats with customers to help sell their goods and services and to generate leads. While we are in the early stages, we continue to expand the number of advertisers we are testing with and have seen good advances in the quality of responses since we began using Llama 3. Next, I’d like to discuss our approach to capital allocation which remains unchanged. We continue to invest both in enhancing our core experiences in the near-term and developing technologies that we believe will transform how people engage with our services in the years ahead. We expect that having sufficient compute capacity will be central to many of these opportunities. So we’re investing meaningfully in infrastructure to support our core AI work in content ranking and ads, as well as our generative AI and advanced research efforts. Our ongoing investment in core AI capacity is informed by the strong returns we've seen and expect to deliver in the future, as we advance the relevance of recommended content and ads on our platform. While we expect the returns from Generative AI to come in over a longer period of time, we’re mapping these investments against the significant monetization opportunities that we expect to be unlocked across customized ad creative, business messaging, a leading AI assistant and organic content generation. As we scale generative AI training capacity to advance our foundation models, we’ll continue to build our infrastructure in a way that provides us with flexibility in how we use it over time. This will allow us to direct training capacity to gen AI inference or to our core ranking and recommendation work, when we expect that doing so would be more valuable. We will also continue our focus on improving the cost efficiency of our workloads over time. Reality Labs remains our other long-term initiative that we continue to invest meaningfully in. Quest 3 is selling well and Ray-Ban Meta smart glasses are showing very promising traction with the early signals that we’re seeing across demand, usage and retention increasing our confidence in the long-run potential of AR glasses. Finally, as we pursue these investments across near and long-term priorities, we will remain focused on operating the business efficiently. Turning now to the revenue outlook. We expect third quarter 2024 total revenue to be in the range of $38.5 billion to $41 billion. Our guidance assumes foreign currency is a 2% headwind to year-over-year total revenue growth based on current exchange rates. Turning now to the expense outlook. We expect full year 2024 total expenses to be in the range of $96 billion to $99 billion, unchanged from our prior outlook. For Reality Labs, we continue to expect 2024 operating losses to increase meaningfully year-over-year due to our ongoing product development efforts and investments to scale our -- to further scale our ecosystem. While we do not intend to provide any quantitative guidance for 2025 until the fourth quarter call, we expect infrastructure costs will be a significant driver of expense growth next year. As we recognize depreciation and operating costs associated with our expanded infrastructure footprint. Turning now to the CapEx outlook. We anticipate our full year 2024 capital expenditures will be in the range of $37 billion to $40 billion, updated from our prior range of $35 billion to $40 billion. While we continue to refine our plans for next year, we currently expect significant CapEx growth in 2025 as we invest to support our AI research and our product development efforts. On to tax. Absent any changes to our tax landscape, we expect our full year 2024 tax rate to be in the mid-teens. In addition we continue to monitor an active regulatory landscape, including the increasing legal and regulatory headwinds in the EU and the US that could significantly impact our business and our financial results. In closing, Q2 was another good quarter. We continue to execute well across our business priorities and have exciting opportunities in front of us to deliver more value to the people and businesses using our products around the world. With that, Krista let's open up the call for questions.
Operator: Thank you. We will now be open the line for question-and-answer session [Operator Instructions] And your first question comes from the line of Brian Nowak from Morgan Stanley. Please go ahead.
Brian Nowak: Great. Thanks for taking my questions. I have two, one for Mark, one for Susan. Mark I wanted to sort of go back to some of the new generative AI-enabled use cases for users and advertisers. You talked about Meta AI, Studio, chatbots, [foundation] (ph) models. If you could just sort of hone in on one or two of those that you are most excited about, we are seeing good signal that could be a real driver for the business in '25, '26 just so we sort of know where are you most focused on all those opportunities it would be helpful. And the second one, Susan, you have a lot of CapEx priorities from building new infrastructure for next-generation models, compute capacity. Just walk us through again on the CapEx philosophy and any guardrails you have around ensuring you generate a healthy return on invested capital for investors from all the CapEx. Thanks.
Mark Zuckerberg: I can take the first one. So I think the things that will drive the most results in 2025 and 2026 are actually the first category of things that I talked about in my comments which are the ways that AI is shaping the existing products. So the ways that it is improving recommendations and helping people find better content, as well as making the advertising experiences more effective. I think there is a lot of upside there. Those are already products that are at scale. The AI work that we are doing is going to improve that. It will improve the experience and the business results. The other areas that we are working on, I mean I think you all know this from following our business for a while, but we have a relatively long business cycle of starting a new product, scaling it to something that reaches 1 billion people or more and only then really focusing on monetizing at scale. So realistically, for things like Meta AI or AI Studio, I mean these are things that I think will increase engagement in our products and have other benefits that will improve the business and engagement in the near term. But before we are really talking about monetization of any of those things by themselves, I mean I don't think that anyone should be surprised that I would expect that -- that will be years, right? It's just -- I think that that's like what we've seen with Reels, it's what we saw with all these things. But I think for those who have followed our business for a long time, you can also get a pretty good sense of when things are going to work years in advance. And I think that the people who bet on those early indicators tend to do pretty well, which is why I wanted to share in my comments the early indicator that we had on Meta AI, which is I mean look, it is early. Last quarter, we -- I think it just started rolling it out a week or two before our earnings call. This time we are a few months later. And what we can say is I think we are on track to achieve our goal of being the most used AI assistant by the end of this year. And I think that is a pretty big deal. Is that the only thing we want to do? No. I mean we obviously want to kind of grow that and grow the engagement on that to be a lot deeper, and then we will focus on monetizing it over time. But the early signals on this are good and I think that -- that's kind of all that we could reasonably have insight into at this point. But I do think that part of what's so fundamental about AI is, it is going to end up affecting almost every product that we have in some way. It will improve the existing ones and will make a whole lot of new ones possible. So it is why there are all the jokes about how all the tech CEOs get on these earnings calls and just talk about AI the whole time. It is because it is actually super exciting, and it is going to change all these different things over multiple time horizons.
Susan Li: And Brian, I can take the second question. On the ROI part of your question, I’d broadly characterize our AI investments into two buckets; core AI and Gen AI. And the two are really at different stages, as it relates to driving revenue for our businesses and our ability to measure returns. On our core AI work, we continue to take a very ROI based approach to our investment here. We are still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains and it makes sense for us to continue investing here. Gen AI is where we are much earlier, as Mark just mentioned in his comments. We don't expect our Gen AI products to be a meaningful driver of revenue in 2024. But we do expect that they are going to open up new revenue opportunities over time that will enable us to generate a solid return off -- of our investment while we are also open sourcing subsequent generations of Llama. And we've talked about the four primary areas that we are focused here on the Gen AI opportunities to enhance the core ads business, to help us grow in business messaging, the opportunities around Meta AI, and the opportunities to grow core engagement over time. The other thing I’d say is, we are continuing to build our AI infrastructure with fungibility in mind, so that we can flex capacity where we think it will be put to best use. The infrastructure that we build for gen AI training can also be used for Gen AI inference. We can also use it for ranking and recommendations by making certain modifications like adding general compute and storage. And we are also employing a strategy of staging our data center sites, at various phases of development, which allows us to flex up to meet more demand and less lead time if needed while limiting how much spend we are committing to in the outer years. So while we do expect that we are going to grow CapEx significantly in 2025, we feel like we have a good framework in place in terms of thinking about where the opportunities are and making sure that we have the flexibility to deploy it, as makes the most sense.
Operator: Your next question comes from the line of Mark Shmulik with Bernstein. Please go ahead.
Mark Shmulik: Yes. Hi, thanks for taking my question. Just as we look at the revenue guidance and the outlook, Susan, any color you can share on just kind of the state of the overall digital ad market? And you've highlighted some areas where you are seeing strength versus kind of some of the idiosyncratic efforts you've made to kind of improve the efficacy of the ad product. Thank you.
Susan Li: Hi, Mark. We are continuing to see healthy global advertising demand, and we are also delivering ongoing ad performance improvements just related to all of the investments that we've continued to make over time. And improving the sort of ads, targeting ranking, delivery, all of the fundamental infrastructure there. And we expect that all of that will continue to benefit ad spend in Q3. We do expect year-over-year growth to slow in Q3, as we are lapping strong growth from China-based advertisers, as well as strong Reels impression growth from a year ago. And we also expect modestly larger FX headwinds in Q3 based on current rates.
Operator: Your next question comes from the line of Eric Sheridan with Goldman Sachs. Please go ahead.
Eric Sheridan: Thank you so much for taking the question. I'll just ask one. You called out building community size and what's happened in the United States, as well as Threads. How are you thinking about those newer faster-growing elements of either Messaging or Threads as a platform and the mix between the potential for engagement growth and overall monetization longer term of either the messaging layer or Threads and what you are most excited about there to build to sort of capitalize on scale but bring it back towards monetization? Thank you.
Mark Zuckerberg: I can start and Susan can jump in, if she has anything else that she wants to add. So the WhatsApp stat I think, is really important as a business trend just because the United States punches above its weight in terms of, it is such a large percent of our revenue. So before, WhatsApp was sort of the leading messaging app in many countries around the world but not in the US. And I think now that we're starting to make inroads into leading in the US as more and more people use the product and realize that, hey, it was a really good experience, the best experience for cross-platform communication and groups and on all these different things. I think that -- that's going to just mean that all of the work that we are doing to grow the business opportunity there over time is just going to have a big tailwind if the US ends up being a big market. So that's one reason why it's really relevant. It is obviously also personally somewhat gratifying to see all the people around us starting to use WhatsApp, so I think that is pretty fun but maybe somewhat less relevant from a business perspective. Threads, I think it is another example of something that it got off to about as good of a start of any app that I can think of. I think, it was the fastest growing app to 100 million people. And it is a good reminder that even when you have that start, the path from there to 1 billion people using an app is still multiple years. And that's our product cycle. And I think that -- that's something that is a little bit different about Meta in the way we build consumer products and the business around them than a lot of other companies that ship something and start selling it and making revenue from it immediately. So I think that's something that our investors and folks thinking about analyzing the business, if needed to always grapple with, is all these new products, we ship them and then there is a multiyear time horizon between scaling them and then scaling them into not just consumer experiences but very large businesses. But the thing that I think is just super exciting about Threads is that we've been building this company for 20 years, and there are just not that many opportunities that come around to grow 1 billion person app. I mean, there are -- I don't know, maybe a dozen of them in the world or something, right? I mean, there are certainly more of them outside the company than inside the company, but we do pretty well and being able to add another one to the portfolio if we execute really well on this is just really exciting to have that potential. Now obviously, there is a ton of work between now and there. I mean, we are almost at 200 million. So it is a really good milestone, I'm excited about that. A lot of work between this and it being a large part of the business. But I do think that these kind of opportunities are pretty rare and that's something that we are just really excited about. I think the team is doing great work on it.
Susan Li: Eric, I would just add to that in terms of [nearer-term] (ph) sources of impression growth, we really expect that video is going to remain a source of impression growth for us in the second half. On Instagram, we expect Reels to continue to drive growth, while on Facebook, we expect to grow overall video time, while increasing the mix of short-form video, which creates more impression growth opportunities. And generally we expect continued community growth foracross our apps.
Operator: Your next question comes from the line of Doug Anmuth with JPMorgan. Please go ahead.
Douglas Anmuth: Hi, thanks for taking my questions. One for Mark, one for Susan. Mark just in terms of infrastructure and CapEx, you've talked about currently building out not just for Llama 3 and 4 but really out to 7 perhaps and then Llama 4, 10x the compute required versus Llama 3. Just given how much you are building ahead, how does that influence the shape of the CapEx curve over a multiyear period? And then Susan, if you could talk a little bit more about the 3Q outlook. I know you are talking about tougher comps, but at the same time, it really suggests only 1 point of FX neutral [decel] (ph) at the high end. So just curious if there's anything else you can point to more specifically that's driving the expected strength here. Thanks.
Susan Li: Thanks, Doug. I can go ahead and talk about both of those. So your first question was sort of about the longer-term CapEx outlook. We haven't really shared an outlook sort of on the longer-term CapEx trajectory. In part infrastructure is an extraordinarily dynamic planning area for us right now. We are continuing to work through what the scope of the Gen AI road maps will look like over that time. Our expectation obviously again, is that we are going to significantly increase our investments in AI infrastructure next year, and we'll give further guidance as appropriate. But we are building all of that CapEx, again with the factors in mind that I talked about previously thinking about both how to build it flexibly, so we can deploy to core AI and Gen AI use cases as needed. And making sure that we both feel good about the returns that we're seeing on the core AI investments, which we are able to measure more immediately. And then we feel good about the opportunities in the gen AI efforts. Your second question was about the Q3 revenue outlook. Again I mentioned this earlier. We have seen healthy global advertising demand on our platform. We are delivering ongoing ad performance improvements, which again we feel like is a result of many, many quarters of effort that have accrued and will continue to accrue value to our platform. And we saw basically in Q2 where revenue grew 22% that there was broad-based strength across regions and verticals including particular strength among smaller advertisers, and we expect that generally to continue into Q3.
Operator: Your next question comes from the line of Justin Post with Bank of America. Please go ahead.
Justin Post: Great. Thank you. I just want to get back to the comment on US young adult user growth, especially maybe on Facebook and Instagram. I know you made a big change with Reels a couple of years ago. But what are those users doing on Facebook and Instagram? And can you give us any quantification of the usage growth? Thank you.
Susan Li: Thanks, Justin. So building products with young adults in mind has been a core priority area for the Facebook team in recent years, and we've been very encouraged to see these efforts translate into engagement growth with this cohort. We have seen healthy growth in young adult app usage in the US and Canada for the past several quarters. And we have seen that products like Groups and Marketplace have seen particular traction with young adults. Posting to groups in the US and Canada has been growing. That's been boosted mainly by young adults. And we also see that they are active users of Marketplace, which has benefited from product improvements and strong demand for second-hand products in the US.
Operator: Your next question comes from the line of Mark Mahaney with Evercore ISI. Please go ahead.
Mark Mahaney: I was going to ask about Marketplace so that's a nice segue. It is a great, somewhat under-monetized or arguably very under-monetized asset. I know you indirectly monetize it and it's a very large marketplace. It may even be bigger than eBay. Your thoughts on what you may want to do in the future in terms of monetizing it, in part maybe even improve the quality of the Marketplace. And then secondly, I just want to ask you about headcount. It is down about 1% year-over-year. You are pretty much back at par with where the employee headcount was prior to significant reduction. How should we think about headcount growth going forward? Did you talk about a significant growth in CapEx? Should we expect a moderate growth in headcount significant? Any thoughts on that would be helpful. Thank you.
Susan Li: Thanks Mark. On your first question about Marketplace, again we are obviously excited that it's been one of the drivers of strength in young adults. I would probably just say that more generally, Marketplace is one prong in a broader commerce strategy that we have which continues to be focused on basically creating the best shopping experience on our platform. Marketplace is obviously consumer oriented. The broader part of the commerce strategy is about making it easier for businesses to advertise their products, for buyers to find and purchase relevant items on our platform. And to that end, I’d say that we feel quite happy with also the investments we've been making in Shops ads. Shops ads revenue is growing at a strong year-over-year pace. We are seeing Shops ads drive incremental performance for advertisers, and it's also working well in combination with some of our other products like Advantage+ shopping. Your second question was about headcount. We continue to be disciplined about where we are allocating new headcount to ensure that it's really focused on our core company priorities, but we are also working down a prior hiring underrun. And as we further close that hiring underrun over the course of this year, I do expect that we will end 2024 with in-seat reported headcount that is meaningfully higher than where we ended 2023. We aren't providing sort of 2025 headcount growth expectations yet as we haven't started our budgeting process yet. But again, I expect that we’ll primarily target our hiring to focus on priority areas, and we will be running a very disciplined headcount process.
Operator: Your next question comes from the line of Youssef Squali with Truist Securities. Please go ahead.
Youssef Squali: Great. Thank you very much. So the AI system using Llama 3.1 has been incorporated in different variations and looks really impressive and seems to be getting closer to becoming a full search engine for virtually everything except for commercial queries so far. So are there any plans to open it up to the broader web? Kind of like what may be OpenAI is off to testing, maybe link it to third-party marketplaces for commercial search, et cetera. And then on Ray-Ban, can you maybe talk a little bit more about the opportunity to deepen your relationship with EssilorLuxottica? What would that look like? What kind of areas are the most exciting to you, Mark in that relationship? Thank you.
Mark Zuckerberg: Yes. I'm very excited with how Llama 3.1 landed. I think the team there is doing really great work going from the first version of Llama, the Llama 2 last year that was a generation behind the frontier and now Llama 3.1, which is basically competitive and in some ways, leading the other top-closed models. Meta AI uses a version of Llama 3.1 as well as a bunch of other services that we've built to kind of build a cohesive product. And when I was talking before about we have the initial usage trends around Meta AI but there is a lot more that we want to add. Things like commerce and you can just go vertical by vertical and build out specific functionality to make it useful in all these different areas are eventually, I think what we're going to need to do to make this just as -- to fulfill the potential around just being the ideal AI assistant for people. So it is a long road map. I don't think, that this stuff is going to get finished in the next couple of quarters or anything like that. But this is part of what's going to happen over the next few years as we build something that will I think, just be a very widely used service. So I'm quite excited about that. And we are going to continue working on Llama 2. So I mean, you mentioned Llama, and I think the question was a little more about Meta AI but they are both -- I mean, they're related Llama is sort of like the engine that powers the product and it's open source, and I'm just excited about the progress that we are making on both of those. On the smart glasses, EssilorLuxottica is a great partner. We are now in the second generation of the Ray-Ban Meta glasses. They are doing well, better than I think we had expected, and we expected them to grow meaningfully from the first generation so that's been a very positive surprise. And I think part of that is that it is just well-positioned to dovetail well with the AI revolution that we are seeing and offering all kinds of new functionality there. So that was great. But EssilorLuxottica is a great company that has a lot of different products that we hope to be able to partner with to just continue building new generations of the glasses and deepen the AI product and make it better and better. I think there is a lot more to go from here. And compared to what we thought at this point, it's doing quite well compared to, I think what it needs to be, to be like a really leading piece of consumer electronics, I think we are still early but all the signs are good.
Operator: Your next question comes from the line of Ron Josey with Citi. Please go ahead.
Ronald Josey: Great. Thanks for taking the question. I want to get back, Mark, to the commentary on open source and Llama 3. Totally understand that Meta is not offering a public cloud, and so what I wanted to hear from you is maybe a little bit more on the product vision of products that come out of Llama 3. And meaning potentially offering some of these products to other companies, call it for customer service or call center offerings or other verticals. And so any insights on just how you envision maybe the open source and Llama 3.1, can sort of offer greater enterprise services for others to benefit from? Thank you.
Mark Zuckerberg: So Llama is the foundation model that people can shape into all kind of different products. So whether it's Meta AI for ourselves or the AI Studio or the business agents or like the assistant that's in the Ray-Ban glasses, like all these different things are basically products that have been built with Llama. And similarly, any developer out there is going to be able to take it and build a whole greater diversity of different things as well. Like I talked about, I think -- the reason why open sourcing this is so valuable for us is that we want to make sure that we have the leading infrastructure to power the consumer and business experiences that we are building. But the infrastructure, it's not just a piece of software that we can build in isolation. It really is an ecosystem with a lot of different capabilities that other developers and people are adding to the mix, whether that's new tools to distill the models into the size that you want for a custom model, or ways to fine-tune things better or make inference more efficient or all different other kinds of methods that we haven't even thought of yet, the silicon optimizations that the silicon companies are doing, all the stuff. It is an ecosystem. So we can't do all that ourselves. And if we built Llama and just kind of kept it within our walls, then it wouldn't actually be as valuable for us to build all the products that we are building as it is going to end up being. So that's the business strategy around that. And that's why we don't feel like we need to necessarily build a cloud and sell it directly in order for it to be a really positive business strategy for us. And part of what we are doing is working closely with AWS, I think, especially did great work for this release. Other companies like Databricks, Nvidia, of course, other big players like Microsoft with Azure, and Google Cloud, they are all supporting this. And we want developers to be able to get it anywhere. I think that's one of the advantages of an open source model like Llama is – it is not like you're locked into one cloud that offers that model, whether it's Microsoft with OpenAI or Google with Gemini or whatever it is, you can take this and use it everywhere and we want to encourage that. So I'm quite excited about that. The enterprise and business applications that we are going to be most focused on, though, in addition to just optimizing the advertiser experience like I talked about in my comments earlier, it is the business agent piece. I just think that there is a huge potential like I said earlier. I think pretty much every business today, it has an e-mail address. They have a website. They have social media accounts. I think in the future, they are going to have at least one, if not multiple business agents that can do the whole range of things from interacting to help people buy things to helping support the sales that they've done, if they have issues with the product, if they need to get in touch with you for something. And we already see people interacting with businesses over messaging working quite well in countries that have low cost of labor. But the thing is that in order to have someone answering everyone's questions is quite expensive in a lot of countries. And I think that this is like a thing that AI, I think is just going to be very well suited towards doing. And when we can make that easy for the hundreds of millions of businesses that use our platforms to pull in all their information and their catalogs, and the history and all the content that they've shared and really just quickly stand up an agent, I think that's going to be awesome. So we can combine Llama with a lot of custom work that we're doing in our business teams and couple that with all the other investment that the rest of the ecosystem is doing to make Llama good. And I think that's going to be huge, but that's just one area. I mean, this really goes across all of the different products that we are building, both consumer and business. So it is a lot of exciting stuff.
Kenneth Dorell: Krista, we have time for one last question.
Operator: Thank you. That question will come from the line of Ross Sandler with Barclays. Please go ahead.
Ross Sandler: Great. Mark, so on Monday in your interview with Jensen, you said something along the lines of if scaling ended up stopping one day, you'd have five years of product work to do and ahead of you. So outside of agents or AI assistants, what other areas in AI are you thinking about or looking at in that five-year road map? And then the second question is maybe one more stab at the capacity question. You guys said that Llama 3.1 was trained on 16,000 H100s. You've also said that you're going to have 600,000 available by year-end. So even if we kind of go up to 160,000 GPUs for Llama 4, we have plenty of extra capacity for inference and future products. I guess how are you guys modeling out this entire kind of CapEx road map between training, inference, and future things? That's all. Thanks a lot.
Mark Zuckerberg: I can start with the first one, and then I'll let Susan answer the second one. It is an interesting question. It is a little hypothetical because I mean, I do think it's true that if, let's say, there were no future foundation models. I think there would just be a huge amount of product innovation that the industry would bring to bear, and that just takes time. But then at the same time there are going to be future foundation models, and they are going to be awesome and unlock new capabilities and we are planning our products around those. So I'm not really planning our product road map assuming that there isn't future innovation. On the contrary, we are planning what's going to be in Llama 4 and Llama 5 and beyond based on what capabilities we think are going to be most important for the road map that I just laid out for having the breadth of utility that you're going to need in something like Meta AI, making it set businesses and creators and individuals can stand up any kind of AI agents that they want, that you are going to have these kind of real-time, multimodal glasses with you all the time that will just be increasingly useful for all the things that you're doing. And that -- I guess this kind of dovetails what I'd expect Susan to talk about next. And we do have this huge set of use cases already about people wanting to discover content and interact with their friends and businesses reaching people, and all that stuff is getting better with this, too. So there is -- I guess my point there was its just – there is some lag between the technology becoming available and the products becoming kind of fully explored in the space. And I just think that -- that was kind of my way of saying that I think that this is just a very exciting area where there's just going to be a lot of innovation for a long time to come. I'll let Susan take a stab at the numbers around the GPUs and all that.
Susan Li: Thank you. We are clearly in the process of building out a lot of capacity, and Mark has alluded to that in his comments about what we have needed to train prior generations and the next generation of Llama. And we are -- and that's driving sort of what we've talked about in terms of the significant growth in CapEx in 2025. And we aren't really in the position now to share a longer-term outlook. When we think about sort of any given new data center project that we are constructing, we think about how we will use it over the life of the data center. We think about the amount of capacity we would use in terms of training whatever the subsequent generations of Llama are and it is architected around that. But then we also look at how we might use it several years into its lifetime towards other use cases across our core business, across what we think might be future needs for inference, for generative AI-based products. So there is sort of a whole host of use cases for the life of any individual data center ranging from gen AI training at its outset to potentially supporting gen AI inference to being used for core ads and content ranking and recommendation and also thinking through the implications, too, of what kinds of servers we might use to support those different types of use cases. So we are really mapping across a wide range of potential use cases when we undertake any given project. And we are really doing that with both a long time horizon in mind, again, because of the long lead times in spinning up data centers, but also recognizing that there are multiple decision points in the lifetime of each data center in terms of thinking through when to order servers and what servers to order and what you will put them towards. And that gives us flexibility to make the sort of the best decisions based on the information we have in the future.
Kenneth Dorell: Great. Thank you all for joining us today. We appreciate your time, and we look forward to speaking with you again soon.
Operator: This concludes today's conference call. Thank you for your participation, and you may now disconnect. |
MSFT | 4 | 2,024 | 2024-07-30 21:27:04 | Operator: Greetings and welcome to the Microsoft Fiscal Year 2024 Fourth Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Brett Iversen, Vice President of Investor Relations.
Brett Iversen: Good afternoon and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer, Alice Jolla, Chief Accounting Officer, and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today’s call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today’s call. On this call we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's fourth quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year unless otherwise noted. We will also provide growth rates in constant currency, when available, as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript, and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the risk factor section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I’ll turn the call over to Satya.
Satya Nadella: Thank you, Brett. We had a solid close to our fiscal year. All-up, annual revenue was more than $245 billion, up 15% year-over-year. And Microsoft Cloud revenue surpassed $135 billion, up 23%. Before I dive in, I want to offer some broader perspective on the AI platform shift. Similar to the cloud, this transition involves both knowledge and capital intensive investments. And as we go through this shift, we are focused on two fundamental things: First, driving innovation across a product portfolio that spans infrastructure and applications so as to ensure that we are maximizing our opportunity, while in parallel continuing to scale our cloud business and prioritizing fundamentals, starting with security. Second, using customer demand signal and time to value to manage our cost structure dynamically and generate durable, long-term operating leverage. With that, let me highlight examples, starting with Azure. Our share gains accelerated this year, driven by AI. We expanded our datacenter footprint, announcing investments across four continents. These are long-term assets around the world to drive growth for the next decade and beyond. We added new AI accelerators from AMD and NVIDIA, as well as our own first party silicon Azure Maia. And we introduced new Cobalt 100, which provides best-in-class performance for customers like Elastic, MongoDB, Siemens, Snowflake, and Teradata. We continued to see sustained revenue growth from migrations. Azure Arc is helping customers in every industry, from ABB and Cathay Pacific, to LaLiga, to streamline their cloud migrations. We now have 36,000 Arc customers, up 90% year-over-year. We remain the hyperscale cloud of choice for SAP and Oracle workloads. Atos, Coles, Daimler Truck AG, Domino’s, Haleon, for example, all migrated their mission-critical SAP workloads to our cloud. And with our Azure VMware Solution, we offer the fastest and most cost-effective way for customers to migrate their VMware workloads too. With Azure AI, we are building out the app server for the AI wave, providing access to the most diverse selection of models to meet customers’ unique cost, latency, and design considerations. All-up, we now have over 60,000 Azure AI customers, up nearly 60% year-over-year, and average spend per customer continues to grow. Azure OpenAI Service provides access to best-in-class frontier models, including as of this quarter GPT-4o and GPT-4o mini. It is being used by leading companies in every industry, including H&R Block, Suzuki, Swiss Re, Telstra as well as digital natives like Freshworks, Meesho, and Zomato. With Phi-3, we offer a family of powerful, small language models, which are being used by companies like BlackRock, Emirates, Epic, ITC, Navy Federal Credit Union, and others. And with Models as a Service, we provide API access to third-party models, including as of last week the latest from Cohere, Meta, and Mistral. The number of paid Models as a Service customers more than doubled quarter-over-quarter, and we are seeing increased usage by leaders in every industry, from Adobe and Bridgestone, to Novo Nordisk and Palantir. Now, on to data. Our Microsoft Intelligent Data Platform provides customers with the broadest capabilities spanning databases, analytics, business intelligence, and governance along with seamless integration with all of our AI services. The number of Azure AI customers also using our data and analytics tools grew nearly 50% year-over-year. Microsoft Fabric, our AI-powered next generation data platform – now has over 14,000 paid customers, including leaders in every industry, from Accenture and Kroger, to Rockwell Automation and Zeiss up 20% quarter-over-quarter. And, this quarter, we introduced new first-of-their-kind real-time intelligence capabilities in Fabric so customers can unlock insights on high-volume, time sensitive data. Now, on to developer tools. GitHub Copilot is by far the most widely adopted AI-powered developer tool. Just over two years since its general availability, more than 77,000 organizations from BBVA, FedEx, and H&M, to Infosys and Paytm have adopted Copilot, up 180% year-over-year. And we are going further. With Copilot Workspace, we offer Copilot-native end-to-end developer productivity across plan, build, test, debug, and deploy cycle. Copilot is driving GitHub growth, all up, GitHub’s annual revenue run rate is now $2 billion. Copilot accounted for over 40% of GitHub revenue growth this year, and is already a larger business than all of GitHub was when we acquired it. We are also integrating generative AI across Power Platform, enabling anyone to use natural language to create apps, automate workflows, or build a website. To date, over 480,000 organizations have used AI-powered capabilities in Power Platform, up 45% quarter-over-quarter. In total, we now have 48 million monthly active users of Power Platform, up 40% year-over-year. Now, on to future of work. Copilot for Microsoft 365 is becoming a daily habit for knowledge workers, as it transforms work, workflow, and work artifacts. The number of people who use Copilot daily at work nearly doubled quarter-over-quarter, as they use it to complete tasks faster, hold more effective meetings, and automate business workflows and processes. Copilot customers increased more than 60% quarter-over-quarter. Feedback has been positive, with majority of enterprise customers coming back to purchase more seats. All-up, the number of customers with more than 10,000 seats more than doubled quarter-over-quarter, including Capital Group, Disney, Dow, Kyndryl, Novartis. And EY alone will deploy Copilot to 150,000 of its employees. And we are going further, adding agent capabilities to Copilot. New Team Copilot can facilitate meetings, and create and assign tasks. And, with Copilot Studio, customers can extend Copilot for Microsoft 365 and build custom copilots that proactively respond to data and events using their own first and third-party business data. To date, 50,000 organizations from Carnival Corporation, Cognizant, and Eaton, to KPMG, Majesco, and McKinsey have used Copilot Studio, up over 70% quarter-over-quarter. We are also extending Copilot to specific industries, including healthcare, with DAX Copilot. More than 400 healthcare organizations including Community Health Network, Intermountain, Northwestern Memorial Healthcare, and Ohio State University Wexner Medical Center have purchased DAX Copilot to date, up 40% quarter-over-quarter, and the number of AI-generated clinical reports more than tripled. Copilot is also transforming ERP and CRM business applications. We again took share this quarter, as customers like ThermoFisher Scientific switched to Dynamics. Our new Dynamics 365 Contact Center is a Copilot-first solution that infuses generative AI throughout the contact center workflow. Companies like 1-800 Flowers, Mediterranean Shipping, Synoptek will rely on it to deliver better customer support. And Dynamics 365 Business Central is now trusted by over 40,000 organizations for core ERP. Microsoft Teams has become essential to how hundreds of millions of people meet, call, chat, collaborate, and do business. We once again saw year-over-year usage growth. Teams Premium has surpassed 3 million seats, up nearly 400% year-over-year, as organizations like dentsu, Eli Lilly, and Ford chose it for advanced features like end-to-end encryption and real-time translation. When it comes to devices, we introduced our new category of Copilot+ PCs this quarter. They are the fastest, most intelligent Windows PCs ever, and they include a new system architecture designed to deliver best-in-class performance and breakthrough AI experiences. We are delighted by early reviews. And we are looking forward to the introduction of more Copilot+ PCs powered by all of our silicon and OEM partners in the coming months. More broadly, Windows 11 active devices increased 50% year-over-year. And we are seeing accelerated adoption of Windows 11 by companies like Carlsberg, E.ON, National Australia Bank. Now, on to security. We continue to prioritize security above all else. We are doubling down on our Secure Future Initiative, as we implement our principles of secure by design, secure by default, and secure operations. Through this initiative, we are also continually applying what we are learning, and translating it into innovation for our customers, including how we approach AI. Over 1,000 paid customers used Copilot for Security, including Alaska Airlines, Oregon State University, Petrofac, Wipro, WTW. And we are also securing customers’ AI deployments, with updates to Defender and Purview. All-up, we now have over 1.2 million security customers. Over 800,000 including Dell Technologies, Deutsche Telekom, TomTom use four or more workloads, up 25% year-over-year. And Defender for Cloud, our cloud security solution, surpassed $1 billion in revenue over the past 12 months as we protect customer workloads across multi-cloud and hybrid environments. Now, let me turn to our consumer businesses, starting with LinkedIn. LinkedIn continues to see accelerated member growth and record engagement. 1.5 million pieces of content are shared every minute on the platform. And video is now the fastest growing format on LinkedIn, with uploads up 34% year-over-year. LinkedIn Marketing Solutions continues to be a leader in B2B digital advertising, helping companies deliver the right message, to the right audience, on a safe, trusted platform. And when it comes to our subscription businesses, Premium sign ups increased 51% this fiscal year, and we are adding even more value to our members and customers with new AI tools. Our reimagined AI-powered LinkedIn Premium experience is now available for every Premium subscriber worldwide, helping them more easily and intuitively connect to opportunity, learn, and get career coaching. Finally, hiring took share for the second consecutive year. And, now, on to Search, Advertising and News. We are ensuring that Bing, Edge, and Copilot collectively are driving more engagement and value to end-users, publishers, and advertisers. Our overall revenue ex-TAC increased 19% year-over-year, and we again took share across Bing and Edge. We continue to apply generative AI to pioneer new approaches to how people search and browse. Just last week, we announced we are testing a new generative search experience, which creates a dynamic response to a user’s query, while maintaining click share to publishers. And we continue to drive record engagement with Copilot for the web. Consumers have used Copilot to create over 12 billion images and conduct 13 billion chats to date, up 150% since the start of the calendar year. Thousands of news and entertainment publishers trust us to reach new audiences with Microsoft Start. And, in fact, we have paid them $1 billion over the last five years. We are helping advertisers increase their ROI too. We have seen positive response to Performance Max, which uses AI to dynamically create and optimize ads. And Copilot in Microsoft Ad Platform helps marketers create campaigns and troubleshoot using natural language. Now, on to gaming. We now have over 500 million monthly active users across platforms and devices. And our content pipeline has never been stronger. We previewed a record 30 new titles at our showcase this quarter. 18 of them such as Call of Duty: Black Ops 6 will be available on Game Pass. Game Pass Ultimate subscribers can now stream games directly on the devices they already have, including as of last month, Amazon Fire TVs. Finally, we are bringing our IP to new audiences. Fallout, for example, made its debut as a TV show on Amazon Prime this quarter. It was the second most watched title on the platform ever, and hours played on Game Pass for Fallout franchise increased nearly 5x quarter-over-quarter. In closing, I am energized about the opportunities ahead. We are investing for the long-term in our fundamentals, in our innovation, and in our people. With that, let me turn it over to Amy.
Amy Hood: Thank you, Satya, and good afternoon everyone. This quarter, revenue was $64.7 billion, up 15% and 16% in constant currency. Earnings per share was $2.95 and increased 10% and 11% in constant currency. In our largest quarter of the year, we again delivered double-digit top and bottom line growth with continued share gains across many of our businesses and record commitments to our Microsoft Cloud platform. Commercial bookings were significantly ahead of expectations and increased 17% and 19% in constant currency. This record commitment quarter was driven by growth in the number of 10-million-dollar-plus and 100-million-dollar-plus contracts for both Azure and Microsoft 365 and consistent execution across our core annuity sales motions. Commercial remaining performance obligation increased 20% and 21% in constant currency to $269 billion. Roughly 40% will be recognized in revenue in the next 12 months, up 18% year-over-year. The remaining portion, recognized beyond the next 12 months, increased 21%. And this quarter, our annuity mix was 97%. At a company level, Activision contributed a net impact of approximately 3 points to revenue growth, was a 2 point drag on operating income growth, and had a negative $0.06 impact to earnings per share. A reminder that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first-party, and includes $938 million from purchase accounting adjustments, integration, and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $36.8 billion and grew 21% and 22% in constant currency, roughly in line with expectations. Microsoft Cloud gross margin percentage decreased roughly 2 points year-over-year to 69% in line with expectations. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage decreased slightly driven by sales mix shift to Azure, partially offset by improvement in Azure even with the impact of scaling our AI infrastructure. Company gross margin dollars increased 14% and 15% in constant currency and gross margin percentage decreased slightly year-over-year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly, even with the impact from purchase accounting adjustments, integration, and transaction-related costs from the Activision acquisition. Operating expenses increased 13% with 9 points from the Activision acquisition. At a total company level, headcount at the end of June was 3% higher than a year ago. Operating income increased 15% and 16% in constant currency and operating margins were 43%, relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate, operating margins increased slightly driven by the higher gross margin noted earlier and improved operating leverage through continued cost discipline. Now to our segment results. Revenue from Productivity and Business Processes was $20.3 billion and grew 11% and 12% in constant currency, slightly ahead of expectations driven by better-than-expected results across all business units. Office commercial revenue grew 12% and 13% in constant currency. Office 365 commercial revenue increased 13% and 14% in constant currency with ARPU growth primarily from E5 momentum as well as Copilot for Microsoft 365. Paid Office 365 commercial seats grew 7% year-over-year with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, although both segments continued to moderate. Office commercial licensing declined 9% and 7% in constant currency, with continued customer shift to cloud offerings. Office consumer revenue increased 3% and 4% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 10% to 82.5 million. LinkedIn revenue increased 10% and 9% in constant currency driven by better-than-expected performance across all businesses. Dynamics revenue grew 16% driven by Dynamics 365 which grew 19% and 20% in constant currency. We saw continued growth across all workloads and better-than-expected new business. Dynamics 365 now represents roughly 90% of total Dynamics revenue. Segment gross margin dollars increased 9% and 10% in constant currency and gross margin percentage decreased roughly 1 point year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by Office 365 as we scale our AI infrastructure. Operating expenses increased 5%, and operating income increased 12% and 13% in constant currency. Next, the Intelligent Cloud segment. Revenue was $28.5 billion, increasing 19% and 20% in constant currency, in line with expectations. Overall, server products and cloud services revenue grew 21% and 22% in constant currency. Azure and other cloud services revenue grew 29% and 30% in constant currency, in line with expectations and consistent with Q3 when adjusting for leap year. Azure growth included 8 points from AI services where demand remained higher than our available capacity. In June, we saw slightly lower-than-expected growth in a few European geos. In our per-user business, the enterprise mobility and security installed base grew 10% to over 281 million seats with continued impact from moderated growth in seats sold outside the Microsoft 365 suite. Therefore, our Azure consumption business continues to grow faster than total Azure. In our on-premises server business, revenue increased 2% and 3% in constant currency. Growth was driven by demand for our hybrid solutions although with slightly lower-than-expected transactional purchasing. Enterprise and partner services revenue decreased 7% on a strong prior year comparable for Enterprise Support Services. Segment gross margin dollars increased 16% and gross margin percentage decreased roughly 2 points year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage decreased slightly driven by sales mix shift to Azure, partially offset by the improvement in Azure noted earlier, even with the impact of scaling our AI infrastructure. Operating expenses increased 5% and operating income grew 22% and 23% in constant currency. Now to More Personal Computing. Revenue was $15.9 billion, increasing 14% and 15% in constant currency, with 12 points of net impact from the Activision acquisition. Results were above expectations driven by Windows commercial and Search. The PC market was as expected and Windows OEM revenue increased 4% year-over-year. Windows commercial products and cloud services revenue increased 11% and 12% in constant currency, ahead of expectations due to higher in-period revenue recognition from the mix of contracts. Devices revenue decreased 11% and 9% in constant currency, roughly in line with expectations, as we remain focused on our higher margin premium products. While early days, we’re excited about the recent launch of our Copilot+ PCs. Search and news advertising revenue ex-TAC increased 19%, ahead of expectations, primarily due to improved execution. Healthy volume growth was driven by Bing and Edge. And in Gaming, revenue increased 44% with 48 points of net impact from the Activision acquisition. Xbox content and services revenue increased 61%, slightly ahead of expectations, with 58 points of net impact from the Activision acquisition. Stronger-than-expected performance in first-party content was partially offset by third-party content performance. Xbox hardware revenue decreased 42% and 41% in constant currency. Segment gross margin dollars increased 21%, with 10 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 3 points year-over-year primarily driven by sales mix shift to higher margin businesses. Operating expenses increased 43% with 41 points from the Activision acquisition. Operating income increased 5% and 6% in constant currency. Now back to total company results. Capital expenditures including finance leases were $19 billion, in line with expectations, and cash paid for PP&E was $13.9 billion. Cloud and AI related spend represents nearly all of total capital expenditures. Within that, roughly half is for infrastructure needs where we continue to build and lease datacenters that will support monetization over the next 15 years and beyond. The remaining cloud and AI related spend is primarily for servers, both CPUs and GPUs, to serve customers based on demand signals. For the full fiscal year, the mix of our cloud and AI related spend was similar to Q4. Cash flow from operations was $37.2 billion, up 29% driven by strong cloud billings and collections. Free cash flow was $23.3 billion, up 18% year-over-year, reflecting higher capital expenditures to support our cloud and AI offerings. For the full-year, cash flow from operations surpassed $100 billion for the first time, reaching $119 billion. This quarter, other income and expense was negative $675 million, more favorable than anticipated with lower-than-expected interest expense and higher-than-expected interest income. Our losses on investments accounted for under the equity method were as expected. Our effective tax rate was approximately 19%, higher than anticipated due to a state tax law signed in June that was effective retroactively. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases, bringing our total cash returned to shareholders to over $34 billion for the full fiscal year. Now, moving to our outlook. My commentary for both the full-year and next quarter is on a U.S. dollar basis unless specifically noted otherwise. Let me start with some full year commentary for FY2025. First, FX. Assuming current rates remain stable, we expect FX to have no meaningful impact to full-year revenue, COGS, or operating expense growth. Next, we continue to expect double-digit revenue and operating income growth as we focus on delivering differentiated value for our customers. To meet the growing demand signal for our AI and cloud products, we will scale our infrastructure investments with FY2025 capital expenditures expected to be higher than FY2024. As a reminder, these expenditures are dependent on demand signals and adoption of our services that will be managed through the year. As scaling these investments drives growth in COGS, we will remain disciplined on operating expense management. Therefore, we expect FY2025 OpEx growth to be in the single digits. And given our focused commitment to managing at the operating margin level, we still expect FY2025 operating margins to be down only about one point year-over-year. And finally, we expect our FY2025 effective tax rate to be around 19%. Now, to the outlook for our first quarter. Based on current rates, we expect FX to decrease total revenue and segment level revenue growth by less than one point. We expect FX to decrease COGS growth by less than one point and to have no meaningful impact to operating expense growth. In commercial bookings, increased long-term commitments to our platform and strong execution across core annuity sales motions should drive healthy growth on a growing expiry base. As a reminder, larger long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should be roughly 70%, down year-over-year driven by the impact of scaling our AI infrastructure. We expect capital expenditures to increase on a sequential basis given our cloud and AI demand, as well as existing AI capacity constraints. As a reminder, there can be quarterly spend variability from cloud infrastructure buildouts and the timing of delivery of finance leases. Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 10% and 11% in constant currency, or US$20.3 to US$20.6 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5 and Copilot for Microsoft 365. We expect Office 365 revenue growth to be approximately 14% in constant currency. In our on-premises business, we expect revenue to decline in the mid to high-teens. In Office consumer, we expect revenue growth in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the high single digits driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the low to mid-teens driven by Dynamics 365. For Intelligent Cloud we expect revenue to grow between 18% and 20% in constant currency, or US$28.6 billion to US$28.9 billion. Revenue will continue to be driven by Azure which, as a reminder, can have quarterly variability primarily from our per-user business and in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q1 revenue growth to be 28% to 29% in constant currency. Growth will continue to be driven by our consumption business, inclusive of AI, which is growing faster than total Azure. We expect the consumption trends from Q4 to continue through the first half of the year. This includes both AI demand impacted by capacity constraints and non-AI growth trends similar to June. Growth in our per-user business will continue to moderate. And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand. In our on-premises server business, we expect revenue to decline in the low single digits as continued hybrid demand will be more than offset by lower transactional purchasing. And in Enterprise and partner services, revenue should decline in the low single digits. In More Personal Computing, we expect revenue to grow between 9% and 12% in constant currency, or US$14.9 billion to US$15.3 billion. Windows OEM revenue growth should be relatively flat, roughly in line with the PC market. In Windows commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid-single digits. As a reminder, our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. In Devices, revenue growth should be in the low to mid-single digits. Search and news advertising ex-TAC revenue growth should be in the mid to high-teens. This will be higher than overall Search and news advertising revenue growth, which we expect to be in the low single digits. And in Gaming, we expect revenue growth in the mid-30s, including approximately 40 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the low to mid-50s, driven by the net impact from the Activision acquisition. Hardware revenue will again decline year-over-year. Now back to company guidance. We expect COGS between US$19.95 billion to US$20.15 billion, including approximately $700 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. We expect operating expense of US$15.2 billion to US$15.3 billion, including approximately $200 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. Other income and expense should be roughly negative $650 million driven by losses on investments accounted for under the equity method as interest income will be mostly offset by interest expense. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q1 effective tax rate to be approximately 19%. In closing, we remain focused on delivering innovations that matter to our global customers of every size. That focus extends to delivering on our financial commitments as well. We delivered operating margin growth of nearly three points year-over-year even as we accelerated our AI investments, completed the Activision acquisition, and had a headwind from the change of useful lives last year. So, as we begin FY2025, we will continue to invest in the cloud and AI opportunity ahead aligned, and if needed adjusted, to the demand signals we see. We are committed to growing our leadership across our commercial cloud and within that, the AI platform, and we feel well positioned as we start FY2025. With that, let's go to Q&A, Brett.
Brett Iversen: Thanks, Amy. We'll now move over to Q&A. Out of respect for others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions?
Operator: [Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.
Keith Weiss: Excellent. Thank you, guys for taking the question and congratulations on another great quarter and really solid overall fiscal year. Right now, there's a industry debate raging around the CapEx requirements around Generative AI and whether the monetization is actually going to match with that. And I think the question for you guys, from a Microsoft perspective, is CapEx still an appropriate leading indicator for cloud growth? Or does the shift in gross margin profile change that equation? Or said another way, maybe can you give us a little bit more help in understanding the timing between the CapEx investments and the yield on those investments? Thank you.
Satya Nadella: Thank you, Keith. Let me start, and then Amy can add to this. I think, I would say we primarily start right now from the demand side. What I mean by that is what's the product – shape of the product portfolio, what we learned even from the cloud transition, which, as you know, Keith, was similar in the sense it was both a knowledge-intensive and a capital-intensive transition. We needed to have the product portfolio where there was the right mix of, I'll call it, infrastructure meters as well as SaaS applications. So that's the first thing that we are looking at. And how is that value landing with customers and what's the growth rate. So when I think about what's happening with M365 Copilot as perhaps the best Office 365 or M365 suite we have had, the fact that we're getting recurring customers, so our customers coming back buying more seats. So GitHub Copilot now being bigger than even GitHub when we bought it. What's happening in the contact center with Dynamics. So I would say – and obviously, the Azure AI growth, that's the first place we look at. That then drives bulk of the CapEx spend, basically, that's the demand signal because you got to remember, even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal, right? So that's, I think, the key way to think about capital cycle even. The asset, as Amy said, is a long-term asset, which is land and the data center, which, by the way, we don't even construct things fully, we can even have things which are semi-constructed, we call [cold] (ph) shelves and so on. So we know how to manage our CapEx spend to build out a long-term asset and a lot of the hydration of the kit happens when we have the demand signal. There is definitely spend for training. Even there, of course, we will only be scaling training as we see the demand accrue in any given period in time. So I would say it's more important to manage, to capture the opportunity with the right product portfolio that's driving value. And on that front, I feel good about the breadth of Microsoft offering, whether it's in consumer side, whether it's on commercial per seat side or on the consumption meters, that's, I think, the fundamental driver.
Amy Hood: And Keith, I do think – and I really do appreciate how you phrased the question as well because I think the timing and some of the questions you all have had really led to how we were talking even about capital expense in our comments – in my comments today. Being able to maybe share a little more about that when we talked about roughly half of FY2024's total capital expense as well as half of Q4's expense, it's really on land and build and finance leases, and those things really will be monetized over 15 years and beyond. And they're incredibly flexible because we've built a consistent architecture first with the Commercial Cloud and second with the Azure stack for AI, regardless of whether the demand at the platform layer or at the app layer or through third parties and partners or, frankly, our first-party SaaS, it uses the same infrastructure. So it's long-lived flexible assets. And if you think about it, that way, you can see what we're doing and focused on is building out this network in parallel across the globe. Because when we did this last transition, the first transition to the Cloud, which seems a long time ago sometimes, it rolled out quite differently. We rolled out more geo by geo and this one because we have demand on a global basis. We are doing it on a global basis, which is important. We have large customers in every geo. And so hopefully, with that sort of shape of our capital expense, it helps people see how much of that is sort of near-term monetization driver as well as a much longer duration.
Keith Weiss: That's super helpful. Thank you very much.
Brett Iversen: Thanks, Keith. Operator, next question please.
Operator: And the next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.
Mark Moerdler: Thank you very much. Thank you for taking the question. And congrats on a strong year. GenAI has been a bit of rollercoaster of a tech over the last year with periods of acceleration, high expectations and the expectations drop as reality kicked in. With Azure growth we've seen this quarter and O365 Commercial, not yet fully visible in numbers even though Amy, you gave us a lot of color on it. Two quick parts to the question. Satya, how should we think about what it's going to take for GenAI to become more real across the industry and for it to become more visible within your SaaS offerings? And Amy, with Cloud, it took time for margins to improve. It looks like with AI, it's happening quicker. Can you give us a sense of how you think about the margin impact near-term and long-term from all the investment on AI? Thank you.
Satya Nadella: Yes. Thanks again, Mark, for the question. So to me, look, at the end of the day, GenAI is just software. So it is really translating into fundamentally growth on what has been our M365 SaaS offering with a newer offering that is the Copilot SaaS offering, which today is on a growth rate that's faster than any other previous generation of software we launched as a suite in M365. That's, I think, the best way to describe it. I mean the numbers I think we shared even this quarter are indicative of this, Mark. So if you look at it, we have both the landing of the seats itself quarter-over-quarter that is growing 60%, right? That's a pretty good healthy sign. The most healthy sign for me is the fact that customers are coming back there. That is the same customers with whom we landed the seats coming back and buying more seats. And then the number of customers with 10,000-plus seats doubled, right? It's 2x quarter-over-quarter. That, to me, is a healthy SaaS core business. And on top of that, some of the things that Amy shared around Dynamic. That's another exciting place for us, which is one, we are gaining share. We are – Dynamics with the GenAI built-in is sort of really biz app, it's probably the category that gets completely transformed with GenAI. Contact centers being a great example. We ourselves are on course to save hundreds of millions of dollars in our own customer support and contact center operations. I think we can drive that value to our customers. And then on the Azure side, you see the numbers very clearly. In fact, I think last quarter is when we started giving you that. You saw an acceleration of that this quarter. One of the other pieces, Mark, is AI doesn't sit on its own, right? So it's just for – we have a concept of design wins in Azure. So in fact, 50% of the folks who are using Azure AI are also using a data meter. That's very exciting to us because the most important thing in Azure is to win workloads in the enterprise. And that is starting to happen. And these are generational things once they get going with you. So that's, I think, how we think about it at least when I look at what's happening on our demand side.
Amy Hood: And, Mark, to answer the second half of your question on margin improvement, looking different than it did through the last cloud cycle. That's primarily for a reason I've mentioned a couple of times. We have a consistent platform. So because we're building to one Azure AI stack, we don't have to have multiple infrastructure investments. We're making one. We're using that internally first-party, and that's what we're using with customers to build on as well as ISVs. So it does, in fact, make margins start off better and obviously scale consistently.
Mark Moerdler: Thank you.
Brett Iversen: Thanks, Mark. Operator, next question please.
Operator: The next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed.
Kasthuri Rangan: Hi. Thank you very much and congrats on a great year – fiscal year ending. A question for you, Amy. When you look at the CapEx, how do you ring efficiencies out of the CapEx? You've disclosed that 50% of the infrastructure, the other 50% tech, is very useful. So in other words, do you have to keep growing CapEx at these elevated rates? Or could you slow down CapEx and still get that consistent revenue growth rate in your Azure and Generative AI? That's the main question in my mind? Thank you so much.
Amy Hood: Thanks, Kash. That's a very good question. There's really two pieces, I think, as I heard your question that I would reflect on. The first is, could we see sort of consistent revenue growth without maybe what you would say is more of this sort of elevated capital expense number or something that continues to accelerate. And the answer to that is yes because there's two different pieces, right? You're seeing half of this go toward long-term builds that Satya mentioned, the pace at which we fill those builds with CPUs or GPUs will be demand-driven. And so if we see differences in demand signal, we can throttle that investment on the CPU side, which we've done for I guess, a long time at this point, as I reflect, and we'll use all that same learning and demand signal understand to do the same thing on the GPU side. And so you're right that you could see relatively consistent revenue patterns and yet see these inconsistencies and capital spend quarter-to-quarter. The other thing, I would note, Kash, is you'll also notice there's a growing distinction between our CapEx number, and on occasion, the cash that we pay for PP&E and you're going to start to see that more often in this period because it happens when we use leases. Leases sort of show up all at once. And so you'll see a little bit more volatility. I've mentioned it back in my comments before, but I mentioned it again just because you're starting to see that distinction in my comments and hopefully that's helpful context.
Satya Nadella: Just one other thing, Amy, if I wanted to add. I think as people think about capital spend, I think it's important to separate out leases from build. And when it comes to build, I think it's important for us to think about – we think about it in terms of what's the total percentage of cost that goes into each line item, land which obviously has a very different duration and a very different lead time. So those are the other two considerations. We think about lead time and duration of the asset. Land, network, construction, the system or the kit and then the ongoing cost. And so if you think about it that way, then you know how to even adjust, if you will, the capital spend based on demand signal.
Kasthuri Rangan: Thank you. It was triggered by the jump in CapEx. And as Amy pointed out, you're guiding to accelerating Azure revenue growth rate, which, I guess, follows the CapEx surge. Thank you so much once again.
Brett Iversen: Thanks, Kash. Operator, next question please.
Operator: The next question comes from the line of Brent Thill with Jefferies. Please proceed.
Brent Thill: Thanks. Amy, the magnitude to beat this quarter was a little lower than we've seen in the past. Was there anything unusual on sales cycle that close rates that you saw? Thanks.
Amy Hood: Thanks, Brent. Actually, no. As I was talking on the quarter, I mean Commercial bookings were much better than we expected going into the quarter. Commitments were very good execution across both the core sort of annuity renewal motion was good, as expected, the larger long-term commitments were better than we expected. So Brent, I would not say there was anything really unusual in how I thought about what we saw in our commercial execution through the quarter.
Brent Thill: Great. Thank you.
Brett Iversen: Thanks, Brent. Operator, next question please.
Operator: The next question comes from the line of Karl Keirstead with UBS. Please proceed.
Karl Keirstead: Okay. Great. So maybe I'll direct this to Amy. Amy, I know when you set your Azure guidance, you're always looking to meet or beat the high-end. The 30% you put up in the June quarter, amazing number given the scale of Azure, but it did come in at the low end of your range. And I'd just love for you to maybe elaborate on the delta. I guess as I reflect on what you said in your comments. There's two things that I heard you say. One, it sounded like there's persistent capacity constraints that you think might get alleviated in the second half? And then secondly, you mentioned perhaps some modest softness in Europe. I presume that's a little bit more economic rather than Azure specific. Is that the right way to frame the performance in the quarter? Thank you.
Amy Hood: Thanks, Karl. Yes, that's exactly right. Maybe I'll just repeat it, just so people can hear it in my words as well to that 30% to 31% guide for Q4 and coming in at the lower end of 30%. You're exactly right. The distinguishing between being at the higher end or at the lower end, really was some softness we saw in a few European geos on non-AI consumption really made the difference in that number. And we've assumed that going forward into H1 inclusive of my guide 28% to 29% going forward. And then let me separate which was your larger point, which is what are the other factors you see ongoing. Number one, you're right, capacity constraints, particularly on AI and Azure will remain in Q4 and will remain in H1. So hopefully, that's helpful.
Karl Keirstead: Yes. Thank you, Amy.
Brett Iversen: Thanks, Karl. Operator, next question, please.
Operator: The next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.
Brad Zelnick: Great. Thank you very much. Amy, with Azure demand, once again greater than available capacity, I appreciate the CapEx investments and the build-out and acceleration you expect in the back half. But as we think about Cloud capacity and AI services specifically, can you talk about both the near-term and long-term strategy around the AI partnerships that you're signing with the likes of Oracle and Cohere, for example? Thank you.
Amy Hood: Thanks, Brad. Maybe separate a couple of things. We are – and we've talked about now for quite a few quarters, we are constrained on AI capacity. And because of that, actually, we've, to your point, have signed up with third parties to help us as we are behind with some leases on AI capacity. We've done that with partners who are happy to help us extend the Azure platform, to be able to serve this Azure AI demand. And you do see us investing quite a bit as we've talked about in builds so that we can get back in a more balanced place.
Satya Nadella: Yes. I mean, to me, it's no different than leases that we would have done in the past. These – you could even say sometimes buying from Oracle, maybe even more efficient leases because they're even shorter date.
Brad Zelnick: Excellent. Thanks for the color.
Brett Iversen: Thanks, Brad. Operator, next question please.
Operator: The next question comes from the line of Mark Murphy with JPMorgan. Please proceed.
Mark Murphy: Thank you very much. With a couple of quarters of Copilot for M365 availability under your belt now, how are you assessing the capability of Copilots to replicate the productivity gains that they've created for developers, which seem to be very high and to do something similar for the broader population of knowledge workers? For instance, you're mentioning the 10,000 feet deals, the repeat purchases, is it possible to eventually see Copilot penetration rate equally high in office as they will be in GitHub?
Satya Nadella: Yes, that's a great question. In fact, the GitHub design system and the GitHub Copilot workspace design system, which now, for example, you start with an issue, you create a plan, from a plan, you create a spec, or you create a spec and from a spec, you create a plan and then you go operate across the full repo. That's effectively the design system that is getting replicated inside of even the M365 Copilot. And you see this even now – for example, you get an email, you're in sales, you want to respond to the customer. The data from the email is essentially context for a prompt but you expand by bringing in all of your CRM data, right? So this customer email is in the context of some order, all of the CRM record gets completed in context and a reply gets generated with the CRM data. That's the type of stuff that's already happening. Then you take something like Copilot Studio, you can start even grounding it in more data and then completing workflows. So you could say if this email comes from this customer whose order date is got a particular issue with it. You can then go and escalate it to somebody else who gets a notification in Teams. And those are the kinds of workflows that are getting built within IT or by end users themselves, what used to be line of business applications to us are Copilot extensions going forward. So we think of this as really a new design system for knowledge and frontline work to drive productivity, which would be very akin to what has happened in software engineering. So when you think about marketing or finance or sales or customer service, we will effectively replicate what you just said, which is the type of productivity we've seen in developers, will come to all of these functions as they think about their work, workflow and workout effect, all being driven by Copilots.
Mark Murphy: Thank you very much.
Brett Iversen: Thanks, Mark. Operator, we have time for one last question.
Operator: And the last question will come from the line of Keith Bachman with BMO Capital Markets. Please proceed.
Keith Bachman: Hi. Good evening, and thank you for the opportunity to ask the question. I actually wanted to veer towards gaming, if I could, for a second. Xbox content services revenue grew 61%, 58 points held from Activision. So net is about 3 points of growth. How should investors think about the longer-term growth potential in this area? You've made significant investments, including the Activision deal. But how should investors be thinking about the growth potential of the gaming? Or what are the puts and takes to help make considerations here? Thank you.
Satya Nadella: Yes. For us, our investment in gaming fundamentally was to have, I would say, the right portfolio of both what we love about gaming and always have loved about gaming, which is Xbox and the content for the console and expand from there so that we have content for everywhere people play games, starting with the PC. So when I think about the Activision portfolio, it comes with great assets for us to cover both the PC and the console. And then, of course, assets to cover mobile sockets, which we never have. So we feel that now we have both the content and the ability to access all the traditional high scale platforms where people play games, which is the console, PC and mobile. But we're also excited about these new sockets, right? I mean the fact that even in this last quarter, we expanded X Cloud to Amazon TV, I forget the name of what it's called. But that's the type of new access that really helps us a lot, get reach new gamers or the same gamer everywhere they want to play. And that ultimately will show up in that software plus services and transaction revenue for us, which is really our long-term KPI, and that's what we're building towards. And that was strategy behind Activision as an asset. Amy, if you want to add to it?
Amy Hood: No. I do think the real goal here is to be able to take a broad set of content to more users in more places, and really build what looks more like to us, the software annuity and subscription business. With enhanced transactions and the ownership of IP, which is quite valuable long-term. As Satya mentioned, things where with the ownership of IP, it can be monetized in multiple ways. And I think we're really encouraged by some of the progress and how we're making progress with Game Pass as well with some of the new announcements. Thank you, Keith.
Brett Iversen: Thanks, Keith. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon.
Amy Hood: Thank you.
Satya Nadella: Thank you all.
Operator: This concludes today's conference. You may now disconnect your lines at this time. Enjoy the rest of your day. |
SBUX | 3 | 2,024 | 2024-07-30 21:24:09 | Operator: Good afternoon. My name is Diego and I will be your conference operator today. I would like to welcome everyone to the Starbucks Third Quarter Fiscal Year 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference call over to Tiffany Willis, Senior Vice President of Investor Relations. Ms. Willis, you may now begin your conference.
Tiffany Willis: Thank you, Diego. Good afternoon and thank you everyone for joining us today to discuss Starbucks third quarter fiscal year 2024 results. Today's discussion will be led by Laxman Narasimhan, Chief Executive Officer; and Rachel Ruggeri, Executive Vice President and Chief Financial Officer. This conference call will include forward-looking statements, which are subject to various risks and uncertainties that can cause our actual results to differ materially from these statements. Any such statement should be considered in conjunction with cautionary statements in our earnings release and risk factors discussed in our filings with the SEC, including our latest annual report on Form 10-K and quarterly report on Form 10-Q. Starbucks assumes no obligation to update any of these forward-looking statements or information. GAAP results in third quarter fiscal year 2024's comparative period includes several items related to strategic actions, including restructuring and impairment charges and other items. These items are excluded from our non-GAAP results. All numbers referenced on today's call are on a non-GAAP basis, unless otherwise noted or there is no non-GAAP adjustment related to the metric. As part of our non-GAAP results, revenue, operating margin and EPS growth metrics on today's call are measured in constant currency, whereby current period results are converted into United States dollars using the average monthly exchange rates from the comparative period rather than the actual exchange rates for the current period, excluding related hedging activities. For non-GAAP financial measures mentioned in today's call, please refer to the earnings release and our website at investor.starbucks.com to find reconciliations of those non-GAAP measures to their corresponding GAAP measures. This conference call is being webcast and an archive of the webcast will be available on our website through Friday, September 13, 2024. And lastly, for your planning purposes, please note that our fourth quarter and full fiscal year 2024 earnings conference call has been tentatively scheduled for Wednesday, October 30, 2024. And with that, I'll now turn the call over to Laxman.
Laxman Narasimhan: Thank you, Tiffany. And thank you for joining us this afternoon. Let me start by laying out our results for this quarter. Our Q3 total company revenue was $9.1 billion, up 1% year-over-year and 6% over Q2. Our global comparable store sales declined 3% year-over-year, driven by a negative 2% comp growth in North America and a negative 14% comp growth in China and partially offset by strong performance in Japan. Our global operating margins contracted by 70 basis points to 16.7% and overall earnings per share for the quarter was $0.93. Our total company results were in line with guidance, but international performance, particularly in China was challenged. We are not satisfied with the results, but our actions are making an impact. Leading business and operational indicators are trending in the right direction ahead of our financial results and our runway for improvement is long. We see green shoots in our US business driven by the three-part action plan outlined last quarter. First, meet and unlock capacity for new demand through a relentless focus and improvements to our US store operations and on elevating the experience we create for our partners and customers. Second, attract new customers and drive transaction growth by launching and integrating more exciting new products with relevant marketing, while maintaining our focus on core coffee forward offerings. And third, reach new customers and demonstrate our value by making sure customers believe that Starbucks experience is worth it every time. First, our largest opportunity, meet and unlock capacity for new demand. A relentless focus on improving operational execution across our nearly 10,000 US company operated stores is the cornerstone of our near-term plan. While it is early days of progress, our plan is working. If you walk away from today's call with one thought, let it be the significant changes and long-term upside potential taking place within our US stores and across our end-to-end supply-chain to unlock growth, enhance the customer experience and drive cost efficiencies. Within our stores, we've seen material positive momentum across core store health and performance metrics with notable improvements in partner scheduling and turnover, critical store issues and inventory management. Stores ranked in our top two operational performance quartiles reached a new high during the quarter, a 28% upwards shift from Q2, but we have more opportunity. Our focus on operational excellence, driven by a reinvention plan has led to a multi-second year-over-year improvement in out-of-the-window times, a nearly 50% reduction in calls received via customer contact center for my order took too long and Mobile Order & Pay and delivery uptime rates of 99%. These are key indicators of our work to drive growth by addressing customer wait times, product availability and the customer experience. This quarter, we also introduced Phase 1 of our Siren Craft systems, which includes several process and partner-driven enhancements to our US store operations. Changes include a new peak time play caller role, strategic investments in partner hours, training, new routines, simple enhancements to technology and an evolved beverage build process. Early deployment across 1,200 stores demonstrated a material incremental improvement across key performance, throughput, efficiency and reliability metrics. Encouraged by this, we fully deployed Siren Craft systems process improvements across our entire portfolio of US company operated stores this week. Later this quarter, we will begin rolling out a simple refit to our espresso machines, which we expect to improve espresso throughput by up to 15% without compromising quality. And with a minor software change in our store production systems, we have a similar ability to improve food throughput. When paired with Siren system equipment announced as part of our reinvention plan, these new processes become a forced multiplier that we expect to drive a true step-change improvement. Early assessments demonstrate the capability to drive a 10-second to 20-second wait time reduction and a resulting comp opportunity range of 1% to 1.5%. Leveraging our Deep Brew analytics platform, we have identified customer experience outlier stores, approximately 10% of our network and have developed targeted plans to address and improve them, including accelerated Siren system deployment. Similarly, we are accelerating the pace of our new-store builds and renovations with 580 net new builds and more than 800 renovations planned in North America for FY 2024. Store development efforts are focused on Tier-2 and Tier-3 cities where we see population growth and forecast both underserved demand and high incrementality. Increasingly, these new-store builds and renovations also include Siren system equipment. In line with prior guidance, we remain on track to deploy equipment in less than 10% of company operated stores by the end of FY 2024 and about 40% by the end of FY 2026. Building on our pilot, Starbucks and Gopuff have agreed to terms for an expanded relationship to open 100 delivery-only kitchens across the US. We're also accelerating the rollout of digital storyboards with target deployment across most US stores in the next two years, a year earlier than originally anticipated. Lastly, we are working on other ways to enhance the cafe experience. This includes new and expanded seating options that elevate many stores, while upholding a safe and inviting place for partners and customers. A key outcome of our operational efforts has been material and sustained improvements to the partner experience. Driven by precision partner-centric staffing and scheduling efforts, we ended the quarter with a new post-pandemic low partner turnover rate, the best shift completion rate in two years and a 13% improvement in average hours per partner, now the highest on record. These initiatives create more stability in our stores, provide more predictability for our partners and sustain our experienced flywheel. Looking beyond our stores, we continue to realize new efficiencies, cost savings and performance improvements across our end-to-end supply chain, thanks to strong support from our suppliers and we see even more headroom. We have a structured process to realize significant continued improvements across our end-to-end supply chain. We are ahead of plan on productivity. We expect our productivity to drive efficiency and unlock capital from areas that don't touch the customer. In turn, these savings will enable us to target investments that drive value for our customers beginning later in Q4, reigniting our North America flywheel for growth. We are early days on this journey, building both our strategic sourcing and revenue management capabilities. Our second priority is to drive demand through relevant product innovation with coffee at our core. We've seen meaningful improvement here as well. This quarter, we drove traffic into our stores through an engaging and innovative pipeline of products supported by integrated marketing campaigns. Cold share was up 1% year-over-year, representing 76% of our beverage mix through the quarter. Our newly formulated iced coffee received positive feedback. Our strength in Cold espresso innovation continued to drive the platform's growth, up 4% year-over-year. And we launched Starbuck's Milano Duetto whole bean coffee in Milan, ahead of a global launch this October. Beyond coffee, our new Summer-Berry Starbucks Refreshers beverages with Pearls drove the highest week one product launch in our history. Their success buoyed the entire Starbucks Refreshers beverage platform to an all-time high during the quarter. As mentioned in Q2, we continue to build out our 24-month product pipeline, while accelerating our pace of innovation. For example, recognize the growing appeal and opportunity created by the energy category, we launched a new hand-crafted iced energy beverages across our US stores in just three months compared to a normal 12 to 18. Looking forward, we believe our Q4 product offerings, including the return of pumpkin spice, combined with supporting marketing activities and offers, provides the right formula to drive customer interest, demand and deeper engagement with both new and existing customers. Our third and final near-term priority is to reach new customers and demonstrate the value we offer by ensuring the Starbucks experience is worth it every time. Recognizing the premium position of our brand, we've been measured in our use of offers. During this quarter, only 14% of our transactions were driven by offers compared to a competitor average of 29%. Of offer-driven transactions, 10% were star-based offers targeted to Starbucks Rewards members. Only 4% were driven by five -- by price-based offers. Our best offers are in the app. Together, offers and other integrated marketing activities when paired with exciting product innovation, successfully grew Starbucks Rewards membership, reactivated many lapsed Rewards members and drove customer traffic on promotional days and product launch weeks. Active US Starbucks Rewards members grew to 33.8 million during the quarter. Members across every decile increased the frequency of their visits. We're focused on the continued growth of the program because the average active member spends materially more annually and drives a higher life-time value for the business than a non-member. Research also tells us that the most inactive Starbucks Rewards members don't realize they've lapsed. This demonstrates a continued opportunity to drive return visits, active member growth and deeper customer loyalty. Looking forward, we will continue to use more targeted offers, coupled with select pricing actions funded by efficiency initiatives to drive traffic and conversion. We plan to leverage a mix of paid media, acquisition and retention offers, disruptive signage and partner education to drive transactions and increase the frequency of visits with a focus on product launches and continued Starbucks Rewards member growth. It's worth remembering the ubiquity of the Starbucks brand and our ability to intercept customers. For instance, our business is up 13% in airports and up 9% in hotels, pointing to these trends. Leveraging our brand and our ability to intercept customers while demonstrating value, not just in price but through a premium experience remains a sizable opportunity across our entire store portfolio. Moving on to digital. As part of our action plan, we made continued improvements to our Starbucks app, including wait time algorithm enhancements that have improved order-ready accuracy by nearly 50 percentage points. This combined with in-app offers helped drive a 10% year-over-year growth in Mobile Order & Pay revenue, a 7% year-over-year increase in MOP transactions. Looking deeper, our data shows that one in four non-Starbucks Rewards members want the ability to use Mobile Order & Pay. Nearly 80% of those customers don't want to join a Rewards program or create an account to do it. In response, we opened MOP for all to provide those customers the convenience they seek, while removing perceived barriers to entry. We believe these enhancements to the digital experience, coupled with more effortless ordering will continue to drive Starbucks Rewards membership over time with customers increasing frequency and spend. Once customers are in our digital ecosystem, they're more likely to remain engaged across channels and drive greater lifetime value. In summary, our plans are beginning to work. We are recovering our brand from its perceptions. We're rebuilding the operational foundation of our stores and supply-chain. We're reducing costs to support investments. We're sustaining partner experience improvements and we're working to make the Starbucks experience worth it every time. While it's early days, I'm confident in the trajectory of our US business and the operational improvements we're making. And I'm reassured by the impact our work is expected to deliver in FY 2025 and beyond. Looking outside the US, we continue to see weakness in parts of our international business and strength in others. Headwinds persist in the Middle East, Southeast Asia, parts of Europe, driven by widely discussed misperceptions about our brand. In some European markets, consumers are stretched. At the same time, we see significant strength in markets like Japan and parts of Latin America. China is one of our most notable international challenges and an area I'd like to talk about in more detail. The competitive market dynamics in China are reflected in our recent results. We continue to face a more cautious consumer spending and intensified competition. In the past year, unprecedented store expansion and a mass segment price war at the expense of comp and profitability have also caused significant disruptions to the operating environment. Still, we have made progress in important areas. Through Q3, metrics like average daily transactions, weekly sales and operating margin improved sequentially quarter-over-quarter. Starbucks Rewards members grew by 1.6 million to a record high 22 million active members and customer connection scores reached a new high, while partner turnover reached a new low. We've built an amazing business in China over the past 25 years, a business for China built by an outstanding local team. We've pioneered the growth of the premium coffee industry in market with our Starbucks and Starbucks Reserve brands and brand equity remains distinctive. We have incredibly committed and expert partners with an unmatched depth in coffee and craft. Our stores are distinctive and industry leading and our supply-chain is world class. New stores have expanded our presence to more than 900 county cities and continue to drive exceptional cash-on-cash returns and a payback of less than two years. We're looking beyond near-term challenges and towards long-term opportunities in the market. We built Starbucks in China around three principles. A great customer experience is grounded in a great partner experience. Our coffee will always be distinctive and high quality with low penetration relative to other markets, which provides continued headroom. Our beautiful stores will celebrate the culture and traditions of China and their local communities. Even in a challenging market, we have stayed true to these principles and our relative premium positioning. This is reflective in the competitive margins we have sustained in the face of price competition. Over the past 25 years, we've gone through different phases of growth in China and have relied on different strategic partnerships to grow our business and capabilities, like joint ventures and strategic partnerships in technology, real estate and supply-chain. As we look forward, we see higher growth and margin opportunities in China. We're building the next generation of Starbucks grounded in our premium brands and with a business that is even more digital, innovative and locally relevant. To do so, as our strategy evolves, we are in the early stages of exploring strategic partnerships to further enhance our competitive position to accelerate growth and innovate to win in the long term in China. We remain completely committed to our business and our partners in China for the next 25 years and beyond. The long-term opportunity for us is significant. Before I close, I would like to confirm that Elliott Management is a shareholder in our company and our conversations to date have been constructive. On the business, my continued confidence is rooted in the focus, energy and effort of our partners across the business and around the globe. Our growing culture of focused innovation and relentless execution continues to enhance our capabilities, operational muscle and executional discipline, driving forward our action plan and our long-term triple shot strategy, while helping return the business to sustainable algorithmic growth. And with that, I'll turn this over to Rachel.
Rachel Ruggeri: Thank you, Laxman, and good afternoon, everyone. As Laxman shared, we are seeing progress against our three-part action plans. Additionally, our efficiency efforts, which are tracking ahead of expectations, partially offset investments associated with the cautious consumer environment. With continued focus on our action plans, efficiency efforts and disciplined operational execution, we expect progress as we close out the year. With that, let me turn to our results. Our Q3 consolidated revenue was $9.1 billion, up 1% from the prior year, demonstrating sequential revenue growth quarter-over-quarter, consistent with what we guided. Revenue growth over the prior year was driven by 8% net new company-operated store growth, partially offset by a 3% decline in comparable store sales from a 5% decrease in transactions and a 2% increase in average ticket as we continue to navigate through a value-driven consumer environment. US led the average ticket increase of 4%, driven by pricing and multi-beverage orders. The increase in average ticket in the US reflects how our innovative products and thoughtful promotions resonated with customers in our quest to offer enhanced value, indicating that our action plans are starting to take hold. Shifting to transactions. US posted a comparable transaction decline of 6%, primarily driven by non-SR members. Across SR customers, as Laxman shared, we saw improved frequency across all deciles. Mobile Order & Pay in the US remained strong in the quarter with positive year-over-year total transaction growth of 7% as customers continue to value both the experience and convenience of the Mobile Order & Pay channel. As we open our app for all with MOP Guest Checkout, which launched earlier this month, we expect to create and deliver value across a broader population, expanding our universe of known customers to deepen engagement, driving increased frequency and spend. In addition to strong SR program growth in the US, we saw strong SR program growth in China. SR members grew to a record 22 million 90-day active members in China. And in June, we also enhanced the program through extending rewards and introducing new diamond tier, which provides exclusive benefits to our most loyal SR members. We're pleased with the SR member growth across both the US and China and expect to see the benefit from this growth in future quarters as new members provide a longer-term benefit. Shifting to margin. Our Q3 consolidated operating margin contracted 70 basis points from the prior year to 16.7%, primarily driven by increased promotional activities, investments in store partner wages and benefits as well as deleverage. The contraction was partially offset by pricing and our continued execution against reinvention-related in-store operational efficiencies, as well as out-of-store efficiencies, which primarily center around our supply-chain. As you've heard Laxman discuss, we're focused on improving operational execution and efficiencies, which is now more important than ever as we build resiliency in our business. Our efficiency efforts are built on creating sustainable improvements in our operations and end-to-end supply-chain, allowing us to both reinvest in our business and drive margin expansion. A testament to these efforts includes the achievement in excess of 200 basis points in year-over-year efficiency gains as of Q3 across both in-store and out-of-store areas, manifesting through our business in reduced store operating expenses and product and distribution costs respectively. Collectively, these line items represent approximately 85% of our annual spend. Our in-store focus, a combination of efficiencies and staffing and scheduling as well as enhancements in our store equipment and new store format design has fueled a reduction in partner turnover, creating greater stability in our stores. We believe that stability not only creates opportunity to nurture stronger connections with customers, but also increases productivity, which translated to roughly 110 basis-point improvement in store-operating expense in the quarter. Our efficiency focus also extends outside of the store as we've been taking a hard look across our supply-chain and other areas including G&A. As Laxman shared, we're working collaboratively with suppliers to identify opportunities to leverage our scale for cost reductions without compromising product quality or distribution timeliness, which led to meaningful savings in the quarter of approximately 100 basis points between rebates and rate savings. In addition, we believe our end-to-end supply-chain focus gives us the opportunity to increase inventory availability with the right products at the right time, enhancing the customer experience while reducing waste. As we've shared, G&A was elevated at more than 7% of revenue through Q2, as we have deliberately invested in resources to continue to grow our technology capability. We have, however, reduced G&A in Q3 and expect it to remain closer to 6% of revenue in the second half of this fiscal year as we balance investments for our long-term growth. When considering our progress this fiscal year, our in-store and out-of-store year-to-date efficiency efforts collectively amounted to nearly 300 basis points of margin improvement. Our significant efficiency runway, coupled with sales growth gives us confidence to drive margin expansion over time. Given this, we have ample opportunities to deliver above our initial goal of $3 billion, driving to $4 billion in efficiencies over the next four years. Q3 EPS was $0.93, down 6% from the prior year. The decline was driven largely by the cautious consumer environment, which in response drove increased promotions and marketing in the quarter, partially offset by our efficiency efforts. Additionally, our higher effective tax rate had a $0.03 unfavorable impact driven by fewer discrete items relative to the prior year. With segment results being discussed in detail in today's Q3 earnings release, I'll now touch on our capital allocation and financial resilience and then move into guidance. As a reminder, our disciplined approach to capital allocation continues to drive financial flexibility, allowing us to continue to make the necessary investments in our business to drive long-term growth. Our new stores continue to be a meaningful part of our growth equation with approximately 85% of our CapEx allocated to our stores, both new stores and renovations. These high-return growth-oriented investments have superior economics, while adding incrementally to our business. Even with over 16,700 stores across the US and another 7,300 in China, we have abundant white space ahead, particularly as populations continue to move to more suburban and rural areas. Take a Tier-3 market in US, for example, a place like Japan, Missouri. A drive-through in that market boasts a year one ROI in excess of 65% with cash margins approaching 30% and a payback period of less than two years. Year-one AUVs reached approximately 2 million with opportunity ahead as we build out the trade area. Importantly, our new store revenue is highly incremental, adding an average of nearly 90% to the trade area attained by our world-class store development partners and their rigorous work that leverages AI-assisted strategic strike -- site selection process. We see that in China as well. Take a new county city, for example. We're in only about 900 of the nearly 3,000 across the market. Today, we see year-one ROI as high as 70% with cash margins averaging over 30% as we've successfully managed both store development and operating costs even in the current macroeconomic backdrop. We believe this is a great investment and accretive to shareholder value, building out the long-term opportunity. With our disciplined approach to capital allocation, underpinned by our strengthening store portfolio, we are reinforcing our financial resilience while remaining committed to our compelling dividend. We continue to target an earnings payout ratio of approximately 50% near the top end of growth companies of our size and scale, resulting in a significant portion of our earnings going directly back to our shareholders. And currently, we have maintained a leverage target below three times lease-adjusted EBITDA, ensuring a strong financial foundation and consistent with our investment-grade credit rating of BBB-plus, which allows us to continue to access capital efficiently. Collectively, our disciplined approach enables us to preserve both balance sheet strength and flexibility, positioning us to successfully navigate through the current macroeconomic environment. Moving to our fiscal year 2024 guidance. We are encouraged with our progress this quarter, and we're pleased to reaffirm all metrics of our full year 2024 guidance. Our confidence is underpinned by the result of our action plans, coupled with the continued efficiency unlocked both in and out of store. In summary, here are key takeaways from my discussion today. First, we are seeing progress against our action plans. Second, our efficiency efforts partially offset investments associated with the cautious consumer environment. Third, we believe our financial fortitude and disciplined capital allocation strategy positions us well for the long term. And last, our full year 2024 guidance remains intact. Before I close, I want to acknowledge all of our partners across the globe, working tirelessly each and every day to elevate the Starbucks experience in our stores, at our roasting plants and in our support centers. You are and always have been our superpower. Thank you, partners. And with that, we'll open the call for questions. Operator?
Operator: [Operator Instructions] In order to allow as many questions as possible, we ask you to please limit yourself to one question at a time. We will come back for follow-up questions as time allows. Your first question comes from Brian Harbour, Morgan Stanley.
Brian Harbour: Yes, thank you. Good afternoon.
Laxman Narasimhan: No, Brian.
Brian Harbour: I wanted to ask a couple of things on kind of the margin and cost side. First of all, G&A, could you talk more about what actions were taken there? Do you still see that as kind of a source of leverage as we go into fiscal 2025? And then on the store side you're obviously generating quite a bit of efficiency. I think you alluded to reinvesting some of that. Where will that go? And then as we also kind of think to next year, is there some continued need for reinvestment, whether it's in labor or certain other things? Could you shed some more light on that?
Rachel Ruggeri: Sure. Thanks, Brian. Let me start with the G&A actions. So in the quarter, our G&A actually declined year-over-year by about 5%. And the drivers of that include performance-based compensation, so lower performance-based compensation, coupled with lapping over some foundation investments from the prior year. In addition to that, given the environment, we made some deliberate decisions to focus on cost efficiencies, which helped us offset some of the investments we've made in wages and benefits as well as the investments we've made in technology. We'll expect that to further into Q4. As we look to the out years, we will continue to drive leverage in our G&A as part of our overall efficiency focus and efforts. Now on the store side, you asked about reinvesting, where does that go? And as far as our in-store and out-of-store efficiencies, those investments largely this year have helped to support the promotional activities as well as the investments we've made in our partner wages and benefits. Now as we look towards next year, we'll continue on our path of efficiency efforts. Those efforts will help us to be able to unlock the capacity to be able to reinvest back into our business in a sundry of different areas, but it will also allow us to drive margin expansion. So, I think that answered all of your questions. Thank you.
Operator: Thank you. Your next question comes from Sara Senatore with Bank of America. Please state your question.
Sara Senatore: Great. Thank you very much. I wanted to ask about the comp -- composition. So I think, Rachel, you mentioned average check benefited from multi-beverage orders, which I guess suggests that perhaps you're not seeing premiumization or customization anymore, but rather just increased group sizes? And then you also mentioned pricing. How much price you have year-over-year if you could give any color on that? And then the final piece, you talked about much lower promotional intensity or mix than what we see from some of your competitors. But I'm trying to understand how does that 14% compare perhaps to what Starbucks might have -- might have seen in the past? Thanks.
Rachel Ruggeri: Sure, Sara. Thank you for the question. I'll start with the 4% check. So, in the US business, our transaction -- our ticket comp increased by 4%. And as I shared in my prepared remarks, that does include about 25% of it was related to beverage attach or multi-beverage orders in response to our promotional offers. So, it showed that our customers responded well to our offers. So, that's really the driver of it. We aren't seeing the customization and the personalization in the same way because our offers were much more targeted and driven around specific beverages as well as overall beverage attach. And so as a result of that, that drove the ticket in the quarter, but we were pleased with that because it shows that customers responded well to those offers. Now when we think about price year-over-year in that 4% ticket, I would say the remainder of the ticket, about 75% is really net price. That includes everything from pricing moves, including the increases that we took in California, coupled with the promotional offers. So, I'd say that's a net pricing impact on that 4%. And in terms of the promotional intensity, I'll turn it over to Laxman in a minute, but what I can say about the promotional environment is we've been very measured from a promotional standpoint given the fact that we have a premium positioning as our brand. And so the majority of our promotional efforts were focused on driving growth in our Starbucks Rewards membership because we know that those members tend to increase their value for us over the lifetime. It's a more efficient way for us to promote. And in the quarter, we were pleased with the fact that between the offers and the marketing activities, we were able to grow our Starbucks Rewards membership in the US as a result of that. We also saw traffic increase on days where we had offers as well as days where we had new product launches. So, that also gave us some encouragement just in terms of the effectiveness of our offers. And with that, I'll turn it over to Laxman.
Laxman Narasimhan: Sara, just to build on the question that you asked in Rachel's response, the Starbucks brand is grounded in the idea that if you exceed the partner expectations, you will exceed the customer expectations. And it is in this experience that we deliver the premiumness of the brand. And when you look at the words worth it for the Starbucks experience, what we measure in our work and brand equity is not just about price, it is about the quality, the distinctive quality, the product customization that you mentioned, the consistency of the experience that we create both in stores and digitally, delivered at a price that customers believe is worth it when they come into the store to transact with us or when they transact with us across channels. Now one of the things that we have been very careful about is that given the premiumness of the brand, we've been very careful about the offers. And as Rachel said, it is at a lower intensity than it is for some of the other brands. What we've tried to do is focus on the Starbucks Rewards members. For our business, 60% of our revenue comes from the SR program and 40% comes from the non-SR program. And what we've found is that some of these offers that we have done, particularly for Starbucks Rewards members has helped drive engagement and incremental visits. We talked a bit about the fact that we've seen engagement go up in every decile of the Starbucks Rewards members. If I look at our non-SR customers, which is about 40% of it, what we've been working on is ensuring that we give them office to come in and become part of the SR program. Additionally, they have told us about a fourth of them tell us that they want the digital convenience, but they don't necessarily want to be part of the program. So, we've done things around how we open up the app for them to order and get the digital convenience. What we see over time is for the non-SR customers, we still have the opportunity to target price investments funded by the progress we're making in our efficiency program. And all the way brings it back to our three-part action plan in terms of what we're doing to continue to deliver the kind of premium experience Starbucks is about.
Operator: Thank you. Your next question comes from Jeffrey Bernstein with Barclays. Please state your question.
Jeffrey Bernstein: Great. Thank you very much. My question was on China. The headwinds, Laxman, as you mentioned, are seemingly large, the comps down 14%. I think you mentioned or just highlighted the ramp-in competition and the macro challenges and the price wars. But with that said, I know you mentioned exploring strategic partnerships and you've had partnerships in the past. Just curious if you could provide some more color. I know in the past, the Board has evaluated alternatives such as the licensing of China, similar to other multinational QSRs, which would kind of allow you to participate in the growth, but mitigate the volatility and reduce your capital needs. So, I'm just wondering what your thoughts are on that, whether that was kind of the reference you made earlier, maybe some of the pros and cons as you contemplate the potential for those strategic alternatives such as licensing? Any color would be great. Thank you.
Laxman Narasimhan: Jeff, thanks so much. We've built a distinctive business in China with both the Starbucks and Starbucks Reserve brands that are relatively more premium relative to what we have in the market. And we've got 60,000 partners, 19,000 of them who are black aprons and coffee. And so the depth of coffee expertise we have is tremendous. Additionally, as we look at the really long term the potential in this business is amazing. I mean, we've essentially very early days given the per-caps we see in the headroom that it provides. So the stores, the brand, the partners, the supply-chain, the digital presence we have, all are distinctive advantages. But as you rightfully said, there's been quite a change in the competitive environment. And we've been very entrepreneurial. I mean, 25 years ago when [indiscernible] went to China, we've created a specialty coffee industry from pretty much nowhere. And we've been very entrepreneurial and we've looked at various ways of making that happen, including joint ventures and partnerships -- strategic partnerships in technology, real estate and supply-chain. We're frankly at the very early stages of this. And so I don't want to necessarily comment specifically on any one option versus another, but we're in the early stages and we recognize that what we want to be sure of is that we're -- we are further strengthening our advantage in this market because the long-term opportunity for us is significant. And we will update you as we as we -- as we make progress on this effort in terms of exploring these strategic partnerships.
Operator: Thank you. And your next question comes from Peter Saleh with BTIG. Please state your question.
Peter Saleh: Great. Thank you. I think you guys mentioned that traffic was down 6% in the US and the majority of that was due to the non-rewards customers, which makes up, call it, 40% of your business. That's a pretty substantial decline in that customer base -- probably a double-digit decline in that customer base. So, can you just talk a little bit about where you think these customers are going and why is it that there is such a steep decline in this customer count in just this segment? Thank you very much.
Laxman Narasimhan: So first of all, I think we are operating in a challenging consumer environment. You see the impact of that in away from home consumption. If you look at our business at home for grocery stores with our brands, you're seeing volume increase, you're seeing share increase in a category that's in decline, but we're seeing volume increase at home. In our ready-to-drink business, we're seeing clearly that there has some challenges, but with the work that our joint-venture team is doing, we're seeing progress there. But away from home consumption, you see the impact of the challenging consumer environment. What we're focused on is what is it that we can do to control what we have. And so the Starbucks Rewards members, you see greater engagement, that is 60% of our revenue. Clearly, if you look at the sort of lower deciles of the Starbucks Rewards program, we see opportunity even there for them to increase their visitations. But if I look at what we're seeing with our non-SR customers, we still maintain the number one position in terms of coffee shops visited from the research that we do internally and for the equity work we've done. So, I think that this is a statement around the overall environment. We know that there are things that we can do in order to communicate value better to our non-SR customers, which is why we've opened up the app for all starting this quarter. And once they come in and once they see what's happening inside the convenience of the mobile auto-pay channel, they will get exposed to what we have inside the app. And we know that we have an opportunity as we look at the end-to-end efficiencies that we can get in our supply-chain that we can target price investments in those areas that will help them realize the price proposition that we have overall. If you really step back and look at us, we've been very disciplined over the last many years. We've taken less pricing than many, but we also recognize the environment we're operating in is challenged. And so, I think what you'll see us do is be measured in the way we do this and do it through the app and target price investments where appropriate, leveraging off the efficiency work that Rachel spoke about.
Operator: Thank you. Our next question comes from Jon Tower with Citi. Please state your question.
Jon Tower: Great. Thanks for taking the questions. I guess maybe first a clarification on the question. Rachel, you mentioned the $4 billion in savings. Just want to ensure that that's a gross or net number. And then I guess maybe going to the Siren stations that you've talked about, I know you're still on track to get 40% or less than 40% done in North America by the end of fiscal 2026. Can you talk about what you're seeing with respect to returns? And what's the impediment to accelerating that type of remodel schedule picking it up, say, instead of less than 40% by the end of 2026, picking that up to 50%, 60% or pulling forward more to current fiscal 2025, say.
Rachel Ruggeri: Jon, I'll start with on the $4 billion of savings over the next four years, that is a net number. So, we have obviously a larger gross number to ensure that we can deliver on that. So that's the way I think about the savings.
Laxman Narasimhan: On your second question on the Siren Craft -- on the Siren systems and the equipment deployment, well, firstly, we've deployed the process improvements across all our stores in the US this week. This has been very well received, the inclusive of the new routines, the training, the beverage bills, the partner investments that we will see transaction impact with that. Now, we have matched our Siren system equipment rollouts with the renovations of store bills because of the returns that that gives us. But it's not stopping us from actually using those Siren system equipment in order for us to debottleneck these outlier stores. And as I mentioned in my prepared remarks, with the work we've done with Deep Brew and the analytics that we have, there were 10% of our stores that have the highest customer service outages. For these 10% stores that is less than 1,000, right, there's work going on store by store. And what we're doing store by store is to look to see this combination of process improvements, how we run the stores as well as looking at a renovation cycle to potentially resequence them in order for us to bring the Siren systems in an accelerated fashion to help us debottleneck these stores. Now later this quarter, we're going to start rolling out a couple of things that will help us attack some of the bottleneck areas we see. For example, with this retrofit to our espresso machines, a same quality, higher throughput, we're going to see the rollout start to over 6,000 espresso-constrained stores starting next quarter. We're doing the same thing with some of the software changes we're making around food and how we drive throughput there. So, these are targeted sequenced efforts that will have high impact on those stores with the greatest constraints. You will see Clover Vertica being all stores by the end of financial year 2025. So, we're going at this, not just waiting for the whole system, but looking at portions of it that we can bring in in a more accelerated fashion in order for us to drive throughput in the stores.
Rachel Ruggeri: If I would just add one more point to that is, I think it's important to note that the Siren system, the equipment is a major overhaul to our overall stores, our engine. It requires quite a bit of CapEx as well as quite a bit of change management. So, we intentionally leverage the renovation and new store process because it allows us to optimize the costs while take advantage of downtime. So that's also an important note in terms of how we've been thoughtful about how we roll these systems out more broadly.
Operator: Your next question comes from Sharon Zackfia with William Blair. Please state your question. Sharon Zackfia, your line is open. Please unmute yourself. All right. We'll move on to the next question. And our next question comes from David Tarantino with Baird. Please state your question.
David Tarantino: Hi, good afternoon. I just wanted to follow up on the US business. A lot of encouraging commentary about some of the internal metrics you're seeing in the business there. But I was hoping maybe you could talk about how that's translating to sales performance and whether you're already starting to see sales responding to some of the progress you're making and maybe more specifically, if you expect the fourth quarter comp growth or transaction growth in the US or North America to be better than what you saw in the third quarter? Thanks.
Laxman Narasimhan: Let me start with the three-part action plan that we had in place. The first one was fixing our stores. And I think that we're making strong progress here. And so if you just look at examples of MOP, the growth rate we had quarter-over-quarter, which was a -- sorry, year-over-year, which was a 10% growth. The uptime that we had in MOP, obviously, big improvements. So, that's an example of the kind of improvements that we're seeing. Our drive-throughs are more efficient. I mean, the multi-second improvements we've seen clearly translate as well into our ability to meet the demand that we have. The product innovations, we touched on some of those that we have and the impact of those, the Summer-Berry Refreshers, the highest sales we've ever had in the launch week leading to the refresher platform reaching 18% of sales. So, examples over there and also the work we're doing with our SR program, an increase in number and increasing the engagement of these. So, those are all the -- all the metrics that we have in terms of the kind of improvements that we're seeing against three-part action plan. As we look ahead into this quarter and we look at, for example, July, what you see in July is the fact that we are seeing shifts in routines in July. We normally see that from a seasonality perspective, but I think we've seen more pronouncements -- more pronounced changes in the routines in July in addition to some of the tech outages that have impacted people across industries. And so, we see the disruptions, for example, in the airport stores that I mentioned or the hospitality stores where we're seeing strong growth. And so what I would say to you is that our guidance does, at the end of the day, reflect the challenging consumer environment and what we expect the comps to be flat to low-single digit for the year. But what I expect is that these actions that we're putting in place will position us stronger to see growth in FY 2025.
Rachel Ruggeri: And just to remind that comp guidance range is a low-single-digit decline to flat.
Operator: Thank you. And our next question comes from Sharon Zackfia with William Blair. Please state your question.
Sharon Zackfia: Hi, can you hear me now?
Rachel Ruggeri: Yes,
Laxman Narasimhan: Yes, we can.
Sharon Zackfia: Okay, perfect. I felt like a Verizon commercial. I wanted to ask, I know you gave the kind of returns you're seeing in US new stores as well as in China. But I think with the weakness you're seeing in comps, it kind of begs the question of how committed you are to this kind of global rate of expansion in the 7% to 8% range for company-owned stores.
Laxman Narasimhan: Well, I'll just make a comment and then hand it to Rachel specifically. So first of all, we're not chasing a number. We look at every project that we have, every site and we look at the incremental returns, the incrementality of the business that it brings and we're entirely driven by ROI. And we see the strong cash-on-cash returns in the US. Rachel spoke to the kind of cash-on-cash returns we're seeing in the Tier-2 and Tier-3 markets where the headroom is large for us. I mean, we're underpenetrated in those markets. And so if you look at the pipeline of real estate investments in the US, they've really targeted Tier-2, Tier-3 mostly. And the work we've done to Deep Brew to identify the sites, to ensure that we build, there's clearly work that's going into how we ensure that the returns we get in these sites are strong. In a very similar way in China, if you look at the cash-on-cash returns that we're getting in the lower-tier cities that we're expanding in, the cash returns are strong. So, we're not really chasing a number. We're chasing a return. And where we see incrementality, where we see returns, we will invest.
Rachel Ruggeri: The only thing I would add to that is just given the fact that we do see these strong returns and the incremental nature to our overall business, we see the vast opportunity. We have a very rigorous site selection process. We also have an ability to be able to monitor overall performance. And the combination of all of that allows us to strengthen our portfolio through the growth of new stores. So, we see it as an important part of our overall long-term growth algorithm. But I think what's important in what Laxman said is it really comes down to ensuring that we keep monitoring the overall economics. And as long as we see the kind of returns we see today, then it supports our long-term growth ambitions.
Operator: Thank you. Your next question comes from John Ivankoe with JP Morgan. Please state your question.
John Ivankoe: Hi, thank you. We generally have the perception that, the US is the leading market for Starbucks around the world. And certainly, it is in terms of total sales. But my question was as you look around the world in Latin America, in Europe, in Asia, and a lot of markets really are competitive and have challenging consumer environments, what have you. Is there anything that you can point to that are -- is being done particularly well in any of these markets from a food, from a service, from a beverage perspective that maybe can be some tangible leading indicators that we can start to get excited about as we think about fiscal 2025 and 2026 innovation past what you've already done? Thank you.
Laxman Narasimhan: I'll just point to our business in Japan, it's been growing double-digits, a terrific round of innovation, a great execution in stores, strengthened digital presence and a brand that really celebrates the coffee house in Japan. I think if you look around the world, we have pockets of these pretty much everywhere. It may not necessarily be uniformly the case, but pretty much everywhere. We have examples of our brand, the experience that we deliver, the products that we bring to bear, the speed of innovation that we have. And by the way, even in pockets in China, we have amazing stories of these in the US too. So, I think that there is a broad set of examples that we constantly look at to learn from and find ways of scaling around the world and that's what we mean at the heart of truly going global, which is our third imperative in our triple shot strategy, it is a way for us to share best practices across the world.
Operator: Thank you. And your next question comes from Christine Cho with Goldman Sachs. Please state your question.
Christine Cho: Yes, thank you. So, you've made some significant investments into staffing, scheduling and partner wage and benefits over the years and it does seem like it's making very good progress so far. But I was wondering if there are any major areas you see incremental opportunities. And just adding on to that, on one hand, you have the goals to improve the cost efficiencies and productivity. But on the other, you will continue to focus on partner and customer experience. So, just curious to your thoughts as to how you strike a balance here. Thank you.
Laxman Narasimhan: I feel very good about the progress we are making on delivering a more stable partner experience in our stores in the US. I think if I just look at the average hours per partner, where we are, it's -- it's reached a real high -- a historic high. So, I feel good about that. I think part of what we are looking to continue to do is how we ensure we simplify in the stores, how we simplify our menus, how we simplify our beverage bills, how we simplify in our supply-chain, what happens upstream versus downstream and how we focus on training, how we ensure more consistency in the experiences that we deliver. And the Siren Craft system is a great example of this. Some of the stories we've heard as we've rolled this out over the course of -- over the last several weeks, including this week across all our network, is just what it's doing in terms of the partner reception and the positivity we hear from partners, including what they say about their ability to connect with customers and also deliver a more personal experience in stores. So, it's clearly -- this is the sort of thing that we have to do and just continue to make the right investments to deliver the right partner experience in order to exceed the customer expectations that I know a premium brand like ours is all about.
Operator: Thank you. The last question comes from David Palmer with Evercore ISI. You may ask your question.
David Palmer: Thank you. I wanted to go back and look at some of the products and the value strategies from April through July. There's -- you were very active with some of the new products and they would be something beyond the coffee core, they would be things that you would think would drive not just the strong trial that you say, but incremental traffic to your business. And I know you were going to dial up some value marketing, maybe you confirm if you felt like you did that. But I'm wondering what do you think worked particularly well, not just in the first trial week or two, but on a more sustaining basis from that in these initiatives, including the value and the new products? And in light of the traffic decline of 6%, I'm wondering what do you think we’re really the offsets? Has there been some decline in the coffee core or is there a daypart, or how should we think about offsets to these things that you're doing? Thanks very much.
Laxman Narasimhan: Thank you, David. Let me just first start with coffee. Right? I think as I said in my prepared remarks, we've gone to one additional point on Cold. So, it's now 76%. Obviously, that's seasonal, but it's 76%. If you look at our espresso business, that's grown 4%. So, espresso drinks are up 4%. So, coffee has grown. And our distinctiveness is in coffee and I think you'll see that in the kind of innovations and new products we bring in, including the launch of Milano Duetto towards the end of this quarter. So, coffee is core to who we are, distinctive in terms of breadth of what we bring and the products will obviously have that. I think one of the things we did talk about was the fact that afternoons are an opportunity for us. And as we look at these new platforms of what we have launched, if I look at Pearls, for example, it was significantly ahead of what we thought it would be to the point where we ran out of supply. And I think that it wasn't a supply issue necessarily, but it was more, the demand was ahead of what we thought it would be. We had to pull back marketing, and my sense is that as you look at what we now have in our stores, they're back in stores with new products and it's a platform that we will continue to build over time. So, we're not just launching a product, we're launching platforms. The energy platform we've been in the energy business since 2007 with the launch of Doubleshot and Triple Shot Espresso. What we now have is we have a zero-calorie energy platform that we are scaling and it's building steadily and will be something that we're committed to over time. If you look at some of our food innovations like the Egg, Mozzarella, Pesto sandwich as an example, it's a terrific sandwich. And again, it's one that's going to join our core, but it's building systematically over time. We still have work to do on supply, around how we ensure stability and reliability of supply, particularly in food in order to get the kind of service that we're going to need across our 10,000 stores with the products that we launch. So, that's an opportunity, David, that I think we still have and the team is working very hard along with our suppliers in order to make that happen.
Operator: Thank you. That was our last question. I will now turn the call over to Laxman Narasimhan for closing remarks. Thank you.
Laxman Narasimhan: Thank you all for the time today. If you take away one thing, let it be this. We are making real progress on our three-part plan. We are focused on what we can control in a consumer environment that can be best be described as complex. Our teams are moving to the urgency. I thank them for their efforts and for staying focused on what we can control. I have full confidence in the long-term potential of Starbucks worldwide. Thank you.
Operator: Thank you. This concludes Starbucks' Third Quarter Fiscal Year 2024 Conference Call. You may now disconnect. |
AMD | 2 | 2,024 | 2024-07-30 19:28:07 | Operator: Greetings, and welcome to the AMD Second Quarter 2024 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 to you Mitch Haws, Vice President Investor Relations. Thank you, Mitch. You may begin.
Mitch Haws : Thank you, and welcome to AMD's Second Quarter 2024 Financial Results Conference call. By now you should have had the opportunity to review a copy of our earnings press release and the accompanying slides. If you have not had the chance to review these materials, they can be found on the Investor Relations page of amd.com. We will refer primarily to non-GAAP financial measures during today's call. The full non-GAAP to GAAP reconciliations are available in today's press release, and the slides posted on our website. Participants on today's conference call are Dr. Lisa Su, our Chair and Chief Executive Officer; and Jean Hu, our Executive Vice President, Chief Financial Officer, and Treasurer. This is a live call and will be replayed via webcast on our website. Before we begin, I would like to note that Dr. Lisa Su will attend the Goldman Sachs Technology Communicopia and Technology Conference on Monday, September 9th, and Mark Papermaster, Executive Vice President and Chief Technology Officer, will attend the Deutsche Bank Technology conference on Wednesday, August 28th. Today's discussion contains forward-looking statements based on current beliefs, assumptions, and expectations. Speak only as of today and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statement in our press release for more information on factors that could cause action results to differ materially. With that, I'll hand the call over to Lisa.
Lisa Su : Thank you, Mitch, and good afternoon to all those listening today. We delivered strong second quarter financial results with revenue coming in above the midpoint of guidance and profitability increasing by a double-digit percentage driven by higher than expected sales of our Instinct, Ryzen, and EPYC processors. We continued accelerating our AI traction, as leading cloud and enterprise providers, expanded availability of Instinct MI300X solutions, and we also saw positive demand signals for general purpose compute in both our client and server processor businesses. As a result, second quarter revenue increased 9% year-over-year to $5.8 billion, as significantly higher sales of our data center and client processors more than offset declines in gaming and embedded product sales. We also expanded gross margin by more than 3 percentage points and grew EPS 19%, as data center product sales accounted for nearly 50% of overall sales in the quarter. Turning to the segments, data center segment revenue increased 115% year-over-year to a record $2.8 billion, driven by the steep ramp of Instinct MI300 GPU shipments and a strong double-digit percentage increase in EPYC CPU sales. Cloud adoption remains strong as hyperscalers deploy fourth-gen EPYC CPUs to power more of their internal workloads and public instances. We are seeing hyperscalers select EPYC processors to power a larger portion of their applications and workloads, displacing incumbent offerings across their infrastructure with AMD solutions that offer clear performance and efficiency advantages. The number of AMD-powered cloud instances available from the largest providers has increased 34% from a year ago to more than 900. We are seeing strong pull for these instances with both enterprise and cloud-first businesses. As an example, Netflix and Uber both recently selected fourth-gen EPYC Public Cloud instances as one of the key solutions to power their mission critical customer facing workloads. In the enterprise, sales were increased by a strong double-digit percentage sequentially. We closed multiple large wins in the quarter with financial services, technology, health care, retail, manufacturing, and transportation customers, including Adobe, Boeing, Industrial Light & Magic, Optiver, and Siemens. Importantly, more than one-third of our enterprise server wins in the first half of the year were with businesses deploying EPYC in their data centers for the first time, highlighting our success attracting new customers, while also continuing to expand our footprint with existing customers. Looking ahead, our next-generation Turin family, featuring our new Zen 5 core is looking very strong. Zen 5 is a grounds up new core design optimized for leadership performance and efficiency. Turin will extend our TCO leadership by offering up to 192 cores and 384 threads, support for the latest memory and I.O. Technologies, and the ability to drop into existing fourth-gen EPYC platforms. We publicly previewed Turin for the first time in June, demonstrating our significant performance advantages in multiple compute-intensive workloads. We also passed a major milestone in the second quarter as we started Turin production shipments to lead Cloud customers. Production is ramping now ahead of launch and we expect broad OEM and cloud availability later this year. Turning to our data center AI business, we delivered our third straight quarter of record data center GPU revenue with MI300 quarterly revenue exceeding $1 billion for the first time. Microsoft expanded their use of MI300X Accelerators to power GPT-4 Turbo and multiple co-pilot services including Microsoft 365 Chat, Word, and Teams. Microsoft also became the first large hyperscaler to announce general availability of public MI300X instances in the quarter. The new Azure VMs leverage the industry-leading compute performance and memory capacity of MI300X in conjunction with the latest ROCm software to deliver leadership-inferencing price performance when running the latest frontier models, including GPT-4. Hugging Face was one of the first customers to adopt the new Azure instances, enabling enterprise and AI customers to deploy hundreds of thousands of models on MI300X GPUs with one click. Our enterprise and Cloud AI customer pipeline grew in the quarter, and we are working very closely with our system and cloud partners to ramp availability of MI300 solutions to address growing customer demand. Dell, HPE, Lenovo, and Supermicro all have Instinct platforms in production, and multiple hyperscale and tier-2 cloud providers are on track to launch MI300 instances this quarter. On the AI software front, we made significant progress enhancing support and features across our software stack, making it easier to deploy high performance AI solutions on our platforms. We also continued to work with the open source community to enable customers to implement the latest AI algorithms. As an example, AMD support for Flash Attention 2 algorithm was upstreamed, providing out-of-the-box support for AMD hardware in the popular library that could increase training and inference performance on large transformer models. Our work with the model community also continued accelerating, highlighted by the launches of new models and frameworks with day one support for AMD hardware. At Computex, I was joined by the co-CEO of Stable Diffusion to announce that MI300 is the first GPU to support their latest SD 3.0 image generation LLM. Last week, we were proud to note that multiple partners used ROCm and MI300X to announce support for the latest Llama 3.1 models, including their 405 billion parameter version that is the industry's first frontier-level open source AI model. Llama 3.1 runs seamlessly on MI300 accelerators, and because of our leadership memory capacity, we're also able to run the FP16 version of the Llama 3.1 405B model in a single server, simplifying deployment and fine-tuning of the industry-leading model and providing significant TCO advantages. Earlier this month, we announced our agreement to acquire Silo AI, Europe's largest private AI lab with extensive experience developing tailored AI solutions for multiple enterprise and embedded customers, including Allianz, Ericsson, Finnair, Korber, Nokia, Philips, T-Mobile, and Unilever. The Silo team significantly expands our capability to service large enterprise customers looking to optimize their AI solutions for AMD hardware. Silo also brings deep expertise in large language model development, which will help accelerate optimization of AMD inference and training solutions. In addition to our acquisitions of Silo AI, [Sology] (ph), and Nod.ai, we have invested over $125 million across a dozen AI companies in the last 12 months to expand the AMD AI ecosystem, support partners, and advance leadership AMD computing platforms. Looking ahead from a roadmap perspective, we are accelerating and expanding our Instinct roadmap to deliver an annual cadence of AI accelerators, starting with the launch of MI325X later this year. MI325X leverages the same infrastructure as MI300 and extends our generative AI performance leadership by offering twice the memory capacity and 1.3 times more peak compute performance than competitive offerings. We plan to follow MI325X with the MI350 series in 2025 based on the new CDNA 4 architecture, which is on track to deliver a 35x increase in performance compared to CDNA 3. And our MI400 series powered by the CDNA “Next” architecture is making great progress in development and is scheduled to launch in 2026. Turning to our AI solutions work, Broadcom, Cisco, HP Enterprise, Intel, Google, Meta, and Microsoft all joined us to announce Ultra Accelerator Link, an industry standard technology to connect hundreds of AI accelerators that is based on AMD's proven infinity fabric technology. By combining UA-Link with the widely supported ultra-Ethernet consortium specification, the industry is coming together to establish a standardized approach for building the next generation of high-performance data centers, AI solutions at scale. In summary, customer response to our multi-year Instinct and ROCm roadmaps is overwhelmingly positive and we're very pleased with the momentum we are building. As a result, we now expect data center GPU revenue to exceed $4.5 billion in 2024, up from the $4 billion we guided in April. Turning to our client segment, revenue was $1.5 billion, an increase of 49% year-over-year driven by strong demand for our prior generation Ryzen processors and initial shipments of our next generation Zen 5 processors. In PC applications, Zen 5 delivers an average of 16% more instructions per clock than our industry leading previous generation of Ryzen processors. For desktops, our upcoming Ryzen 9000 series processors drop into existing AM5 motherboards and extends our performance and energy efficiency leadership across productivity, gaming, and content creation workloads. For notebooks, we announced our Ryzen AI 300 series that extends our industry-leading CPU and GPU performance and introduces the industry's fastest NPU with 50 tops of AI compute performance for Copilot Plus PCs. The first Ryzen AI 300 series notebooks went on sale over the weekend to strong reviews. And more than 100 Ryzen AI 300 series premium, gaming, and commercial platforms are on track to launch from Acer, ASUS, HP, Lenovo, and others over the coming quarters. Customer excitement for our new Ryzen processors is very strong, and we are well positioned for ongoing revenue share gains based on the strength of our leadership portfolio and design win momentum. Now turning to our gaming segment, revenue declined 59% year-over-year to $648 million as semi-custom SoC sales declined in-line with our projections. Semi-custom demand remains soft, as we are now in the fifth-year of the console cycle and we expect sales to be lower in the second half of the year compared to the first half. In gaming graphics, revenue increased year-over-year driven by improved sales of our Radeon 6000 and 7000 series GPUs in the channel. Turning to our embedded segment, revenue decreased 41% year-over-year to $861 million. The first quarter marked the bottom for our embedded segment revenue. Although second quarter revenue was flattish sequentially, we saw early signs of order patterns improving and expect embedded revenue to gradually recover in the second half of the year. Longer term we are building strong design win momentum for our expanded embedded portfolio. Design wins in the first half of the year increased by more than 40% from the prior year to greater than $7 billion, including multiple triple-digit million-dollar wins combining our adaptive and x86 compute products. We announced our Alveo V80 accelerators that deliver leadership capabilities in memory-intensive workloads and entered early access on next-generation Edge AI solutions with more than 30 key partners on our upcoming second-gen Versal adaptive SoCs. Last week, we also announced Victor Peng, President of AMD, would retire at the end of August. Victor has made significant contributions to Xilinx and AMD, including helping scale our embedded business and leading our cross-company AI strategy. On a personal note, Victor has been a great partner to me in sharing the success of our Xilinx acquisition and integration. On behalf of all of the AMD employees and board, I want to thank Victor for all of his contributions to AMD success and wish him all the best in his retirement. In summary, we delivered strong second quarter results and are well positioned to grow revenue significantly in the second half of the year, driven by our data center and client segments. Our data center GPU business is on a steep growth trajectory as shipments ramp across an expanding set of customers. We're also seeing strong demand for our next generation Zen 5 EPYC and Ryzen processors that deliver leadership performance and efficiency in both data center and client workloads. Looking ahead, the rapid advances in generative AI and development of more capable models are driving demand for more compute across all markets. Under this backdrop, we see strong growth opportunities over the coming years and are significantly increasing hardware, software and solutions investments with a laser focus on delivering an annual cadence of leadership data center GPU hardware, integrating industry leading AI capabilities across our entire product portfolio, enabling full stack software capabilities, amplifying our ROCm development with the scale and speed of the open source community and providing customers with turnkey solutions that accelerate the time to market for AMD based AI systems. We are excited about the unprecedented opportunities in front of us and are well positioned to drive our next phase of significant growth. Now I'd like to turn the call over to Jean to provide some additional color on our second quarter results. Jean?
Jean Hu : Thank you Lisa, and good afternoon everyone. I'll start with a review of our financial results and then provide our current outlook for the third quarter. We're very pleased with our overall second quarter financial results that came in above expectations. On a year-over-year basis, data center segment revenue more than doubled. Client segment revenue grow significantly, and we expand the gross margin by 340 basis points. For the second quarter of 2024, revenue was $5.8 billion, up 9% year-over-year, as revenue growth in the data center and the client segments was partially offset by lower revenue in our gaming and embedded segments. Revenue increases 7% sequentially, primarily driven by growth in the data center and the client segments revenue. Gross margin was 53%, up 340 basis points year-over-year, primarily driven by higher data center revenue. Operating expenses were $1.8 billion, an increase of 15% year-over-year, as we continue to invest in R&D to address the significant AI growth opportunities ahead of us and enhanced go-to-market activities. Operating income was $1.3 billion representing a 22% operating margin. Taxes, interest expense and other was $138 million. Diluted earnings per share was $0.69, an increase of 19% year-over-year. Now turning to our reportable segment. Starting with the data center. Data Center delivered record quarterly segment revenue of $2.8 billion, up 115%, a $1.5 billion increase in year-over-year. The Data Center segment accounted for nearly 50% of total revenue, led primarily by the steep ramp of AMD Instinct GPUs and strong double-digit percentage EPYC Server revenue growth. On a sequential basis, revenue increased 21%, driven primarily by strong momentum in AMD Instinct GPUs. Data center segment operating income was $743 million or 26% of revenue compared to $147 million or 11% a year ago. Operating income was up more than 5 times from the prior year, driven by higher revenue and operating leverage, even as we significantly increase our investment in R&D. Client segment revenue was $1.5 billion, up 49% year-over-year and 9% sequentially driven primarily by AMD Ryzen processor sales. Client segment operating income was $89 million or 6% of revenue compared to operating loss of $69 million a year ago. Gaming segment revenue was $648 million down 59% year-over-year and 30% sequentially. The decrease in revenue was primarily due to semi-customer inventory digestion and the lower end-market demand. Gaming segment operating income was $77 million, or 12% of revenue compared to $225 million or 14% a year ago. Embedded segment revenue was $861 million, down 41% year-over-year, as customers continue to normalize their inventory levels. On sequential basis, embedded segment revenue was up 2%. Embedded segment operating income was $345 million or 40% of revenue compared to $757 million or 52% a year ago. Turning to the balance sheet and the cash flow. During the quarter, we generated $593 million in cash from operations and the free cash flow was $439 million. Inventory increased sequentially by [$339 million] (ph) to $5 billion, primarily to support the continued ramp of a data center GPU product. At the end of the quarter, cash, cash equivalent, and short-term investments were $5.3 billion. In the second quarter, we returned $352 million to shareholders repurchasing 2.3 million shares, and we have $5.2 billion of authorization remaining. During the quarter, we retired $750 million of debt that matured this past June utilizing existing cash. Now turning to our third quarter, 2024 outlook. We expect revenue to be approximately $6.7 billion plus or minus $300 million. Sequentially, we expect revenue to grow approximately 15%, primarily driven by strong growth in the data center and the client segment. We expect embedded segment revenue to be up and the gaming segment to decline by double digit percentage. Year-over-year we expect revenue to grow approximately 16%, driven by the steep ramp of our AMD Instinct processors and strong server and client revenue growth to more than offset the declines in the gaming and embedded segments. In addition, we expect third quarter non-GAAP gross margin to be approximately 53.5%. Non-GAAP operating expenses to be approximately $1.9 billion. Non-GAAP effective tax rate to be 13%. And the diluted share count is expected to be approximately 1.64 billion shares. Also during the third quarter, we expect to close the acquisition of Silo AI for approximately $665 million in cash. In closing, we made significant progress during the quarter toward achieving our financial goals. We delivered record MI300 revenue that exceeded $1 billion and demonstrated solid traction with our next-gen Ryzen and EPYC product. We expanded gross margin significantly and drove earnings growth while increasing investment in AI. Looking forward, opportunities ahead of us are unprecedented, will remain focused on executing to our long-term growth strategy, while driving financial discipline and operational excellence. With that, I will turn it back to Mitch for the Q&A session.
Mitch Haws : Thank you, Jean. John, we're happy to poll the audience for questions.
Operator: Thank you, Mitch. We will now be conducting the question-and-answer session. [Operator Instructions] And the first question comes from the line of Ben Reitzes with Melius Research. Please proceed with your question.
Ben Reitzes: Hey, thanks a lot. Congratulations on these results. Lisa, I wanted to ask you about MI300, how you see it playing out sequentially for the rest of the year. I guess there is about $2.8 billion left to hit your annual target. So I'm wondering if you see things picking up in the fourth quarter and how that's going sequentially. And if you don't mind, I wanted to also ask about next year if you see potential for rapid growth. You're probably aware of some of the chatter out there, and I just was wondering if you are already seeing signs that you can grow significantly, given your road map for next year. Thank you so much.
Lisa Su: Yes. Great, Ben. Thanks for the question. So first of all on sort of MI300 and the customer evolution, we are very happy with how MI300 has progressed. When we started the year, I think the key point for us was to get our products into our customers' data centers, to have them qualify their workloads, to really ramp in production and then see what the production capabilities are especially performance and all of those things. And I can say now being sort of more than halfway through the year, we've seen great progress across the board. As we look into the second half of the year I think we would expect that MI300 revenue would continue to ramp in the third quarter and the fourth quarter. And we are continuing to expand both current deployments with our existing customers, as well as we have a large pipeline of customers that we are working through that are getting familiar with our architecture and software and all that stuff. So I’d say overall, very pleased with the progress, and really continuing right on track to what we expected from the capabilities of the product. As we go into next year, I mean one of the important things that we announced at Computex, was increasing and expanding our road map. I think we feel really good about our road map. We are on track to launch MI325 later this year. And then next year, our MI350 Series, which will be very competitive with Blackwell Solutions. And then we're well on our way to our CDNA Next as well. So I think, overall we remain quite bullish on the overall AI market. I think the market continues to need more compute. And we also feel very good that our hardware and software solutions are getting good traction, and we are continuing to expand that pipeline.
Ben Reitzes: Thank you.
Operator: And the next question comes from the line of Aaron Rakers with Wells Fargo. Please proceed with your question.
Aaron Rakers: Yeah, thanks for taking my question. And congrats on the quarter as well. I guess sticking on the Data Center side, as we look forward and you think about the full year, I'm curious of how you're currently thinking about the EPYC server CPU growth expectations as we go forward. And any kind of updated thoughts on your ability to kind of continue to gain share in the server market? Just kind of just update us on how you see the server market playing out over the next couple of quarters.
Lisa Su: Yes, sure Aaron. Thanks for the question. So we are very pleased with the progress that we've made with EPYC. I think a couple of things. First of all, in terms of competitive positioning and just the traction in the market, our fourth-gen EPYC between Zen 1 Bergamo is really doing very well. We've seen broad adoption across cloud, and then we've been very focused on enterprise as well as third-party cloud instances. And as I said in the prepared remarks, we are starting to see very nice traction in enterprise with both new customers as well as existing customers, and then for third-party cloud adoption, also a good pickup there as well. So I think overall, I think our EPYC portfolio has done well. Going into the second half of the year, I think we also feel good about it. There are a couple of positives there. We see -- first of all the market looks like it's improving, so we have seen some return to spending in both enterprise and cloud. And so I think those are positive market trends. And then in addition to that, we are in the process of launching Turin. So we started production here in the second quarter and we are on track to launch broadly in the second half of the year. We'll see some revenue of Turin in the second half of the year contributing as well. So overall, I think the server market and our ability to continue to grow share in the server market is one of the things that we see in the second half of the year.
Operator: And the next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. Lisa, I wanted to ask about the Data Center GPU roadmap. As you said, 325 launching later this year, so I guess I had two questions. Does the greater than $4.5 billion, does that include any revenue from 325? And can you talk a little bit more about 350? Obviously, we are seeing a big rack scale or shift toward rack-scale systems for the competition's product. And I'm wondering if that's what 350 is going to look like. Is it going to have liquid cooling and is it going to have a rack scale aspect to it? Thanks.
Lisa Su: Yes, absolutely. So let me start with your original question. I mean, I think looking at 325X, we are on track to launch later this year. From a revenue standpoint there will be a small contribution in the fourth quarter but it really is still mostly the MI300 capabilities. And 325 will start in the fourth quarter and then ramp more in the first half of next year. And then as we look at the 350 Series, what we are seeing and the reason we call it a series is because there will be multiple SKUs in that series that we'll go through the range of, let's call it, air-cooled to liquid-cooled. In spending time with our customers. I think there are people who certainly want more rack level solutions, and we are certainly doing much more in terms of system-level integration for our products. You will see us invest more in system-level integration. But we also have many customers who want to use their current infrastructure. I think the beauty of the MI350 series is, it actually fits into the same infrastructure as the MI300 series. And so it would lend itself to, let's call it a pretty fast ramp if you've already invested in 300 or 325. So we see the range of options, and that's part of the expansion of the road map that we are planning.
Operator: And the next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi, thanks for having me ask a question and congrats on the strong results. Well, Data Center is obviously very important. I just want to pivot to the Client side. Lisa, can you talk about the AI PC side of things? How you believe AMD is positioned? Are you seeing any competitive intensity changing with the emergence of ARM based systems? Just wanted to see how you are expecting that to roll out and what it means to second half seasonality.
Lisa Su: Yes. Sure, Ross. So first, we are very pleased with our Client business results. I think we have a very strong road map, so I'm very pleased with the road map. The Zen 5 based products, we're launching both notebook and desktop in the middle of this year. What we've seen is actually very positive feedback on the product. So we just actually launched the first Strix-based notebooks over the weekend. They went on sale. You may have seen some of the reviews. The reviews are very positive. Our view of this is the AI PC is an important add to the overall PC category. As we go into the second half of the year, I think we have better seasonality in general, and we think we can do, let us call it above-typical seasonality, given the strength of our product launches and when we are launching. And then into 2025, you're going to see AI PCs across sort of a larger set of price points which will also open up more opportunities. So overall, I’d say, the PC market is a good revenue growth opportunity for us. The business is performing well. The products are strong. And we are working very closely with both the ecosystem partners, as well as our OEM partners to have strong launches here into the second half of the year.
Ross Seymore: And is the ARM side changing anything or not really?
Lisa Su: Look, I think at this point the PC market is a big market and we are underrepresented in the market. I’d say that we take all of our competition very seriously. That being the case, I think our products are very well positioned.
Operator: And the next question comes from the line of Matt Ramsay with Cowen. Please proceed with your question.
Matt Ramsey: Thank you very much. Good afternoon. Lisa, I wanted to maybe draw a parallel between the Instinct portfolio that your company is rolling out now and what you guys did five or six years ago with EPYC. And I remember when the Naples product launched, there was a lot of, I’d say, reaction positively and negatively and sort of sentiment around where your road map might go to relatively small perturbations in what the volumes were, super early. But if I remember back to that, what was the most important was that was the toehold into the market for long-term engagement, both on the software side and the hardware side with your customers two, three, four generations forward. So is that an accurate parallel to where you guys are with MI300? And maybe you could talk about the level of engagement, the intensity of engagement, the breadth of it across the customer base with 350 and 400. Thanks.
Lisa Su: Yes, absolutely, Matt. So look as I said earlier, we are very pleased with the progress that we are making on the Instinct road map. This is absolutely a long-term play so absolutely, you are correct. It has a lot of parallels to the EPYC journey, where you really have to -- you gain more opportunities, broader workloads, larger deployments as you go from generation to generation. So we are playing the long game here. Our conversations with our customers, so I’d start with first, in the near-term, we had some very key milestones that we wanted to pass this year. And as I said, they related to getting hardware in volume in multiple hyperscalers, as well as large Tier 2 customers. We've done that. We've now seen our software in a lot of different environments, and it is matured substantially. ROCm is in very -- from a standpoint of features, functions, out-of-box performance, getting to performance with customers, we've gained a lot of confidence and learned a lot in that whole process. The networking aspects of building out the rack scale and the system-level items are areas that we are continuing to invest in. And then the point of having long-term conversations across multiple generations is also really important. So I think all of those things have progressed well. We view this as very good progress for MI300, but we have a lot more to do. And I think the various road maps will help us open up those opportunities over the next couple of years.
Matt Ramsey: Appreciated. Thank you.
Lisa Su: Thanks Matt.
Operator: And the next question comes from the line of Vivek Arya with Bank of America Securities. Please proceed with your question.
Vivek Arya: Thanks for taking my question. Lisa, there seems to be this ongoing industry debate about AI monetization and whether your customers are getting the right ROI on their CapEx. And today, they have these three options, right? They can buy GPUs from your largest competitor with all the software bells and whistles and incumbency or they can do custom chips or they can buy from AMD. So how do you think this plays out next year? Do you think your customers given all this concern around monetization, does it make them consolidate their CapEx around just the other two suppliers? How is your visibility going into next year, given this industry debate? And how will AMD continue to kind of carve a position between these two other competitive choices that are out there? Thank you.
Lisa Su: Yes, sure, Vivek. Well, I mean I think you talk to a lot of the same people that we talk to. I think the overall view on AI investment is we have to invest. I mean the industry has to invest. The potential of AI is so large to impact the way enterprises operate and all that stuff. So I think the investment cycle will continue to be strong. And then relative to the various choices for the size of the market, I firmly believe that there will be multiple solutions, whether you are talking about GPUs or you are talking about custom chips or ASICs, there will be multiple solutions. In our case, I think we've demonstrated a really strong road map and the ability to partner well with our customers. And from the standpoint of that deep engagement, hardware, software co-optimization is so important in that. And for large language models, GPUs are still the architecture of choice. So I think, the opportunity is very large. And I think our piece of that is really strong technology with strong partnerships with the key AI market makers.
Vivek Arya: Thank you Lisa.
Lisa Su: Thanks Vivek.
Operator: And the next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
Joe Moore: Great. Thank you. I also wanted to ask about MI300. I wonder if you could talk about training versus inference. Do you have a sense -- I know that a lot of the initial focus was inference, but do you have traction on the training side? And any sense of what that split may look like over time?
Lisa Su: Yes, sure. Thanks for the question Joe. So as we said on MI300, there are lots of great characteristics about it. One of them is our memory bandwidth and memory capacity is leading the industry. From that standpoint, the early deployments have largely been inference in most cases, and we have seen fantastic performance from an inference standpoint. We also have customers that are doing training. We've also seen that from a training standpoint, we've optimized quite a bit our ROCm software stack, to make it easier for people to train on AMD. And I do expect that we'll continue to ramp training over time. As we go forward, I think you'll see -- the belief is that inference will be larger than training from a market standpoint. But from an AMD standpoint, I’d expect both inference and training to be growth opportunities for us.
Joe Moore : Great. Thank you.
Operator: And the next question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Hi, thank you so much for taking the question. I had a question on the MI300 as well. Curiously, if you are currently shipping to demand or if the updated annual forecast of $4.5 billion is in some shape or form supply constrained. I think last quarter you gave some comments on HBM and CoWoS. Curious if you could provide an update there. And then my Part B to my question is on profitability for MI300. I think in the past, you've talked about the business being accretive and improving further over time as you sort of work through the kinks, if you will. Has that view evolved or changed at all, given sort of the competitive intensity and your need to invest, whether it be through organic R&D or some of the acquisitions you've made? Or are you still confident that profit margins in the business continue to expand? Thank you.
Lisa Su: Yes. Sure, Toshiya. Thanks for the question. So on the supply side, let me make a couple of comments and then maybe I'll let Jean comment on sort of the trajectory for the business. So on the supply side, we made great progress in the second quarter. We ramped up supply significantly exceeding $1 billion in the quarter. I think the team has executed really well. We continue to see line of sight to continue increasing supply as we go through the second half of the year. But I will say that the overall supply chain is tight and will remain tight through 2025. So under that backdrop, we have great partnerships across the supply chain. We've been building additional capacity and capability there. And so we expect to continue to ramp as we go through the year. And we'll continue to work both supply as well as demand opportunities, and really that's accelerating our customer adoption overall, and we'll see how things play out as we go into the second half of this year.
Jean Hu: Yes. On your second question about the profitability, first our team has done a tremendous job to ramp the product MI300. It is a very complex product. So we ramped it successfully. At the same time, the team also started to implement operational optimization to continue to improve gross margin. So we continue to see the gross margin improvement. Over time, in the longer term, we do believe gross margin will be accretive to corporate average. From a profitability perspective, AMD always invests in platforms. If you look at our Data Center platform especially both the [Server] (ph) and the Data Center GPU side, we are ramping the revenue. The business model can leverage very significantly even from GPU side. Because the revenue ramp has been quite significant, the operating margin continued to expand. We definitely want to continue to invest as the opportunity is huge. At the same time, it is a profitable business already.
Toshiya Hari: Thank you very much.
Operator: And the next question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi, guys. Thanks for taking my question. I wanted to dig into the Q3 guidance a little bit, if I could. So with Gaming down double digits, it probably means you've got close to $1 billion of growth revenue across Data Center, Client, and Embedded. I was wondering if you could give us some color on how that $1 billion-ish splits out across those three businesses. Like if I had 70% of it going to Data Center and 20% going to Client and 10% going to Embedded, like would that be like way off? Or how should we think about that apportioning out across the segment?
Lisa Su: Yes. Maybe Stacy, let me give you the following color. So the Gaming business is down double digit as you state. Think of it as the Data Center is the largest piece of it, client next. And then on the Embedded side think of it as single-digit sequential growth.
Stacy Rasgon: Got it. So I mean within that Data Center piece then, how does that split out? I mean, is the bulk of it [indiscernible] Instinct? Or is it sort of equally weighted between Instinct and EPYC? Or like again how does it -- again if you got, I don't know $400 million to $600 million of sequential Data Center growth or something like that, how does it split up?
Lisa Su: Yes. So again, without being that granular, we will see both -- certainly, the Instinct GPUs will grow and we'll see also very nice growth on the server side.
Operator: And the next question comes from the line of Harsh Kumar with Piper Sandler. Please proceed with your question.
Harsh Kumar: Hi, Lisa. From my rudimentary understanding, the large difference between your Instinct products and the adoption versus your nearest competitor is kind of rack level performance and that rack level infrastructure that you may be lacking. You talked a little bit about UALink. I was wondering if you could expand on that and give us some more color on when that might -- when that gap might be closed. Or is this a major step for the industry to close that gap? Just any color would be appreciated.
Lisa Su: Yes. So Harsh, overall, maybe if I take a step back and just talk about how the systems are evolving, there is no question that the systems are getting more complex, especially as you go into large training clusters, and our customers need help to put those together. And that includes the sort of Infinity Fabric-type solutions that are the basis for the UALink things as well as just general rack level system integration. I think what you should expect, Harsh is, first of all, we're very pleased with all of the partners that have come together for UALink. We think that's an important capability. But we have all of the pieces of this already within sort of the AMD umbrella with our Infinity Fabric, with the work with our networking capability through the acquisition of Pensando. And then you'll see us invest more in this area. So this is part of how we help customers get to market faster is by investing in all of the components, so the CPUs, the GPUs, the networking capability as well as system-level solutions.
Harsh Kumar: Thank you Lisa.
Lisa Su: Thanks Harsh.
Operator: And the next question comes from the line of Blayne Curtis with Jefferies. Please proceed with your question.
Blayne Curtis: Hi, good afternoon. Thanks for taking my question. I just want to ask another question on MI300. Just curious if you can kind of characterize the makeup of the customers in the first half. I know you had, end of last year, a government customer. Is there still a government contingency? And kind of the second part of it is really you've invested in all these software assets. Kind of curious the challenge of ramping the next wave of customers. I know there's been a lot of talk on some hardware challenges, memory issues and such, but then you're investing in software. I'm sure that's a big challenge, too. Just kind of curious what the biggest hurdle is for you to kind of get that next wave of customers ramp.
Lisa Su: Yes. So Blayne, a lot of pieces to that question, so let me try to address them. First, on your question about I think you are basically asking about the supercomputing piece. That was mainly Q4 and a bit in Q1. So if you think about our Q2 revenue, think about it as almost all AI. So it is MI300X, it's for large AI, hyperscalers as well as OEM customers going to enterprise and Tier 2 data centers. So that's the makeup of the customer set. And then in terms of the various pieces of what we're doing, I think first on your question about memory, I think there's a lot of noise in the system. I wouldn't really pay attention to all that noise in the system. I mean, this has been an incredible ramp. And I'm actually really proud of what the team has done in terms of just definitely fastest product ramp that we've ever done to $1 billion here in the -- over $1 billion in the second quarter, and then ramping each quarter in Q3 and Q4. In terms of memory, we have multiple suppliers that we've qualified on HBM3. And it is a tricky -- memory is a tricky business but I think we've done it very well and that's there. And then we are also qualifying HBM3E for future products with multiple memory suppliers as well. So to your overarching question of what are the things that we're doing, the exciting part of this is that the ROCm capability has really gotten substantially better because so many customers have been using it. And with that, what we look at is out of box performance, how long does it take a customer to get up and running on MI300? And we've seen, depending on the software that companies are using, particularly if you are based on some of the higher-level frameworks like PyTorch, et cetera, we can be out-of-the-box running very well in a very short amount of time, like let's call it, very small number of weeks. And that's great because that's expanding the overall portfolio. We’re going to continue to invest in software and that was one of the reasons that we did the Silo AI acquisition. It is a great acquisition for us, 300 scientists and engineers. These are engineers that have experience with AMD hardware and are very, very good at helping customers get up and running on AMD hardware. And that's -- so we view this as the opportunity to expand the customer base with talent like Silo AI, like Nod.ai which brought a lot of compiler talent. And then we continue to hire quite a bit organically. So I think Jean said earlier that we see leverage in the model, but we are going to continue to invest because this opportunity is huge, and we have all of the pieces. This is just about building out scale.
Blayne Curtis: Thanks so much.
Lisa Su: Thanks.
Operator: And the next question comes from the line of Tom O'Malley with Barclays. Please proceed with your question.
Tom O'Malley: Hi, Lisa. Thanks for taking my question. I'll give you a breather from the MI300 for a second, but just to focus on Client in the second half. No problem. Focused on Client in the second half, you kind of said above-seasonal for September, December. You're obviously launching a new notebook, desktop product, but you're also talking about AI PC. Could you just break down where you're seeing those above-seasonal trends? Is it the ASP uplift you're getting from the new products? Is it a unit assumption that's coming with AI PC? Just any kind of breakdown between those two and why you're seeing it a little bit better. Thank you.
Lisa Su: Sure, Tom. So I think you actually said it well. We are launching Zen 5 desktops and notebooks with volume ramping in the third quarter. And that’s the primary reason that we see above-seasonal. The AI PC element is certainly 1 element of that, but there is just the overall refresh. Usually, desktop launches going into a third quarter are good for us, and we feel that the products are very well positioned. So those are the primary reasons.
Operator: And our final question comes from the line of Chris Danely with Citi. Please proceed with your question.
Chris Danely: Again. Thanks for speaking me in. Just a question on gross margin. So if we look at your guidance, it seems like the incremental gross margin is dropping a little bit for Q3. Why is that happening? And then just a follow-up on another part of the gross margin angle. Have you changed your gross margin expectations for the MI300? Has the accretion point moved out a little bit?
Jean Hu: Yes, Chris, thanks for the question. I think, first we have made a lot of progress, as you mentioned, this year to expand our gross margin from 2023 at a 50 percentage point to, we actually guided 53.5% for Q3. The primary driver is really the faster Data Center business growth. If you look at the Data Center business as a percentage of revenue from 37% in Q4 last year to now close to 50%. That faster expansion really helped us with the gross margin. When you look at the second half we will continue to see Data Center to be the major driver of our top-line revenue growth, will help with the margin expansion. But there are some other puts and takes. I think Lisa mentioned the PC business actually is going to do better in second half, especially typically, seasonally, it tends to be more consumer-focused. So that really is a little bit different dynamics there. Secondly, I’d say, Embedded business, we are going to see Embedded business to be up sequentially each quarter. But the recovery, as we mentioned earlier, is more gradual. So when you look at the balance of the picture, that's why we see the gross margin -- the pace of the gross margin changed a little bit, but we do see continued gross margin expansion. As far as MI300, we are quite confident over the long-term, it will be accretive to our corporate average. We feel pretty good about the overall Data Center business to continue to be absolutely the driver of gross margin expansion.
Chris Danely: Thank you.
Operator: Thank you. I would like to turn the floor back over to Mitch for any closing comments.
Mitch Haws: Great. That concludes today's call. Thanks to all of you for joining us today.
Operator: And ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
CHTR | 2 | 2,024 | 2024-07-26 12:47:15 | Operator: Hello. And welcome to Charter Communications' Second Quarter Investor Call. We ask that you please hold all questions until the completion of the formal remarks, at which time you'll be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. I will now turn the call over to Stefan Anninger.
Stefan Anninger: Thanks, operator, and welcome, everyone. The presentation that accompanies this call can be found on our website, ir.charter.com. I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, which we encourage you to read carefully. Various remarks that we make on this call concerning expectations, predictions, plans, and prospects constitute forward-looking statements, which are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only and Charter undertakes no obligation to revise or update such statements. On today's call, we have Chris Winfrey, our President and CEO, and Jessica Fischer, our CFO. With that, let's turn the call over to Chris.
Chris Winfrey: Thanks, Stefan. During the second quarter, we lost 149 ,000 internet customers, most of which was driven by the end of the Affordable Connectivity Program. We added over 550,000 Spectrum Mobile lines and close to 2.2 million lines year-over-year. Revenue was up slightly in the quarter, while adjusted EBITDA grew by 2.6%. We put a lot of effort into the ACP program, and it wasn't renewed. Beginning early this year, we've been actively working with customers to preserve their connectivity. Our service and retention teams are handling the volume of calls well, and we've retained the vast majority of ACP customers so far. The real question is customers' ability to pay, not just now, but over time. I expect we'll have a better view of the total ACP impact once we're inside the fourth quarter. The lack of ACP will also drive higher levels of market churn and selling opportunities for connectivity services over time. Turning back to today's results, the second quarter already tends to be a seasonally weak quarter. The loss of ACP impacted both churn and low-income broadband connects, helping drive the Mobile-only broadband category back to pre-pandemic levels. That shift added to an already low level of move activity and overall market connect volume. That said, we performed better than our expectations for Internet in a quarter, and we competed well compared to previous quarters against both wireline overbuild and cell phone Internet, each with expanded footprints. Overall churn remains at low levels, even with the end of the ACP program, and we remain confident in our ability to return to healthy, long-term growth. Our Internet product is faster and more reliable. Our pricing is lower when similarly bundled with mobile. We expect market activity and selling opportunities to pick up over time, and the cell phone companies will face challenges. as a customer bandwidth demands continue to grow. If we take a step back, our success will be premised on our high capacity, fully deployed network and the products it can deliver. We already have a one gigabit network everywhere we operate across 58 million passings. And when our network evolution initiatives complete, we'll have a ubiquitous, symmetrical, multi-gig capable network supporting continued growth in data demand from customers and new applications such as AR, VR and AI. All at an incremental investment of just a $100 per passing. Those wireline network capabilities are combined with mobile capabilities everywhere we operate, creating the nation's first converged network. Uniquely providing seamless connectivity and the fastest mobile service where 87% of traffic is delivered by our own gigabit capable WiFi network. And our converged connectivity product set is poised to get better through speed upgrades and over 43 million access points, which will grow with our own and our partner's ongoing WiFi router and CBRS access point deployment. That converged network is also expanding, covering more passings as we grow our footprint with high ROI construction opportunities in both rural and non-rural areas. As we show on slide 4 of today's investor presentation, we are very well positioned competitively with higher quality products, lower pricing, and the ability to deliver a converged bundle of products. In Internet, data usage continues to grow and demand for faster speeds will grow with it. During the second quarter, roughly 30% of residential internet customers who do not buy traditional video from us, used over a terabyte of data per month, which together with overall usage is increasing. This quarter, we saw the most additions to our gig speed tier ever, an area we can grow. Our mobile offering continues to evolve, driving strong results. Our second quarter mobile line Net Ad performance was better than the first quarter results, even without the incremental benefit of our free mobile retention offer to former ACP customers. And we also had our highest port ends quarter ever. In April, we began offering Anytime Upgrade to new and existing Unlimited Plus customers. Anytime Upgrade allows Unlimited Plus customers to upgrade their phones whenever they want, eliminating traditional wait times, upgrade fees, and condition requirements. And during the second quarter, customers increasingly chose our Unlimited Plus package priced at $40 versus $30. In April, we also launched a new repair and replacement plan for just $5 per month. That price point is very competitive in driving higher take rates. These new affordable value-added services enhance our profitable growth and competitively open access to new customer segments. Along those lines, in May, we launched our new phone balance buyout program. Now when a customer switches to the Spectrum Mobile from another provider and purchases at least three lines, we'll pay off their existing phone balance on ported lines up to $2,500 for five lines. This new program helps multiline mobile customer prospects with device balances and other providers to more easily switch to Spectrum Mobile. And of course, Spectrum One continues to perform well at both Connect and at promotional roll-off, offering the fastest connectivity with differentiated features. Today, approximately 8% of our total passings take our converged offering of internet and mobile. We've remained underpenetrated despite having a differentiated and superior offering with market -leading pricing at promotion and at retail. Finally, turning to video, losses continued in video where we've seen downgrade churn from programmer rate increases, we passed through. The loss of ACP in the second quarter also impacted video downgrades as customers made choices based on affordability. Over the last several years, due to margin pressure from programming increases, we've moved away from selling bundles with traditional discounts. But as we look to better differentiate ourselves in a competitive marketplace, we are considering ways to better leverage our unique capabilities across our full set of products, including video, particularly now that we're adding significant value back into the video product for consumers with hybrid linear DTC bundles, more economical package choices, and with our Xumo Box. In May, we reached a new agreement with Paramount that gives us the ability to offer the ad-supported versions of Paramount's direct-to-consumer services, Paramount Plus and VET Plus, to our traditional cable package customers at no additional cost. We plan to launch the Paramount DTC inclusion offer to our customers around Labor Day. Earlier this month, ViX, the leading Spanish language DTC product from TelevisaUnivision became available to a large number of customers with eligible spectrum video packages at no extra cost. We launched Disney Plus Basic to TV Select customers as a DTC inclusion in January, and will begin to offer Disney Plus Premium to add free version of Disney Plus to customers as a $6 upgrade later this quarter. We also have planned to offer Hulu to our TV Select customers at the incremental retail price for Disney's duo basic bundle $2 in the fourth quarter. So our efforts to deploy a new hybrid DTC linear model first for the industry remain on track and we expect it to be fully deployed next year. Together with Xumo our goal is to deliver utility and value for our customers irrespective of how they want to view content and better and more stable economics for programming partners. But the associated DTCs have to be part of the full package service. Customers can't be forced to pay twice and if the DTC standalone pricing is less expensive at retail, then that's what we really should help programmers sell instead. Fundamentally, we believe that evolving the video business even if it isn't growing helps customer acquisition of retention, still has positive cash flow, it provides us with option value. And over time, we believe a high quality video product gives us the opportunity to reintroduce more value into the converged connectivity relationship. So stepping back, we're executing well on many multiyear transformational programs. We're growing EBITDA despite the loss of ACP and a competitive cycle by driving efficiency without impacting our service and sales capabilities. We remain fully focused on driving growth using our unique set of scaled assets and the highest quality products and services in order to create long-term value for shareholders. With that, I'll turn the call over to Jessica.
Jessica Fischer : Thanks, Chris. Let's turn to our customer results on slide 6. Including residential and SMB, we lost 149,000 Internet customers in the second quarter. While in Mobile, we added 557,000 mobile lines. Video customers declined by 408,000 and wireline voice customers declined by 280,000. As Chris mentioned, our second quarter Internet losses were primarily driven by the end of the ACP program. ACP program connects ended in early February. In May, the program's original $30 subsidy was reduced to $14. And in June, that subsidy was reduced to zero. We estimate that the end of the program's impact on our second quarter internet gross additions and churn drove over 100,000 of our 149,000 internet losses in the quarter. And from a financial perspective, there was an approximately $30 million headwind to second quarter revenue from onetime non-recurring ACP related items in the quarter. In addition, similar to the end of the Keep Americans Connected program in June 2020, many of our ACP customers had past due balances that had been fully reserved for accounting purposes. We took steps to eliminate a portion of those back balances for certain customers and put a portion of their remaining balances on payment plans. For certain customers with a low likelihood to pay post ACP, we have been recognizing revenue on a cash basis, resulting in slightly less revenue and less bad debt in the second quarter than we would have otherwise had. So far, we are performing well with ACP retention, but the largest driver of Internet customer losses associated with the end of the ACP program will be in non-pay disconnects, and they will occur in the third and fourth quarters, likely weighted to the third. We continue to do everything we can to preserve connectivity for former ACP subsidy recipients. We have a number of products and offers to assist those that have lost their ACP subsidy, including our Spectrum Internet Assist program, our Internet 100 products, and we've been offering all of our ACP customers a free mobile line for one year. And we continue to market offers targeted at low income customers, a segment that we have historically served well. Turning to rural, we ended the quarter with 582,000 subsidized rural passings. We grew those passings by 89,000 in the second quarter and by 345,000 over the last 12 months. We had 36,000 net customer additions in our subsidized rural footprint in the quarter. We continue to expect to activate approximately 450,000 new subsidized rural passings in 2023, about 50% more than 2023. We also continue to expect our RDOF build to be completed by the end of 2026, two years ahead of schedule. Moving to second quarter financial results starting on slide 7. Over the last year, Residential customers declined by 1.3%. Residential revenue per customer relationship grew by 0.4% year-over-year, given promotional rate step-ups, rate adjustments, and the growth of Spectrum Mobile, partly offset by a higher mix of non-video customers, growth of lower-priced video packages within our base, and some internet ARPU compression related to retention offers extended to customers that previously received an ACP subsidy. As slide 7 shows, in total, Residential revenue declined by 0.6% year-over-year. Turning to commercial, SMB revenue grew by 0.6% year-over-year, reflecting SMB customer growth of 0.2% year-over-year and higher monthly SMB revenue per SMB customer, primarily due to rate adjustment. Enterprise revenue grew 4.5% year-over-year, driven by enterprise PSU growth of 6.1% year-over-year. And when excluding all wholesale revenue, enterprise grew by 5.9%. Second quarter advertising revenue grew by 3.3% year-over-year, given political revenue growth. Core ad revenue was down about 2% year-over-year. Other revenue grew by 6% year-over-year, primarily driven by higher mobile device sales. And in total, consolidated second quarter revenue was up 0.2% year-over-year and 0.1% year-over-year when excluding advertising revenue. Moving to operating expenses and adjusted EBITDA on slide 8, in the second quarter, total operating expenses declined by 1.4% year-over-year. Programming costs declined by 9.8% year-over-year due to a 9.5% decline in video customers year-over-year and a higher mix of lighter video packages, partly offset by higher programming rates. Other costs of revenue increased by 12.6%, primarily driven by mobile service direct costs and higher mobile device sales. Cost-to-service customers declined 4.2% year-over-year given productivity from our 10-year investments, including lower labor costs and lower bad debt expense, as we saw some favorability and our mobile bad debt as a portion of revenue due to an improved customer tenure and credit profile. And, as I mentioned earlier, a portion of our uncollectible billings offset revenue in the quarter. Sales and marketing costs grew by 1.9% as we remain focused on driving customer acquisition. Finally, other expense grew by 4.7%, mostly driven by an insurance expense benefit from the prior year quarter. Adjusted EBITDA grew by 2.6% year-over-year in the quarter, and when excluding advertising, EBITDA grew by 2.4% year-over-year. While we don't manage the business at a single product line P&L level, we continue to compute allocations internally, and this quarter, for the first time, our standalone mobile adjusted EBITDA was positive, even when including the headwind of subscriber acquisition costs and without the benefit of GAAP revenue allocation to mobile revenue. Our mobile profitability this quarter marks a significant milestone. It shows that we're on the path to establishing a mobile business that is very profitable. Overall, our goal is to deliver solid EBITDA growth, and we believe we can continue to do that even as we make significant investments in the business and face a challenging competitive environment and the end of the ACP program. Our expense management process is working with growing realization of impacts in the second quarter. We continue to expect accelerating EBITDA growth in the back half of the year, given our expense management initiatives, Spectrum 1 promotional roll-off, and political advertising revenue. Turning to net income on slide 9, we generated $1.2 billion of net income attributable to Charter shareholders in the second quarter, in line with last year, as higher adjusted EBITDA was mostly offset by higher other operating expense, primarily due to restructuring and severance costs and net amounts of litigation settlements. Turning to slide 10, capital expenditures totaled $2.85 billion in the second quarter, in line with last year's second quarter spend. Line extension spend totaled $1.1 billion, $37 million higher than last year, driven by our subsidized rural construction initiative and continued network expansion across residential and commercial green sales and market fill-in opportunity. Second quarter capital expenditures, excluding line extensions, totaled $1.7 billion, which was similar to the prior year period. For the full year 2024, we now expect capital expenditures to total approximately $12 billion, down from between $12.2 billion and $12.4 billion previously. Our reduced outlook for 2024 capital spending reflects lower internet and video customer net additions, including the impact of the end of the ACP program, which drives lower CPE costs. We're also actively managing vendor rates and construction materials to make our capital expenditures more efficient. We still expect line extension spend of approximately $4.5 billion, and network evolution spend of approximately $1.6 billion. Turning to free cash flow on slide 11, free cash flow in the second quarter totaled $1.3 billion, an increase of approximately $630 million compared to last year's second quarter. The year-over-year increase was primarily driven by higher adjusted EBITDA, lower cash taxes due to timing, and a favorable change in working capital. On that front, we've been managing the balance sheet to provide us better overall cash flow and increased flexibility. Over the last several quarters, we sold our towers portfolio, which generated almost $400 million in proceeds. We launched our EIP securitization program in the second quarter, which backs a new $1.25 billion credit facility at favorable interest rates. And we've been working with our vendor base to extend our payment terms, utilizing a supply chain financing tool to support our working capital favorability. We will continue to identify and capitalize on balance sheet opportunities to help fund our unique one-time capital investments. We finished the quarter with $96.5 billion in debt principle. Our current rent rate annualized cash interest is $5.1 billion, and we repurchased $1.5 million Charter shares and Charter Holdings common units, totaling $404 million at an average price of $271 per share. Given our long dated and 86% fixed rate debt structure, our sensitivity to higher rates is relatively low. If we refinanced all of our debt due in 2025 and 2026 at current rates, the impact to our rent rate interest expense would be less than $60 million. As of the end of the second quarter, our ratio of net debt to last 12 months adjusted EBITDA moved down to 4.32x. We expect to continue to move closer to the middle of our 4x to 4.5x target leverage range through the end of this year. And we remain fully committed to maintaining our split rated debt structure, including access to the investment grade market, given the significant benefits that it offers to all of our capital providers. We continue to be confident in the long-term trajectory of the business. We have the best products at the best prices in our industry, and we remain under penetrated relative to our long-term potential. That combined with the investments that we're making in the business and our expense savings initiative will continue to drive strong EBITDA growth and value creation for many years to come. And with that, I'll turn it over to the operator for Q&A.
Operator: [Operator Instructions] Our first question will come from Craig Moffett with MoffettNathanson.
Craig Moffett: Hi. Thank you. Perhaps no surprise. I'd like to drill down a little bit more on the ACP impacts. A couple of questions. First, to what extent are you seeing ACP showing up in reduced gross editions that is just lower market activity because new customers can't sign up for or ACP customers who are moving can't continue to sign up for the program even before you start to see non-pay disconnects. And then second, what impact is it having on ARPU? You reported 1.7% broadband ARPU the same as last quarter. Had it not been for ACP, could you just tell us what that would have been as you're starting to now lap some of the Spectrum 1 discounts that were included in the numbers in the past?
Chris Winfrey: Sure. Hey, Craig. I'll take the first one. Jessica can take the second. For ACP, we estimated the impact was well over 100,000 inside the quarter to net editions loss. And for us to say that means that we have a high level of confidence probably higher than that. So half of which was from voluntary churn and the other half was coming from reduced gross editions, as you mentioned, from low income segments that had been connecting at a higher rate at a much lower rate once ACP disappeared. Of course, we saw some of that impact already inside of Q1. And we saw the same inside of Q2. So that's the drivers inside there, about half and half. And it's really the combination of those when I mentioned that we saw a reversion to the pre-pandemic mobile only broadband category where you've seen that category increase, which is taking out volume from the marketplace in terms of a source of acquisition. It's temporary. It's one time in nature. And so as we've spoken about before, it's really about just managing through that one-time impact and trying to make sure that we're doing all the right things for preserving that base, and keeping them connected, which we're doing, but also making sure that we're making the right investments and the right moves for the business as usual underlying growth trajectory. Jessica on the ARPU.
Jessica Fischer : Yes. So Internet ARPU increased 1.7% year-over-year in the quarter. If you adjusted, Craig, for the $30 million in one-time ACP related items that I mentioned and for the impact of the mobile revenue allocation, that ARPU growth would have been 2.7%. I didn't incorporate the cash basis accounting impact that I mentioned earlier. It's small, and unless those customers do end up paying at a rate that's higher than our expectation, I think it recurs in revenue going forward. But so I think you would have been, but for those two items, that's a 2.7%
Stefan Anninger : Thanks Craig. Operator, we will take our next question, please.
Operator: Our next question comes from the line of Sebastiano Petti with JP Morgan.
Sebastiano Petti: Hi, thanks for taking the question. I think, Chris, in the prepared remarks, you said you competed well against fixed wireless and fiber, even though their footprints are expanding. Given the prevalence of what we're seeing in terms of open access and other host cell provider getting into the mix and increasing the fiber availability, have you seen a demonstrable change in the fiber deployments year-to-date as you think about that insurgent or non-incumbent fiber bill to some extent? And again, just trying to think about that increase in open access and wholesaler, how does it change, if at all, how you're thinking about the competitive environment on a go-forward basis in terms of other converged players or options moving into your footprint?
Chris Winfrey: Sure. Look, the competitive fiber overbuild has maintained a relatively steady pace. If anything, it's slightly lower than what it had been. And so we don't see any dramatic change there. When I talked about maintaining our competitiveness means having a similar impact, despite the fact that you have an expanding footprint. So you could, if I was being bullish, I would argue that that's an improvement, and as opposed to just staying steady. And so we're competing well, both in the wireline overbuild space, which is more permanent, as well as the cell phone internet space as well. In terms of some of the experiments that you're seeing as it relates to wholesale access and whatnot, it's still a fiber overbuild at the end of the day. And there's still economics that need to be deployed. And those economics are, in my mind, are not very good. They haven't been for decades of the economics of an overbuilder on an existing footprint. So I don't think it, A, dramatically changes the outputs that they can provide because the economics aren't any different, and B, it's really small. What you're talking about that's been done is just a very small percentage of the U.S. footprint. So the ability to project products both from a sales and marketing and service perspective really is impacted by the ubiquitous nature of the technology that you have and the ability to provide those products in the marketplace. And so from our perspective, when we look at it and say, what's unique about us is we have a gigabit network deployed everywhere we operate. In addition to that, we're upgrading that wireline network to have symmetrical and multi-gig speeds everywhere, not just in redline pockets, but everywhere that we operate, and then you combine that with our WiFi and CBRS capabilities and a very strategic relationship that we have with a great partner in Verizon, it gives us the ability to provide seamless connectivity, converged broadband everywhere you go inside of our footprint, and that's unique. The only other operator who has those type of capabilities really is Comcast. And so I think that's the real strategic advantage for us, and it's not because we have that capability in 2%, 3%, or 5% of our footprint. We have it everywhere we operate, and it allows us to be loud in the marketplace, talk about not only the product advantages of having that seamless connectivity, but the ability to save customers hundreds and thousands of dollars really with a better product. And so I don't see anything that's really changed. Other than some of these joint ventures announcements that you've seen, if you really sit back and think about it from both a strategy and from a valuation perspective, I think it's flattering. It tells you the strategic asset that we have. And so if you take a look at the slide that we have on page 4 of the deck today, you think about everything that I said and our capabilities, and then you think about where others are trying to go, many of the MNOs, I do think that's flattering both from a strategic, from an operating and from evaluation perspective of what we have and what we're capable of doing. It has people's attention.
Sebastiano Petti: And if I could ask a quick follow-up on wireless, it sounds, I think you noted that even excluding the retention offer for the ACP subscribers, mobile lines would have been up. I mean, can you help us think about what you're seeing in terms of just the contract buyout and some of the other offers you have in the market, and does your maybe go-to-market need to evolve at all as we think about obviously fears or concerns about what an upgrade cycle might mean from the Apple iPhone in the back half of the year. Thank you.
Chris Winfrey: Sure. Well, mobile wasn't just up. What I was saying is it was up quarter-over-quarter. We had a very good first quarter. It was clearly up even more this quarter. And if you excluded the benefit of the ACP mobile only, mobile retention offers, we still would have been better than a very strong first quarter. That reflects just the general momentum that we have, but also, we have evolved the product. And so we've rolled out the Anytime Upgrade Program, which is unique in the market. We have even though it sounds small, it's attractive to customers, service, and repair function that's, I think, competitive. And now with the phone balance buyout program, which is also pretty unique in the marketplace. And all of those rolled out sequentially during the course of the quarter and have continued to improve our selling capabilities along the way. I think that positions us well in any market. We've not been, I think, where you were going, we've not been, we don't intend to be in the business of subsidizing phones. But we do have really good programs that make it attractive for customers to not only come in to be a customer spectrum mobile, but also to stay with us because we have the ability through the Anytime Upgrade Program to really at a low competitive cost, keep them current with their models of phones now and in the future. And stating the obvious, the biggest advantage here beyond just the devices really is the ability to provide a higher quality, faster mobile service, seamless connectivity, and to be able to save them hundreds or thousands of dollars a year. I mean, if you think about our pricing at $30 for unlimited and $40 for unlimited plus on one line and each incremental line, it's really competitive. It's very good. So we're happy with where we are with the product. We will continue to evolve it. I think some of those feature sets that will evolve really include things like mobile speed boost, which ties to the capabilities that we have with WiFi and wireline, and the ability to have spectrum mobile as an SSID. So those of you in the New York and LA markets, for example, what you'll notice is as you travel outside of your home with Spectrum Mobile, an auto-authenticated attachment to Spectrum Mobile SSID, which boosts your speed wherever you go, and it increases your access and your reliability, which is the nature of seamless connectivity.
Stefan Anninger: Thanks, Sebastiano. Operator, we'll take our next question, please.
Operator: Our next question comes from the line of Jonathan Chaplin with New Street Research.
Jonathan Chaplin: Thanks, guys. Two questions. One just on broadband market growth for Chris, and then one on free cash flow for Jessica. Chris, could you give us a little bit more context around the ACP impact from lower gross ads in 1Q? I think you said it was sort of roughly the same as in 2Q, so maybe it was 50,000, but what I'm trying to get to is an understanding of what's going on with underlying growth. It looks like it actually improved for you a little bit sequentially, and so either broadband market growth in aggregate isn't getting any worse, maybe it's getting a little better, or you're just doing better on market share relative to your competitors. And we'd love to understand that a little bit better. And then Jessica, it sounded like from your discussion of working capital that this isn't a timing impact in 2Q. You've changed how you manage working capital, and so you should expect to be able to sort of retain this benefit to free cash flow as we go through the year. I just wanted to confirm that. And then do you have to get all the way back to 4.2x to 4.25x leverage before you would accelerate share repurchases again? Thanks.
Chris Winfrey: So Jonathan, there's I think a few derivatives inside of your question. And so let me try to give you what you're looking for in the way that we think about it. And inside of the first quarter, we had performed better relative to prior quarters and prior year on competitive switching. And so that was in the marketplace, so available subscriber ads and disconnects. But we saw, as you highlighted as well, once everybody had reported, we saw a significant reduction in the first quarter of this year in the available gross ads, a significant drop year-over-year and that was due to housing starts, rental vacancies, but also the removal of ACP for new connects, all of which driving your version to mobile-only back to pre-pandemic levels. That broadband market growth rate overall we still saw is significantly reduced for all those factors inside of Q1 but a dramatic drop, and so that put our performance in relative light given the overall market backdrop, a lot of which was one time in nature. In Q2, and while it's early because we don't have all the data, I think our evidence shows that for the first time and due to, again, all of the one-time factors and most dramatically the loss of ACP, the broadband market actually shrunk as a one-time event. And so if you put our performance and then our statements about relative competition in context with that, and I think we're doing pretty well. And that was the nature of the comments that I provided in the prepared remarks. I do think that, as I mentioned, moves will come back. It's hard to predict exactly when, but moves will come back, housing starts will return, apartment rental rates will go back up, and most importantly, the most dramatic effect is once you flush out the ACP impact between Q2 and Q3 predominantly, then you'll be able to get back into a much more normalized environment. And I think the product investments that we're making and the attractiveness of the value that we provide puts us in great position for when that volume returns, and we're doing everything we can in the meantime to preserve all the ACP customers doing really well, but at the same time making sure that we're ready to come out in a good light on the back end once the volume does pick back up.
Jessica Fischer : On the free cash flow side, Jonathan, so I think we had previously talked about working capital for the year, coming back to being in a place that was relatively flat. As I said, we're working on the balance sheet and trying to make sure we can extract appropriate cash from the balance sheet to support what we're doing across the business. I think that we'll probably do better than that sort of flat working capital expectation, but I'm not prepared to say by exactly how much. The variability in working capital has a lot to do with exactly how expense timing and capital timing lands over the course of the year, and so while I think that we'll get good benefits out of just the balance sheet management side, I'm not going to take up the total thoughts that we've had on working capital today. On your other question, sort of how do we think about, I think it was sort of a one and then the other. Do you have to get all the way back to the middle of your range before you accelerate buybacks? I'm in the same place that I was last quarter, which is that I think that we can continue to do buybacks over the course of the rest of the year and still do what we have said that we would do from a leverage perspective. And I don't think of it as do you have to do one and then the other. I'm pretty confident in the trajectory of the business for the second half of the year. And so, I think that we can have sort of good pacing on buybacks and meet what we've said about leverage at the same time. That being said, the capital allocation strategy hasn't changed. We still go after high ROI, organic investment first. We still look then at whether there's a creative M&A opportunity is next. And those come before sort of this balance sheet management and share buybacks that happens as the last set of priorities there. And so, we haven't given a guide around where we think that we'll go in terms of total buybacks. It's because we want to make sure that we maintain that flexibility to do what we think is most important for the business, which is to make the right investments to drive growth of the business going forward.
Stefan Anninger: Operator, we'll take our next question, please.
Operator: Our next question will come from Ben Swinburne with Morgan Stanley.
Benjamin Swinburne: Thanks. Good morning. Chris, I believe you guys took some cost action. I don't know if there were headcount reductions this year at Charter, but I know you guys have had a cost plan you've been working on. I'm wondering if you could just talk about what you guys are doing and how you're approaching that. And I think you had suggested you guys weren't going to touch any sort of customer-facing resources. So just give us a sense of where you are on that and your philosophy as you look through the rest of the year and how we might think about that impacting the financials. And then maybe for Jessica, I don't know if you have any visibility at this point into Q3, ACP impact from that 100,000, but if you do, I'd love to hear it. And try to understand the decline in bad debt. I know you touched on it in your prepared remarks. I don't know if that tells us something about your third quarter ACP expectation, or if you still expect cost of service to be flat for the year, we just want a little more color around those trends. Thank you both.
Chris Winfrey: Hey, Ben. So there's kind of three parts to that, which is, I'll start with the second one you had, is the Q3 ACP. I'll handle that. And Jessica can comment on bad debt and then cost reductions. Jessica can go through and I can tag team there a bit. But from a Q3 ACP outlook, we're not going to be providing any customer net additions guidance today, but for sure there's going to be, as we both mentioned, I think Jessica and I, that there'll be more non-pay disconnect in the third quarter. But there are a lot of other moving parts and we're competing well. I think that maybe the interesting tidbit here is maybe talking a little bit more about recent trends. June was oddly the best loss of the second quarter. And internet net ads trends in July have been similar to what we saw in June. Sounds great. But the reality is the ACP related non-pay disconnect activity hasn't started yet. And we'll know really more about sustainable payment trends than nothing to be scared of today, but sustainable payment trends really through August with the non-pay beginning then and trailing into a little bit into Q4. So when you step back, I know you know this, but ultimately this ACP transitions are onetime event. And so we're very focused on really isolating the ACP impact internally and evaluating not only obviously our performance on retaining those customers because we want to keep them connected. We think it's very valuable and we can, but also what's the underlying trend absent the ACP impact to make sure that we're getting better every day. So Jessica on the ACP does bad debt piece.
Jessica Fischer : Yes. So if you think about what happened in bad debt in the year-over-year, Ben, there's a few things going on. One really with tenure and credit profile in our mobile customer base that's been improving, particularly for customers that have EIP plans with us. And on the ACP front, we took a lot of bad debt along the way, particularly for customers who entered the ACP program and they had outstanding unpaid balances. And so those have really been reserved throughout the ACP program. I mentioned it in the remarks but there also is a portion of the ACP customer base where we have a very low expectation of payment for them and so instead of taking their revenue into revenue and then taking bad debt expenses and offset, we actually didn't recognize revenue for those customers. So when you see that it means that bad debt expense, I think absent that you might have had -- you would have had more bad debt expense if we had put that back in the other direction. And then the last point I mean we did have overall lower resi revenue in 2Q in the year-over-year and some mixed changes and so with other things being equal that also drives a little bit of downward pressure on bad debt. All of that is to say I wouldn't read anything sort of into what is it that you think about Q3 and looking at what happened with bad debt in the year-over-year, I think there are a number of factors going on there. As you think about then what's happening on the overall cost reduction side which I think was your other question. The expense management process is pretty extensive. While we're not doing anything that will impact our sales or service capabilities, we have things that are big things that are small some short some medium some long-term opportunities all across the business. We've made progress with some vendor cost reductions with reduced spend around discretionary categories like real estate and third-party services, some reductions to overhead expenses and implementing some tools to increase our efficiency and actually I think the benefits from those came a little faster into 2Q than what we had anticipated, but we're already realizing the benefits of some of the changes will continue to build on additional opportunities over time. As you look at the rest of the year, I think we had given some thoughts on our outlook for expenses. We had expected programming costs per video customer to grow in the 1% to 2% range year-over-year. I now expect that to be flattish year-over-year. We previously had said that we expected costs to serve to be flat with 2023. I now expect that to decline by 1% to 2% inclusive of bad debt expense. And in sales to marketing, I think we had said 2% to 3% growth. And at this point, I would expect us to be in the low end of that range, if not a bit below. I also, as an aside, just want to clarify something I said earlier. My comments on working capital. I want to be clear that the comments on working capital are on cable working capital. Mobile continues to have the detriment of the EIP notes. And so those will continue to be a drag, though the securitization plan that we did in the quarter does help that.
Chris Winfrey: And on the cost if you just take one a different layer of look, the, so Jessica's right, we're doing lots on vendor savings, overheads, organizational effectiveness lower growth environment, all that's true, but just want to make sure everybody understands that the key focus for us in terms of real permanent lasting and accelerating cost reduction is just to be a better service operator. So continue to invest in our frontline, have better tools, process and systems to make the investments that we've made in tenure. And we see that, and so we are having real results from some of the one time and permanent cost reductions, but we're also probably having bigger success on reducing the amount of service calls, reducing our truck roles, increasing the quality of the service that we provide, that's where the money's at. And then when you think about operating leverage, which is a term that you've used before the best way to have a better operating leverage is to have more customers and to have more products per household and have higher revenue. And that way you can, together, being a better service operator and having higher penetration of your products, you actually lower your cost to serve per customer, you lower your cost of capital per customer as well and you become a better cash flow operator. So all of those things still hold true. And it's why, when we talk about expense management, that we talk about really not doing anything that would impact sales or service, because that's the true efficiency opportunity and that's the opportunity to deliver long-term free cash flow and our views on that and our frontline hasn't changed at all.
Stefan Anninger : Thanks, Ben. Operator, we'll take our next question, please.
Operator: Our next question will come from Jessica Reif Ehrlich with Bank of America Securities.
Jessica Ehrlich: Question on video, I guess, can you talk about the take-up of direct-to-consumer in these hybrid linear offers? And you've mentioned a couple that are coming, Paramount Plus and Hulu, is there anything else on the horizon? And then secondly, you mentioned political advertising should pick up in the second half. Given the current political environment, can you give us some color and expectations and if that's increasing?
Chris Winfrey: Sure. On the first one, Jessica, the DTC take-up is going very well. The first one, I know a lot of people think about Disney deals in September, but we launched I think late in January on Disney Plus Basic and it's going well and it's growing every month. We're adding some additional features into it, which will be helpful to even further accelerate the monthly growth that we see. That includes, as I mentioned, in the prepared remarks, the addition of the Disney Plus Premium as an incremental add-on. That will be coming soon, as well as the Disney Duo Basic bundle of plus $2 for Hulu. So that allows you to have a comprehensive package the same way that exists inside of retail and that's helpful, it was always the design. But there's complexity in terms of implementing all of this, also because some of the authentication principles that vary between different operators in terms of credentials and TV everywhere and whatnot. But it's going well and accelerating, ESPN Plus, I didn't mention that on the call, it's also having very good take-up, it's high value into our RSN packages, it's a small portion of the base, but the penetration is going well. And Paramount Plus will launch soon and ViX we just launched and we've always had Max and so that has existed already within the TV everywhere authenticated universe and our expectation is over the next year or so that we'll have a fully baked set of products which really what we're working towards and the more scale we get there the more effective it's going to be. We're not sitting here saying that we're going to arrest completely the loss of video but I think what we are saying is to the extent we're going to put video on our broadband bill, it better have value and if it doesn't have value to the customer then we'd rather they just go take that through the direct-to-consumer applications and we need to be proud of what we're putting on the bill and that's not where the MVPD space has been in a long time as we see a path to being able to be proud of what we're putting on the broadband bill as a video product that it may be expensive but it has a significant amount of value and using that to drive the converge connectivity relationships. So while it may not be growing it's still really important and I think it can be very valuable to our converge connectivity relationships. In terms of what's up next, we're not going to go give a programming renewal schedule but we're optimistic that this has been adopted both from an understanding that the DTCs really do need to be included as part of the full video package. And that's actually better for programmers because of reduced churn and upsell opportunities into the ad-free versions of these products as well. And that look, at the end of the day, if a customer can go out and get the same product at a cheaper price in the marketplace, I think they should. I don't think we should ask them to pay more through us. And so those are some of the core principles that we've had. I'm not committing, but those are some of the bigger ones. And political advertising it's always, as you know, it's always a jump ball as to exactly where it's going to go. And it's evaluated on a state-by-state basis. And so you can't really say that it's an -- it's the same nationally everywhere. So it depends on some of the swing states. Admittedly the events of the past week have jumbled what you thought that might look like. And certainly when you take a look at fundraising and the volatility in what could be swing states, it looks like political advertising net-net nationally is going to be higher than what it probably would have been just a 10 days ago. But it doesn't mean it happens necessarily in the right states for us. And so we're keeping an eye on that. And it's nice when it happens, but it's one time in nature. And so that's why we always try to talk about our results with and without the impacts of political advertising. Because what is this year's windfall will be next year's headwind. And we want to make sure everybody's focused on the right thing, which is the underlying growth profile of the subscription business. Which includes the core advertising, which continues to do well with or without political advertising.
Stefan Anninger : Thanks, Jessica. Operator, we'll take our last question, please.
Operator: Our final question will come from the line of Peter Cipino with Wolfe Research.
Peter Cipino: Thanks and good morning. I have an ACP question that looks beyond the third quarter. Arguably, ACP has been history's greatest retention program for broadband operators and you took good advantage of it. Looking beyond the wave of involuntary disconnects in Q3 and not to say 2025, does that retention benefit go away? I mean, certainly it does. And then what needs to step up in its place or should we expect a slightly higher underlying churn rate attributable to those four or five million former ACP subs who go from having essentially no churn to maybe having a normal churn rate?
Chris Winfrey: Sure. Well, look, once upon a time there wasn't an ACP, but it's been a long time. When you think about, we had the, during the pandemic we had the, we were a big participant in the remote education offer, the Keep Americans Connected, the EBB, which evolved and became the Emergency Broadband Benefit, which evolved and became the ACP. And we've been a significant participant in all of those, as has the industry. I think we all have a lot to be proud of for stepping up and really driving those programs, but they didn't exist before. And broadband is a really important product. And from a charter perspective, we have ways to continue to address that marketplace. Before I go there, you asked about the market level activity. I do think that in an environment where ACP or an equivalent doesn't exist, that by definition you have more customers coming in and out of broadband based on affordability. That's rise up transaction volume, both from a non-pay disconnect, as well as from a gross ad sales perspective. When you have better products and better price, that can work towards your advantage. So it's not all bad from our perspective. And but we also have the ability to, at acquisition and for retention, offer unique products. Our Internet 100 is attractively priced. It's not for everybody, but it's affordable. We also, and you can pair that together with Spectrum One, so the ability to have a free mobile line for the first year, and then that line rolls to $30 after a year. If you think about a typical one-line environment or even in a typical two-line environment, the average cost of a line is over $60. And so even at retail rate of $30, we've built in a savings of $30 per month through taking mobile together with our attractively priced, high-powered broadband product. And that's as much, if not more, than the ACP benefit, which means that if you take our products, we can effectively -- we have the built -in ACP savings available to you when you really take full advantage of our product set. And so that is a product and a combination that didn't fully exist prior to all of these programs. And I think we can, by having a wider availability for low income population of these broadband offers, which we have together with our Spectrum 1 offer combined, I think we can save customers as much if not more than they were they're getting through ACP relative to the past. So I think we're in good position to be able to address the base. But the market activity, for sure, is going to be higher than what has been the past couple of years.
Stefan Anninger : Thanks, Peter. And that concludes our call. We'll see you next quarter.
Chris Winfrey: Thanks, everyone. |
TSLA | 2 | 2,024 | 2024-07-24 01:45:26 | Travis Axelrod: Good afternoon, everyone and welcome to Tesla's Second Quarter 2024 Q&A Webcast. My name is Travis Axelrod, Head of Investor Relations and I’m joined today by Elon Musk, Vaibhav Taneja, and a number of other executives. Our Q2 results were announced at about 3.00 p.m. Central Time and the Update Deck we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. During the question-and-answer portion of today's call, please limit yourself to one question and one follow-up. Please use the raise hand button to join the question queue. Before we jump into Q&A, Elon has some opening remarks. Elon?
Elon Musk: Thank you. So to recap, we saw large adoption exploration in EVs, and then a bit of a hangover as others struggle to make compelling EVs. So there are quite a few competing electric vehicles that have entered the market. And mostly they’ve not done well, but they’ve discounted their EVs very substantially, which has made it a bit more difficult for Tesla. We don’t see this as long-term issue, but really -- fairly short-term. And we still obviously firmly believe that EVs are best for customers and that the world is headed for a fully electrified transport, not just the cars, but also aircrafts and boats. Despite many challenges the Tesla team did a great job executing and we did achieve record quarterly revenues. Energy storage deployments reached an all-time high in Q2, leading to record profits for the energy business. And we are investing in many future projects, including AI training and inference and great deal of infrastructure to support future products. We won't get too much into the product roadmap here, because that is reserved for product announcement events. But we are on track to deliver a more affordable model in the first half of next year. The big -- really by far the biggest differentiator for Tesla is autonomy. In addition to that, we've scale economies and we're the most efficient electric vehicle producer in the world. So, this, anyway -- while others are pursuing different parts of the AI robotic stack, we are pursuing all of them. This allows for better cost control, more scale, quicker time to market, and a superior product, applying not to -- not just to autonomous vehicles, but to autonomous humanoid robots like Optimus. Regarding Full Self-Driving and Robotaxi, we've made a lot of progress with Full Self-Driving in Q2 and with version 12.5 beginning rollout, we think customers will experience a step change improvement in how well supervised full self-driving works. Version 12.5 has 5x the parameters of 12.4 and will finally merge the highway and city stacks. So the highway stack is still at this point is pretty old. So often the issues people encounter are on highway, but with 12.5, we are finally merged the two stacks. I still find that most people actually don't know how good the system is, and I would encourage anyone to understand the system better, to simply try it out and let the car drive you around. One of the things we're going to be doing just to make sure people actually understand the capabilities of the car is when delivering a new car and when picking up a car for service to just show people how to use it and just drive them around the block. Once people use it at all they tend to continue using it. So it's very compelling. And then this I think will be a massive demand driver, even unsupervised full self-driving will be a massive demand driver. And as we increase the miles between intervention, it will transition from supervised full self-driving to unsupervised full self-driving, and we can unlock massive potential in [V3] (ph). We postponed the sort of Robotaxi the sort of product unveil by a couple of months where it were -- it shifted to 10/10 to the 10th October -end because I wanted to make some important changes that I think would improve the vehicle -- sort of Robotaxi, the thing that we are -- the main thing that we are going to show and we are also going to show off a couple of other things. So moving it back a few months allowed us to improve the Robotaxi as well as add in a couple other things for the product unveil. We're also nearing completion of the South expansion of Giga Texas, which will house our largest training cluster to date. So it will be an incremental for 50,000 H100s plus 20,000 of our hardware 4 AI5 Tesla AI computer. With Optimus, Optimus is already performing tasks in our factory. And we expect to have Optimus production Version 1 in limited production starting early next year. This will be for Tesla consumption. It's just better for us to iron out the issues ourselves. But we expect to have several thousand Optimus robots produced and doing useful things by the end of next year in the Tesla factories. And then in 2026, ramping up production quite a bit, and at that point we'll be providing Optimus robots to outside customers. That will be Production Version 2 of Optimus. For the energy business, this is growing faster than anything else. This is -- we are really demand constrained rather than production constrained. So we are ramping up production in our U.S. factory as well as building the Megapack factory in China that should roughly double our output, maybe more than double -- maybe triple potentially. So in conclusion, we are super excited about the progress across the board. We are changing the energy system, how people move around, how people approach the economy. The undertaking is massive, but I think the future is incredibly bright. I really just can't emphasize just the importance of autonomy for the vehicle side and for Optimus. Although the numbers sound crazy, I think Tesla producing at volume with unsupervised FSD essentially enabling the fleet to operate like a giant autonomous fleet. And it takes the valuation, I think, to some pretty crazy number. ARK Invest thinks, on the order of $5 trillion, I think they are probably not wrong. And long-term Optimus, I think, it achieves a valuation several times that number. I want to thank the Tesla team for a strong execution and looking forward to exciting years ahead.
Travis Axelrod: Great. Thank you very much, Elon, and Vaibhav has opening remarks as well.
Vaibhav Taneja: Thanks. As Elon mentioned, the Tesla team rose to the occasion yet again and delivered on all fronts with some notable records. In addition to those records, we saw our automotive deliveries go sequentially. I would like to thank the entire Tesla team for their efforts in delivering a great quarter. On the auto business front, affordability remains a top of mind for customers, and in response in Q2, we offered attractive financing options to offset sustained high interest rates. These programs had an impact on revenue per unit in the quarter. These impacts will persist into Q3 as we have already launched similar programs. We are now offering extremely competitive financing rates in most parts of the world. This is the best time to buy a Tesla, I mean, if you are waiting on the sidelines, come out and get your car. We had a record quarter on regulatory credits, revenues, and as well. On net, our auto margins remained flat sequentially. It is important to note that the demand for regulatory credits is dependent on other OEMs plans for the kind of vehicles they are manufacturing and selling as well as changes in regulations. We pride ourselves to be the company with the most American-made cars and are continuing our journey to further localize our supply chain, not just in the U.S., but in Europe and China as well for the respective factories. As always, our focus is on providing the most compelling products at a reasonable price. We have stepped up our efforts to provide more trims that have estimated range of more than 300 miles on a single charge. We believe this, along with the expansion of our supercharging network, is the right strategy to combat range anxiety. Since the revision of FSD pricing in North America, we've seen production rates increase meaningfully and expect this to be a driver of vehicle sales as the feature set improves further. Cost per vehicle declined sequentially when we removed the impact of Cybertruck. While we are experiencing material costs trending down, note that there is latency on the cost side and such reductions would show up in the P&L when the vehicles built with these materials get delivered. Additionally, as we get into the second half of the year, it is important to note that we are still ramping Cybertruck and Model 3 and are also getting impacted by varying amounts of tariffs on both raw materials and finished goods. While our teams are working feverishly to offset these, unfortunately it may have an impact on the cost in the near-term. We previously talked about the potential of the energy business and now feel excited that the foundation that was laid over time is bearing the expected results. Energy storage deployments more than doubled with contribution not just from Megapack, but also Powerwall, resulting in record revenues and profit for the energy business. Energy storage backlog is strong. As discussed before, deployments will fluctuate from period to period with some quarters seeing large increases and others seeing a decline. Recognition of storage gigawatt hours is dependent on a variety of factors, including logistics timing as we send units from a single factory to markets across the world, customer readiness and in case of EPC projects on construction activities. Moving on to the other parts of the business, service and other gross profits also improved sequentially from the improvement in service utilization and growth in our collision repair business. The impact of our recent reorg is reflected in restructuring other - on the income statement. Just to level set, this was about $622 million of charge, which got recorded in the period. And I want people to remember that we've called it out separately on the financials. Sequentially, our operating expenses excluding surcharges reduced despite an increase in spend for AI-related activities and higher legal and other costs. On the CapEx front, while we saw a sequential decline in Q2, we still expect the year to be over $10 billion in CapEx as we increase our spend to bring a 50k GPU cluster online. This new cluster will immensely increase our capabilities to scale FSD and other AI initiatives. We reverted to positive free cash flow of $1.3 billion in Q2. This was despite restructuring payments being made in the quarter and we ended the quarter with over $30 billion of cash and investments. Once again, we've begun the journey towards the next phase for the company with the building blocks being placed. It will take some time, but will be a rewarding experience for everyone involved. Once again, I would like to thank the entire Tesla team for their efforts.
A - Travis Axelrod: Great. Thank you very much, Vaibhav. Now let's go to investor questions. The first question is, what is the status on the Roadster?
Elon Musk: With respect to Roadster, we've completed most of the engineering. And I think there's still some upgrades we want to make to it, but we expect to be in production with Roadster next year. It will be something special, like the whole thing [Indiscernible].
Travis Axelrod: Fantastic. The next question is about timing of Robotaxi event, which we've already covered. So we'll go to the next question, when do you expect the first Robotaxi ride?
Elon Musk: I guess that, that's really just a question of when can we expect the first -- or when can we do unsupervised full self-driving. It's difficult, obviously, my predictions on this have been overly optimistic in the past. So I mean, based on the current trend, it seems as though we should get miles between interventions to be high enough that -- to be far enough in excess of humans that you could do unsupervised possibly by the end of this year. I would be shocked if we cannot do it next year. So next year seems highly probable to me based on [quite simply] (ph) plus the points of the curve of miles between intervention. That trend exceeds humans for sure next year, so yes.
Travis Axelrod: Thank you very much. Our third question is, the Cybertruck is an iconic product that wows everyone who sees it. Do you have plans to expand the cyber vehicle lineup to a cyber SUV or cyber van?
Elon Musk: I think we want to limit product announcements to when we have a special -- specific product announcement event, rather than earnings calls.
Travis Axelrod: Great, thank you. Our next question is, what is the current status of 4680 battery cell production and how is the ramp up progressing?
Lars Moravy: Yes, 4680 production ramped strongly in Q2, delivering 51% more cells than Q1 while reducing COGS significantly. We currently produce more than 1,400 Cybertrucks of 4680 cells per week, and we'll continue to ramp output as we drive cost down further towards the cost parity target we set for the end of the year. We've built our first validation Cybertruck with dry cathode process made on our mass production equipment, which is a huge technical milestone and we're super proud of that. We're on track for production launch with dry cathode in Q4, and this will enable cell cost to be significantly below available alternatives, which was the original goal of the 4680 program.
Travis Axelrod: Great. Thank you very much. The next question is any update on Dojo?
Elon Musk: Yes, so Dojo, I should preface this by saying I'm incredibly impressed by NVIDIA's execution and the capability of their hardware. And what we are seeing is that the demand for NVIDIA hardware is so high that it's often difficult to get the GPUs. And there just seems this, I guess I'm quite concerned about actually being able to get state-of-the-art NVIDIA GPUs when we want them. And I think this therefore requires that we put a lot more effort on Dojo in order to have -- in order to ensure that we've got the training capability that we need. So we are going to double down on Dojo, and we do see a path to being competitive with NVIDIA with Dojo. And I think we kind of have no choice because the demand for NVIDIA is so high and the -- it's obviously their obligation essentially to raise the price of GPUs to whatever the market will bear, which is very high. So, I think we've really got to make Dojo work and we will.
Travis Axelrod: Right. The next question is what type of accessories will be offered with Optimus?
Elon Musk: There's -- Optimus is intended to be a generalized humanoid robot with a lot of intelligence. So it's like saying what kind of accessories will be offered with a human. It's just really intended to be able to be backward compatible with human tasks. So it would use any accessories that a human would use. Yes.
Travis Axelrod: Thank you. The next question is, do you feel you're cheating people out of the joys of owning a Tesla by not advertising?
Elon Musk: We are doing some advertising, so, want to say something?
Vaibhav Taneja: Yes, I would say something. Our fundamental belief is that we need to be providing the best products at a reasonable price to the consumers. Just to give you a fact, in U.S. alone in Q2, over two-thirds of our sales were to -- deliveries were to people who had never owned a Tesla before and which is encouraging. We've spent money on advertising and other awareness programs and we have adjusted our strategy. We're not saying no to advertising, but this is a dynamic play and we know that we have not exhausted all our options and therefore plan to keep adjusting, but in the latter half of this year as well.
Travis Axelrod: Great. Thank you very much. The next question is on energy growth, which we already covered in opening remarks, so we'll move on to the next one. What is the updated timeline for Giga Mexico and what will be the primary vehicles produced initially?
Elon Musk: Well, we currently are paused on Giga Mexico. I think we need to see just where things stand after the election. Trump has said that he will put heavy tariffs on vehicles produced in Mexico. So it doesn't make sense to invest a lot in Mexico if that is going to be the case. So we kind of need to see where the things play out politically. However, we are increasing capacity at our existing factories quite significantly. And I should say that the Cybertaxi or Robotaxi will be produced here at our headquarters at Giga Texas.
Travis Axelrod: All right. Thank you.
Elon Musk: And as well Optimus towards the end of next year for Optimus production Version 2, the high volume version of Optimus will also be produced here in Texas.
Travis Axelrod: Great. Thank you. Just a couple more. Is Tesla still in talks with an OEM to license FSD?
Elon Musk: There are a few major OEMs that have expressed interest in licensing Tesla full self-driving. And I suspect there will be more over time. But we can't comment on the details of those discussions.
Travis Axelrod: All right. Thank you. And the last one, any updates on investing in xAI and integrating Grok into Tesla software?
Elon Musk: I should say Tesla is learning quite a bit from xAI. It's been actually helpful in advancing full self-driving and in building up the new Tesla data center. With -- regarding investing in xAI, I think, we need to have a shareholder approval of any such investment. But I'm certainly supportive of that if shareholders are, the group -- probably, I think we need a vote on that. And I think there are opportunities to integrate Grok into Tesla's software, yes.
Travis Axelrod: All right. Thanks very much. And now we will move on to analyst questions. The first question comes from Will Stein from Truist. Will, please go ahead and unmute yourself.
Will Stein: Great. Thanks so much for taking my question. And this relates a little bit to the last one that was asked. Elon, I share your strong enthusiasm about AI and I recognize Tesla's opportunity to do some great things with the technology. But there are some concerns I have about Tesla's commercialization and that's what I'd like to ask about specifically. There were some news stories through the quarter that indicated that you redirected some AI compute systems that were destined for Tesla instead to xAI or perhaps it was to X, I'm not sure. And similarly, a few quarters ago, if you recall, I asked about your ability to hire engineers in this area, and you noted that there was a great desire for some of these engineers to work on projects that you were involved with, but some of them weren't at Tesla, they were instead at xAI or perhaps even X again. So the question is, when it comes to your capital investments, your AI R&D, your AI engineers, how do you make allocation decisions among these various ventures and how do you make Tesla owners comfortable that you're doing it in a way that really benefits them? Thank you.
Elon Musk: Yes, I mean, I think you're referring to a very -- like an old article, regarding GPUs. I think that's like 6 or 7 months old. At Tesla, we had no place to try them on, so it would've been a waste of Tesla capital because we would just have to order H100 and have no place to try them on. So it was just -- there was -- this wasn't a, let's pick xAI of Tesla. There's -- there was no -- the Tesla data centers were full. There was no place to actually put them. The -- we've been working 24/7 to complete the South extension on the Tesla Giga factory in Texas. That South extension is what will house 50,000 H100s and we're beginning to move the H100 server racks into place there. But we really needed -- we needed that to complete physically. You can't just order compute -- order GPUs and turn them on, you need a data center, it's not possible. So I want to be clear, that was in Tesla's interest, not contrary to Tesla's interest. Does Tesla no good to have GPUs that it can't turn on. That South extension is able to take GPUs, which is really just this week. We are moving the GPUs in there and we'll bring them online. With regard to xAI, there are a few that only want to work on AGI. So what I was finding was that when trying to recruit people to Tesla, they were only interested in working on AGI and not on Tesla's specific problems and they want to start -- do a start-up. So it was a case of either they go to a start-up or -- and I am involved or they do a start-up and I am not involved. Those are the two choices. This wasn't they would come to Tesla. They were not going to come to Tesla under any circumstances. So, yes.
Vaibhav Taneja: Yes, I mean, I would even add that AI is a broad spectrum and there are a lot of things which we are focused on full time driving as Tesla and also Optimus, but there's the other spectrum of AI which we're not working on, and that's the kind of work which other companies are trying to do in this case, xAI. So you have to keep that in mind that it's a broad spectrum. It's not just one specific thing.
Elon Musk: Yes. And once again, I want to just repeat myself here. I tried to recruit them to Tesla, including to say like, you can work on AGI, I if you want and they refused. Only then was xAI created.
Will Stein: I really appreciate that clarification. If I can ask one follow-up, it relates to the new vehicles that you're planning to introduce next year. I understand this is not the venue for product announcements, but when we think about the focus, I've heard on the one hand that the focus is on cost reduction. On the other hand, you also said that the Roadster would come out. Should we expect other maybe more limited variants like, similar to the cars that you make today, but with some changes or improvements or different, some other variability in the form factors. It should -- we expect that to be a significant part of the strategy in the next year or two?
Elon Musk: I don't want to get into details of product announcements. And we have to be careful of the Osborne effect here. So, if you start announcing some great thing, it affects our near-term sales. We're going to make great products in future just like we have in the past, end of story.
Travis Axelrod: Right. The next question comes from Ben Kallo from Baird. Ben, please go ahead and unmute yourself.
Ben Kallo: Hi. Thanks for taking my question. When we think about revenue contribution and with energy growing so quickly and Optimus on the come, how do we think about the overall segments longer term? And then do you think that auto revenue will fall below 50% of your overall revenue? And then my follow-up is just on the last call you talked about, distributed compute on your new hardware. Could you just update us and talk a little bit more about that, the timeline for it and how you would reward customers for letting you use their compute power and their cars? Thanks.
Elon Musk: Yes, I mean, as I've said a few times, I think the long-term value of Optimus will exceed that of everything else that Tesla combined. So, it's simply -- just simply consider the usefulness utility of a humanoid robot that can do pretty much anything you ask of it. I think everyone on earth is going to want one. There's 8 billion people on earth, so it's 8 billion right there. Then you've got, all of the industrial uses, which is probably at least as much, if not way more. So I suspect that the long-term demand for general purpose humanoid robots is in excess of 20 billion units. And Tesla is -- that has the most advanced humanoid robot in the world, and is also very good at manufacturing, which these other companies are not. And we've got a lot of experience -- with the most experienced with the world leaders in real world AI. So we have all of the ingredients. I think we are unique in having all of the ingredients necessary for large scale, high utility, generalized humanoid robots. That's why my rough estimate long-term is in accordance with the ARK [ph] Invest analysis of market cap on the order of $5 trillion for -- maybe more for autonomous transport, and it's several times that number for general purpose humanoid robots. I mean, at that point, I'm not sure what money even means, but in the benign AI scenario, we are headed for an age of abundance where there is no shortage of goods and services. Anyone can have pretty much anything they want. It's a wild -- very wild future we're heading for.
Ben Kallo: On the distributed compute?
Elon Musk: Yes, distributed compute, that seems like a pretty obvious thing to do. I think the -- where this distributed compute becomes interesting is with our next generation Tesla AI truck, which is hardware viable or what we're calling AI5, which is -- from the standpoint of inference capability comparable toB200 -- and a bit of B200. And we are aiming to have that in production at the end of next year and scale production in '26. So it just seemed like if you've got -- even if you've got autonomous vehicles that are operating for 50 or 60 hours a week, there's a 168 hours in a week. So you have somewhere above I think a 100 [indiscernible] net computing. I think we need a better word than GPU because GPU means graph express in unit. So there's a 100 hours plus per week of AI compute, AI advanced compute from the fleet, from the vehicles and probably some percentage from the humanoid robots that it would make sense to do distributed inference. And if you're -- if there's a fleet of at some point a 100 million vehicles with AI5 and beyond, because you have AI 6 and 7 and whatnot, and there may be billions of humanoid robots that is just a staggering amount of inference compute or that could be used for general purposes at computing. It doesn't have to be used for, the humanoid robot or for the car. So I think, that's just -- that -- that's a pretty obvious thing to say, like, well, it's more useful than having to do nothing.
Travis Axelrod: All right. Thank you. The next question comes from Alex Potter from Piper Alex. Alex, please go ahead and unmute yourself.
Alex Potter: Perfect. Thanks. I wanted to ask a question on FSD licensing. You mentioned that in passing previously, was just wondering if you can elaborate maybe on the mechanics of how that would work. I guess presumably this would not be some sort of simple plug and play proposition that presumably an OEM would need, I don't know, several years to develop its own vehicle platform that's based on FSD. I imagine they would need to adopt Tesla's electrical architecture, compute, sensor stack. So I, correct me if I'm sort of misunderstanding this, but if you had a cooperative agreement of some kind with another OEM, then presumably it would take you several years before you'd be able to recognize licensing revenue from that agreement. Is that the right way to think about that?
Elon Musk: Yes. The OEMs not real fast. There's not really a sensor suite, it's just cameras. But they would have to integrate our AI computer and have cameras with a 360 degree view. And at least the gateway, like the what talks to the internet, and communicates with the Tesla system, what that you need kind of a gateway computer too. So it's really gateway computer with the cellular and Wi-Fi connectivity, the Tesla AI computer, and seven cameras, or not cameras, again, a 360 degree view. But this will -- given the speed at which, the auto industry moves, it would be several years before you would see this in volume.
Alex Potter: Okay, good. That's more or less what I expected. So then the follow-up here is, if you did sign an FSD licensing agreement with another automaker, when do you think you would disclose that? Would you do it right when you signed the agreement or only after that multiple years has passed and the vehicle is ready to be rolled out? think it depends on the OEM. I guess we'd be happy either way. Yes, it depends on, what kind of arrangement we enter into. A lot of those things are, we are not resolved yet, so we'll make that determination as and when we get to that point.
Elon Musk: And the kind of deals that are obviously relevant are only if, some OEM is willing to do this in a million cars a year or something significant. It's not -- if it's like 10,000 or a 100,000 cars a year. We can just make that ourselves.
Travis Axelrod: All right, thank you. The next question comes from Dan Levy from Barclays. Dan, please go ahead and unmute yourself.
Dan Levy: Hi, good evening. Thanks for taking the questions. First, wanted to start with a question on Shanghai. You've leveraged Shanghai as an export center really due its low cost, and that makes sense. But maybe you can just give us a sense of, of how the strategy changes, if at all, given, the implementation of tariffs in Europe. Also to what extent, your import of batteries from China into the U.S., how that might change given the tariffs. Thank you.
Elon Musk: Yes. I think I covered some part of it in my opening remarks, but just to give you a little bit more, just on the tariff side, the European authorities did sample certain other OEMs in the first round to establish the tariffs for cars being imported from China into Europe. While we were not picked up in our individual examination in the first round, they did pick us up in the second round. They visited our factory. They -- we worked with them, provided them all the information. As a result, we were adjusting our import strategy out of China into Europe. But -- and one other thing to note is in Q2 itself, we started building right hand from model wise out of Berlin and we also delivered it in U.K. And we're adjusting as needed, but we will keep adjust. We're still importing Model 3s into Europe, out of Shanghai. And we are still evaluating what is the best alternate manage all this just on the examination by the European authorities. Like I said, we cooperated with them. Well, we are confident that they, we should get a better rate than what they have imposed for now. But this is literally evolving and we are adjusting as fast as we can with this. It is -- I would also add that, because of this, you've seen the impact that Berlin is doing more imports into places like Taiwan as well as, U.K I just mentioned. So it will keep changing and we will keep adapting as we go about it.
Dan Levy: Great. Thanks. Yes, thank you. As a follow-up, wanted to ask about the Robotaxi strategy and specifically the shareholder deck here notes that the release is going to be -- one of the gating factors is regulatory approval. So maybe you could help us understand which regulations specifically are the ones that we should be looking for? Is it FMVSS, that's standard? And then to what extent does the strategy shift? You've done with FSD more of a nationwide, no boundary approach. Is the Robotaxi approach one that's more geofenced, so to speak, and is more driven by a state by state approach?
Elon Musk: I mean, our solution is a generalized solution like what everybody else has. They, if you see like Waymo has one of it, they have a very localized solution that requires high density mapping. It's not -- it's quite fragile. So, their ability to expand rapidly is limited. Our solution is a general solution that works anywhere. It would even work on a different earth. So if you're rendered a new Earth, it would work on a new earth. So it's -- there's this capability I think in our experience, once we demonstrate that something is safe enough or significantly safer than human. We are fine that regulators are supportive of deploying deployment of that capability. It's difficult to argue with if you -- if you've got a large number of -- yes, if you've got billions of miles that show that in the future unsupervised FSD is safer than human. What regulator could really stand in the way of that? They would -- they're morally obligated to approve. So I don't think regulatory approval will be a limiting factor. I should also say that the self-driving capabilities of this are deployed outside of North America are far behind that in, in North America. So with the -- with Version 12.5, and maybe a 12.6, but pretty soon we will ask for regular regulatory approval of the Tesla supervised FSD in Europe, China, and other countries. And I, I think we're likely to receive that before the end of the year, which will be a helpful demand driver in those regions obviously.
Travis Axelrod: Thank you. Just to …
Elon Musk: Go ahead, Travis.
Travis Axelrod: In terms of like, as Elon said, in terms of regulatory approval, the vehicles are governed by FMVSS in U.S., which is the same across all 50 states. The road rules are the same across all 50 states. So creating a generalized solution gives us the best opportunity to deploy in all 50 states, reasonably. Of course there are state and even local and municipal level regulations that may apply to, being a transportation company or deploying taxes. But as far as getting the vehicle on the road, that's all federal and that's very much in line with what you was just suggesting about the data and the vehicle itself.
Vaibhav Taneja: And to add to the technology point, the end-to-end network basically makes no assumption about the location. Like you could add data from different countries and it just like perform equally well there, just like almost like close to zero US specific, um, code in there. It's all just the data that comes from the U.S
Elon Musk: Yes. To, to that end of the show, it's like, we can go as humans to other countries and drive with some reasonable amount of assessment in those countries. And that's how you design the FSC software. Yes, exactly.
Travis Axelrod: Great. Thanks guys. The next question comes from George from Canaccord. George, please go ahead and unmute yourself.
George Gianarikas: Hi, everyone. Thank you for taking my questions. Maybe just to expand on the regulatory question for a second. And I could be comparing apples and oranges, but GM canceled their pedal less, wheel less vehicle. And according to the company this morning, their decision was driven by uncertainty about the regulatory environment. And from what we understand, and again, maybe I'm wrong here, but the Robotaxi that has been shown at least in images of the public is also pedal less and wheel less. Is there a different regulatory concern just if you deploy a vehicle like that that doesn't have pedal -- pedals or a wheel, and that may not be different from just regular FSD on a traditional Tesla vehicle. Thank you.
Elon Musk: Well, obviously the real reason that they cancel it is because GM can't make it work, not because the regulators, they're blaming regulators. That's misleading of them to do so, because Waymo is doing just fine in those markets. So it's just that their technology is not far.
George Gianarikas: Right. And maybe just as a follow-up, I think you mentioned, that FSD take rates were up materially after you reduced the price. Is there any way you can help us quantify what that means Exactly? Thank you.
Vaibhav Taneja: Yes, we shared the [indiscernible] that there we've seen a meaningful increase. I don't want to get into specific because we started from a low base and -- but we are seeing encouraging results. And the key thing here is, like Elon said, you need to experience it because words can't describe it till the time we actually use it. And that's why we are trying to make sure that every time a car is getting delivered, people are being showed how this thing is working because when you see it working, you realize how great it is. I mean, just to give you one example, so again, there's a bias example, but I have a more than 20 mile commute into the factory almost every day. I have zero interventions on the latest stack, and the card just literally drives me over. And especially with the latest version wherein, we are also tracking your eye movement, the steering wheel lag is almost not there as long as you're not wearing sunglasses.
Elon Musk: Well, we are fixing the sunglasses thing. It's coming soon. So you will be able to drive -- you'll be able to have sunglasses on and have the car drive.
George Gianarikas: Yes.
Elon Musk: So -- but there's number of times I've talked with smart people who like live in New York or maybe downtown Boston and don't ever drive and then ask me about FSD, I'm like, you can just get a car and try it. And if you're not doing that, you have no idea what's going on.
Travis Axelrod: Thank you. The next question comes from Pierre from New Street. Pierre, please unmute yourself.
Ferragu Pierre: Hey, guys. Thank you for taking my question. So it's on Robotaxi again, and I completely get it that with a universal solution, we will get like regulatory approval, we'll get there eventually clicking up miles and compute, et cetera. And my question is more, how you think about deployments, because I'm still like, I'm thinking once you have a car that can drive everywhere, that can replace me, it can replace a taxi, but then to do the right hailing service, you need a certain scale. And that means a lot of cars on the road and so you need an infrastructure to just maintain the cars, take care of them, et cetera. And so my question is, are you already working on that? Do you have already an idea of what, like your plan to deploy looks like? And is that like a test Tesla only plan or are you looking at partners, local partners, global partners to do that? And I'll have a quick follow-up.
Elon Musk: Yes. This would just be the Tesla network. You just literally open the Tesla app and summon a car and resend a car to pick you up and take you somewhere. And you can -- our -- we'll have a fleet that's I don't know, on order of 7 million dedicated global autonomy soon. In the years come it'll be over 10 million, then over 20 million. This is immense scale. And the car is able to operate 24/7, unlike the human driver. So, the capability to -- like, if there's this basically instant scale with a software update. And now this is for a customer on fleet. So you can think of that as being a bit like Airbnb, like you can choose to allow your car to be used by the fleet, or cancel that and bring it back. It can be used by the fleet all the time. It can be used by the fleet some of the time, and then Tesla would take -- would share on the revenue with the customer. But you can think of the giant fleet of Tesla vehicles as like a giant sort of Airbnb equivalent fleet, Airbnb on wheels. The -- I mean, then in addition we would make some number of cars for Tesla that would just be owned by Tesla and be added to the fleet. I guess that would be a bit more like Uber. But this would all be a Tesla network. And there's an important clause we've put in, in every Tesla purchase, which is that the Tesla vehicles can only be used in the Tesla fleet. They cannot be used by a third-party for autonomy.
Ferragu Pierre: Okay. And do you think that scale is like progressively so you can start in a city with just a handful of cars and you grow the number of cars over time? Or do you think there is like a critical mass you need to get to, to be able to offer like a service that is of competitive quality compared to what like the -- like Uber would be typically delivering already?
Elon Musk: I guess I'm not -- maybe I'm not conveying this correctly. The entire Tesla fleet basically becomes active. This is obviously maybe there's some number of people who don't want their car to own money, but I think most people will. It's instant scale.
Travis Axelrod: Thank you. Our next question comes from Colin from Oppenheimer. Colin, please unmute yourself.
Colin Rusch: Sorry about that guys. I've got two questions around energy storage. With the tight supply and the stationary storage, can you talk about your pricing strategy and how you're thinking about saturation and given geographies given that some of these larger systems are starting to shift wholesale power markets in a pretty meaningful way quickly?
Vaibhav Taneja: So, I mean, we are working with a large set of players in the market and our pipeline is actually pretty long. And there's actually very -- there's actually long end in terms of where you enter into a contract where delivery started -- starts happening. And so far we have good pricing leverage. And now Mike, chime in on this too.
Unidentified Company Representative: Yes, I mean there's a lot of competition from Chinese OEMs just like there is in the vehicle space. So we're in close contact with our customers and making sure that we're remaining competitive in where they're needing to be competitive to, to secure contracts to sell power and energy in the markets. We had a really strong contracting quarter and continue to build our backlog for 2025 and 2026. So we feel pretty good about where we are in the market. We realize that competition is strong, but we have a pretty strong value proposition with offering a fully integrated product with our own power electronics and site level controls. So …
Vaibhav Taneja: Yes, and again, the aspect which people miss do not fully understand is that there's also a whole software stack, which comes with from Megapack, right? And that is a unique proposition which we -- which is only available to us, and we are using it with other stuff too, but that gives us a much more of an edge as compared to the competition.
Elon Musk: Yes, we find customers that they can sort of put together a hodgepodge solution. And so, and then sometimes they'll pick that solution, and then that doesn't work. And then they come back to us.
Unidentified Company Representative: Yes, and we're not really seeing saturation for like, on a global scale. There's little pockets of saturation in different markets, but we're more seeing that there's markets opening up given demand on the grid just continues to increase more than anyone expects. So that just opens up markets, really across the world in different pockets.
Vaibhav Taneja: Yes, I mean just even on the AI computer side, right? These GPUs are really powerful already and the amount of new pipeline, which we're getting for people for data center backup and things like that is increasing at a pretty large scale.
Colin Rusch: Yes. Thanks. And then the follow-up here is 4680 process technology and the role to role process. There's some news around your equipment suppliers. Can you talk about how far along you are in, in potentially qualifying an incremental supplier around some of that, those critical process technology steps?
Lars Moravy: Yes, I can talk about that. As you're probably referring to the lawsuit that we have with one of our suppliers, look, I don't think this is going to affect our ability to roll out 4680. We have very strong IP position in the technology and the majority of the equipment that we use is in-house designed and some of it's in-house build. And so we can take our IP stack and have someone else build it if we need to. So it's, that's not really a concern right now.
Elon Musk: Yes. I, I think people don't understand just how much demand there will be for grid storage. They really just like the [indiscernible] I think are underestimating this demand by probably orders magnitude. So that the actual energy, total energy output of, say the U.S grid is if the power plants can operate a steady state is at least two to three times, the amount of energy it currently produces, because there are a huge gap. There's a huge difference in the -- from peak to trough in terms of energy of power generation. So in order for a grid to not have blackouts, it must be able to support the load at the worst minute of the worst day of the year, the coldest or hottest day, which means that for the rest of the time, the rest of the year, it's got massive excess power generation capability, but it has no way to store that energy. Once you add battery packs, you can now run the power plants at steady state. Steady state means that basically any given grid anywhere in the world can produce in terms of cumulative energy in the course of the year, at least twice what it is currently producing in some cases, maybe three times.
Travis Axelrod: All right. Thank you, Elon. The next question comes from Colin Langan from Wells Fargo. Colin, please unmute yourself.
Colin Langan: Oh, great. Thanks for taking my questions. Do you hear me?
Travis Axelrod: Yes.
Colin Langan: Yes. Sorry. I guess when we are going to ask, if Trump wins, there's a higher chance that IRA could get cut. I think Elon, you had commented online that Tesla doesn't survive on EV subsidies. But when Tesla lose a lot of support if IRA goes away? I think model Y3 and Y get IRA help for customers, and I think your batteries get production tax credits. So, just one, can you clarify if the end, if IRA ends, would it be a negative for your profitability in the near-term? Why might it not be a negative? And then, any framing of the current support you get, IRA-related?
Elon Musk: I guess that there would be like some impact, but I think it would be devastating for our competitors. But -- and it would hurt Tesla slightly. But long-term probably actually helps Tesla would be my guess. Yes -- but I've said this before on earnings calls, it -- the value of Tesla overwhelmingly is autonomy. These other things are in the noise relative to autonomy. So I recommend anyone who doesn't believe that Tesla will solve vehicle autonomy should not hold Tesla stock. They should sell their Tesla stock. You should believe Tesla will solve autonomy, you should buy Tesla stock. And all these other questions are in the noise.
Vaibhav Taneja: Yes, I mean, I'll add this just to clarify a few things that -- at the end of the day, when we are looking at our business, we've always been looking at it whether or not IRA is there and we want our business to grow healthy without having any subsidies coming in, whichever way you look at it. And that's the way we have always modeled everything. And that is the way internally also even when we are looking at battery costs, yes, I --, there are manufacturing credits which we get, but we always drive ourselves to say, okay, what if there is no higher benefit and how do we operate in that kind of an environment? And like Elon said, we definitely have a big advantage as compared to a competition on that front. We've delivered it and you can see it in the numbers over the years. Like, so there is you cannot ignore the fundamental size of the business. And then on top of it, once you add autonomy to it, like even said, it becomes meaningless to you think about the short-term.
Travis Axelrod: Okay. I think that's unfortunately all the time we have for today. We appreciate all of your questions. We look forward to talking to you next quarter. Thank you very much and goodbye.
Elon Musk: That's excellent. |
TXN | 2 | 2,024 | 2024-07-23 19:43:08 | Dave Pahl: Welcome to the Texas Instruments Second Quarter 2024 Earnings Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Executive Officer, Haviv Ilan; and our Chief Financial Officer, Rafael Lizardi. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. In addition, today's call is being recorded and will be available via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in the earnings release published today as well as TI's most recent SEC filings for a more complete description. Today, we'll provide the following updates. First, Haviv will start with a quick overview of the quarter. Next, he'll provide insight into second quarter revenue results with some details of what we're seeing with respect to our end markets. Lastly, Rafael will cover the financial results, give an update on capital management as well as share the guidance for the third quarter of 2024. With that, let me turn it over to Haviv.
Haviv Ilan: Thanks, Dave. Let me also start by welcoming everyone to the call. I'm looking forward to joining our quarterly earnings calls moving forward and sharing more details about our business strategy with the investment community. It is an opportunity for me to directly share more information about our results and our strategic progress. With that, I'll start with a quick overview of the second quarter. Revenue in the quarter came in about as expected at $3.8 billion, an increase of 4% sequentially and a decrease of 16% year-over-year. Analog revenue declined 11% year-over-year, and Embedded Processing declined 31%. Our other segment declined 22% from the year ago quarter. Now, I'll provide some insight into our second quarter revenue by end-market. Our results continue to reflect the asynchronous behavior across our end-markets that we've seen throughout this cycle. Similar to last quarter, I'll focus on sequential performance as it is more informative at this time. First, the Industrial market was down low-single digits. The Automotive market was down mid-single digits. Personal Electronics grew mid-teens with broad-based growth while demonstrating continued improvement compared to its low point in the first quarter of 2023. Next, Communication Equipment was up mid-single digits. And finally, Enterprise Systems was up about 20%. Lastly, before I pass it on to Rafael, I'd like to share a few comments regarding our capacity investments. We and our customers remain pleased with our progress of the expansion of our 300-millimeter manufacturing capacity. These investments reflect our confidence in the opportunity ahead, which remains high for several reasons. First, we have a high level of confidence in the secular growth of semiconductor content, particularly in industrial and automotive, where we have greater exposure and strong product positions. Second, geopolitically dependable low-cost 300-millimeter capacity will be increasingly critical and valuable and our investments enable us to support customer demand at scale. To share more details on our progress, which we believe is helpful for all of our shareholders to understand, I plan to hold an off-cycle capital management call with Rafael and Dave on August 20th. During the call, I will provide more granularity on our capacity investments along with the framework of revenue and free cash flow per share scenarios. With that, let me turn it over to Rafael to review profitability, capital management, and our outlook.
Rafael Lizardi: Thanks, Haviv, and good afternoon, everyone. As Haviv mentioned, second-quarter revenue was $3.8 billion. Gross profit in the quarter was $2.2 billion or 58% of revenue. Sequentially, gross profit margin increased 60 basis points, primarily due to higher revenue as well as lower manufacturing unit costs due to increased factory loadings and more manufacturing internally with more wafers on 300-millimeter. Operating expenses in the quarter were $963 million, up 3% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.7 billion, or 23% of revenue. Operating profit was $1.2 billion in the quarter, or 33% of revenue, and was down 37% from the year-ago quarter. Net income in the second quarter was $1.1 billion, or $1.22 per share. Earnings per share included a $0.05 benefit for items that were not in our original guidance. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1.6 billion in the quarter and $6.4 billion on a trailing 12-month basis. Capital expenditures were $1.1 billion in the quarter and $5 billion over the last 12 months. Free cash flow on a trailing 12-month basis was $1.5 billion. As a reminder, free cash flow includes benefits from the CHIPS Act investment tax credit, which was $312 million for second quarter. In the quarter, we paid $1.2 billion in dividends and repurchased $71 million of our stock. In total, we returned $4.9 billion to our owners in the past 12 months. Our balance sheet remains strong with $9.7 billion of cash and short-term investments at the end of the second quarter. In the quarter, we repaid $300 million of debt. Total debt outstanding is now $14 billion with a weighted-average coupon of 3.8%. Inventory at the end of the quarter was $4.1 billion, up $23 million from the prior quarter and days were 229, down 6 days sequentially. For the third quarter, we expect TI revenue in the range of $3.94 billion to $4.26 billion and earnings per share to be in the range of $1.24 to $1.48. We continue to expect our effective tax rate to be about 13%. In closing, we will stay focused in the areas that add value in the long term. We continue to invest in our competitive advantages, which are manufacturing and technology, a broad product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash flow per share growth over the long term. With that, let me turn it back to Dave.
Dave Pahl: Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for a follow-up. Operator?
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. There were some comments from a geopolitical perspective. One of the candidates is talking about the China-Taiwan relationship. And I'm just asking how the geopolitical environment is sort of impacting your customers' buying decisions. I think you said last call that even some of your Chinese customers who are exporting product want geopolitically dependable capacity. I think you talked about that being kind of an increasingly big factor in autos. Can you talk about that and is that beginning to drive some share gains for you?
Haviv Ilan: Thanks, Tim. I'll take that. It's Haviv. First, geopolitical dependable capacity is not a new thing for us. We've started to see these requests coming, I think two or three years ago when tensions started to rise, but as we reflect on it now three years in, it's obvious that there is more and more attention usually at the highest levels of our customers. I'm talking about leadership of CEOs or Chief Purchasing Officers, looking at their supply chain and making sure that they are going to be immune from you know whatever is thrown at them, part of it is geopolitical tensions. And this is where TI is a great answer. We are a very unique supplier in the sense of we can provide the capacity at scale, meaning the amount of wafers and the size of our -- the capacity that we are building is very high. It is a very affordable capacity as building our parts on 300-millimeter wafers allows for a lower cost per chip and then building them internally in our assembly and test houses also provides a very good low-cost structure. And last but not least is this geopolitically dependable capacity, meaning our fabs are being built in the US, mainly in Texas and in Lehi, Utah and we provide a capacity that is at scale, affordable, and dependable. And yes, every time there is some news out there, you know, we are seeing more interest. We've seen that grown over the last several years, and in that sense, our discussions with our customers are providing us more opportunity to win positions in future platforms. I do believe we are taking a bigger share and this is part of our confidence to continue with our investments to serve that opportunity moving forward. Last but not least, you have touched China. Yes, you're right. If I take an example and just on the automotive side, our customers in China do care a lot about their export business. In that sense, our capacity is highly welcomed by them because we can compete at the market price with a very competitive offering, yet have that dependability to serve their customers not only in China but also outside of China for their export business.
Dave Pahl: Follow-on, Tim?
Timothy Arcuri: I do. Yes. Rafael, can you give us an update on CHIPS Act? Do you know how much you're getting yet? And can you kind of talk about that?
Rafael Lizardi: Yes, sure, Tim. So on the grant, frankly, we're still going through the process. So we submitted the application and we're just working through the details with the CHIPS program office. But given your question, let me comment also on the ITC the Investment Tax Credit. Today, to date, we have accrued about $1.8 billion in total, that's under 25% ITC. This benefit already started flowing through the income statement as lower depreciation. In addition, in second quarter, we received, as I said in the prepared remarks, $312 million of cash benefits and that is reflected in operating and free cash flow. And we expect to receive another $200 million in 3Q and for a total of $1 billion for 2024.
Timothy Arcuri: Great.
Dave Pahl: Thank you, Tim. We'll go to the next caller, please.
Operator: Thank you. Our next question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi, guys. Thanks for taking my questions. In Q2, it looked like the strength was primarily from personal electronics, given industrial and auto were down. And maybe calculators as well, I don't know other was pretty strong. I was wondering if you could give us some color on where your expectations for the growth in Q3 sequentially is coming from. Is it still primarily at personal electronics? And I guess maybe calculators or other stuff? How do I think about the end-market trends as we go forward into next quarter?
Haviv Ilan: Thanks for the question. Stacy, I'll start and I'll let Dave add some more color on Q2. So if I go back to the second quarter, yes, if you look at our results, industrial did decline at the low-single digits. Automotive continued to decline at mid-single digits. That was the third quarter in a row of that decline. Although from a year-over-year perspective, it's still doing well, meaning less than 10% of a decline. It declined about 9% in Q2. Yes, there is strength in personal electronics and I do see that market at -- you know it went down through the entire cycle. It troughed sometime in the first quarter of 2023 and we've seen that market strengthening. And again, it grew mid-teens sequentially, but close to 20% year-over-year. So there is definitely strength over there. And I would also say that on the enterprise market, yes, smaller revenue for us, but we are seeing a recovery over there, and I believe that inventory correction is behind us. Regarding the Other business, it grew thanks to our calculator business, as you mentioned, but also our DLP business, which mainly serves the personal electronics market. And Dave, maybe you can add some more color on the sectors as we talked about Q2.
Dave Pahl: Yes. I think as we have seen even inside of industrial, we've had sectors behave asynchronously. So when we first began to see weakness in industrial, which really began in the third quarter, that was -- that was the peak in third quarter of 2022. That was the peak in industrial and we talked about seeing about half of the sectors or so show weakness and those early, but I'll call them earlier-stage sectors, some of them have found bottoms and begun to grow and you can see some of that bottoming process taking place. The others, we're only three or so quarters in and we've got several of them that are continuing to decline at double-digit rates. So again, as we've seen all of our markets behave asynchronously inside of the sectors, we've seen that in industrial as well. Do you have a follow-on, Stace?
Stacy Rasgon: I do actually. Maybe to re-ask the same question. So you're guiding a revenue sequentially up close to $300 million. How do I think about that $300 million growth parsing out across the end markets into Q3?
Haviv Ilan: Yes, Stacy, I'm on the calls, but still we are not going to predict or to give a guidance by market for the third quarter. I mean, it's at the midpoint of the range. We expect revenue to grow about 7%. But as you know, it's not unusual for us to see sequential growth in the third quarter. I mean, typically this is a seasonal --
Stacy Rasgon: Is it TE, is what I'm asking, is it mostly --
Haviv Ilan: Yes, typically Q3 is a quarter where if you go back to pre-COVID days, this is the quarter where customers are preparing their end equipment or the end-product for the holiday season. So it's usually a strong quarter for the company and we are seeing that a very similar behavior right now at the midpoint of our -- of the range of our forecast. I don't know, Dave, if you want to add anything.
Dave Pahl: I think that's good.
Haviv Ilan: Okay.
Dave Pahl: Thank you, Stacy. And we'll go to the next caller.
Stacy Rasgon: Thank you, guys. Thank you.
Operator: Thank you. Our next question comes from the line of Vivek Arya with Bank of America. Please proceed with your question.
Vivek Arya: Thanks for taking my question. I wanted to ask about the China market and what you're seeing in terms of not just the demand side, but are you seeing any incremental supply coming on that can create a concern from a pricing perspective? Because every time this question is asked to industries or not just TI, the answer is always that, well, the IP is not there, they don't have product breadth and whatnot, but they're still buying a lot of trailing edge equipment. So at what point Haviv does that start to become a concern from just a global capacity and global pricing perspective for Texas Instruments?
Haviv Ilan: Thanks, Vivek. Let me start with the first part of your question on how the China market did because I think it was a good quarter for our China business. Our China headquarters business grew sequentially at about 20% versus the first quarter. And we've seen the momentum across all markets. I mean, all five markets grew sequentially, I think 15% or 20%. So they all did well. And this is after seven quarters of sequential decline. So if you think about the way I look at the China market and it was exposed to all -- to all market -- to all end-markets for TI, it took seven quarters for this asynchronous cycle to go through starting with PE, Personal Electronics, then spreading to Industrial and Enterprise and just slightly to Automotive. But all of these have now corrected and Q2 was a good quarter for our business. And I believe we are now shipping to end demand, meaning customers have stopped managing their inventories over there. Now in terms of the competition in China, I don't think that's -- I mean, we've been very vocal about it. This is first not new that the competition has intensified over the last -- the past several years and I think it's growing stronger. I think it's a mistake for us to think that these guys are only doing simple parts. These are very ambitious, highly educated competitors. And our job here in TI, and that's what I try to teach the team is to compete. And I will tell you that, yes, the market is more competitive in China, but we can compete and we can win business in very attractive margins. So we are going to continue to do that. Our goal -- objective is to continue and gain market share in China.
Dave Pahl: Yes. And if I just add one thing, Haviv, the growth in China that we saw was strong across all the markets, including automotive and industrial there. So --
Haviv Ilan: Correct.
Dave Pahl: So, I think that's an important point. So, Vivek, you have a follow-on?
Vivek Arya: Yes. Thank you, Dave. So I know for Q3, you're not giving specific end-market commentary, but just from an industry perspective, how would you describe the supply-demand situation in industrial and automotive semis just because we see such a broad range of data points? Do you think we are past the worst in terms of inventory adjustment and supply issues for those two end markets? And if you could describe the situation in those two markets separately, that would be really, really helpful. Thank you.
Haviv Ilan: Dave, I'll let you take this one.
Dave Pahl: Okay. Yes, I think of what we can see, Vivek. Of course, we don't get any data feeds on customer inventory. We don't get any data feeds on customer shipments, but we can look into things like the order patterns, we can look at feeds that we get in consignment. We can see what's happening in with our inventories and our position. So as we've talked about, cancellations as an example, as a measure have continued to come down. Our lead times I described is very stable. We've got immediate availability of almost all of our products. So that does drive a lower visibility with backlog because customers can get product when they need it. And we do believe that some markets PE bottomed up back in first quarter of 2023 and has been more seasonal since then. We've seen some of the other markets that as we've shared earlier, are beginning to grow. So there's likely a bottom forming it with within some of those markets. We've got industrial and automotive that have continued to decline. Now I'd say with industrial, I mentioned earlier, some of the sectors are forming a bottom, others are continuing to decline. And automotive, where we've got three quarter behind us, right. So that's how as we look into where we are positioned today, but we don't have a strong signal that can tell us exactly to be able to answer the question that you asked.
Haviv Ilan: Yes, the only one comment I will add, Vivek, in terms of the difference. So automotive so far at least just year-to-date is down mid-single digits and that is off of a very good 2023 for us, right. We grew about 17% in 2023. And I think it's just helped by the strong secular content growth that we see in automotive. And this is across the -- both combustion engines of ICE and EVs. So that's maybe the difference -- the slight difference I see between these two markets.
Dave Pahl: Okay. Thank you, Vivek. We'll go to the next caller, please.
Operator: Thank you. Our next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi guys. Thanks for letting me ask the question. Haviv, it's great to have you on the call. So I'll ask one for you and maybe Rafael would chime in as well. You guys have given at least Rafael in the past some mid-quarter updates or earnings call updates on capex and depreciation versus your pre-existing plan. So are you still planning to spend $5 billion a year? And is the depreciation ranges, Rafael, you gave before still apply or are we going to have some more flexibility on those metrics going forward?
Haviv Ilan: Yes. Okay, I'll start and Rafael maybe you can provide some more color. So first, again, our strategy has not changed and it continues to serve us well. As I said before, the secular growth in industrial and automotive and our position, our market position, and our product portfolio position gives us the confidence that there is a higher opportunity over there. On top of it, as we said earlier, customers do want and value geopolitically dependable capacity. So we are pleased with our progress. Our CapEx strategy provide us both with capacity for growth and flexibility. And at the end of the day, CapEx supports revenue growth and need to be prepared for different scenarios. Now we always continue to evaluate our plans and investments based on what we see on the demand environment, the dynamics, the growth opportunities in the market. And to talk more about it, we -- as I said in my prepared remarks, we see our -- we are going to have our off-cycle capital management call in a month, in four weeks, just an opportunity to share just additional insight. So we'll go through our investment plan with more granularity on what exactly we are doing per factory and then we'll provide a framework of revenue scenarios and what would free cash flow per share and CapEx do, you know, versus each and every scenario. And regarding depreciation, Rafael, I don't know if you want to add anything.
Rafael Lizardi: Yes. So I'll just comment on depreciation. Ross, I'm going to narrow that depreciation range a little bit both for 2024 and 2025. So for 2024, we now expect depreciation to be between $1.5 billion and $1.6 billion. And for 2025, we now expect depreciation to be about $2 billion to $2.3 billion.
Dave Pahl: Do you have a follow-on, Ross?
Ross Seymore: I do, and thanks for all those details, Haviv, and Rafael. So one for you, Rafael. If I heard you right on the gross margin rising in the second quarter, you mentioned that loadings increased. I thought that they were going to decrease to burn some inventory now that you had that at kind of the $4 billion target. So did something change there? And what's the expectations for utilization going forward?
Rafael Lizardi: Yes. So the loadings came in about as expected, but let me just tell you more about it. Second quarter loadings were up versus first quarter. And as you saw, we were essentially flat on inventory. So essentially the ins and out where pretty much offsetting. When it comes to third quarter, we expect utilization or factory loadings to be flat to slightly up. And in our base-case for our -- the EPS guidance that we have, that's what we have in there. But of course, we have time during the quarter to adjust those loading depending on what we expect for fourth quarter. On GPM specifically for third quarter, I would -- in the base-case, at the midpoint of our guidance, I would expect GPM percent to be up versus the second quarter.
Ross Seymore: Thank you, Dave.
Dave Pahl: Thank you, Ross, and we'll go to the next caller, please.
Operator: Thank you. Our next question comes from the line of Chris Danley with Citibank. Please proceed with your question.
Chris Danley: Hey, thanks for letting me ask a question, guys. Just to follow up on Ross' question in terms of gross margin. So depreciation is going up like 100 million bucks roughly per quarter for next year. But if utilization rates keep going up i.e., if nothing gets any worse, do you think -- is it possible that your gross margins are bottoming now? Or is there anything else that could drive them lower or maybe provide a tailwind, just give us maybe the mechanics around it for the next several quarters.
Rafael Lizardi: Sure, sure. I'll be happy. And I'll keep it -- well, at the end of the day, yes, it is possible that is the case. It's all going to depend on revenue, of course. So the main driver is revenue. So as we -- and in addition to revenue, as we bring more executing our strategy to load more 300-millimeter wafers and bring in more external loadings internal, the fall-through excluding depreciation will likely trend more in the range of 75% to 85% on a year-on-year basis. Now, of course, any one quarter, even any one year, you may have puts and takes that you know utilization or factory loadings is one of those that sometimes it goes against you, sometimes it goes in favor. But in general, expect that fall-through in 75% to 85%, not counting depreciation. So you do the math, whatever revenue assumption you want to put over the next several quarters or years, do that fall-through and you can very easily model where -- and then I just gave you the depreciation, right. So you can then model what gross margins can do over the next several years.
Chris Danley: Great. Thanks for the additional breadcrumbs. They're very useful. My follow-up is just on bookings. I think last quarter, you said that bookings were increasing every month. Is that still true? And do you think that for the industrial automotive space, we're at least getting close to the bottom there, or do you feel any better about either of those end markets on a relative basis?
Dave Pahl: Yes. So again, as you look at those things, revenue did increase as well as orders throughout the quarter, which is very typical as that we would see in the second quarter. And certainly, as we've got growth at the midpoint, that would not be unexpected. Again, those other sides of lead times, really on all of our products, having immediate availability and stable lead times, cancellations continuing to decline. All those things, I think point to supply and demand becoming more in balance and that availability. So -- and there was a second part of your question, Chris, that I'm not addressing. I'm not sure what it was. Can you just repeat it for me?
Chris Danley: Yes, it was just our bookings still increasing month over month. And then between the auto or the industrial end market, do you feel any better or worse about either of those?
Dave Pahl: Well, yes, again, I think that we've got half of the sectors that again we can see forming a bottom inside of industrial overall that it's been elongated. But if you look at it sector by sector, it's probably a better view overall. And in auto, this is our third quarter of decline. We're down about 13% from where the revenue peaked. It's a pretty shallow decline compared to how the other markets had behaved so far. So that's what we see. So, thank you, Chris. [Multiple Speakers]
Operator: Thank you. Our next question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Thank you. Hi, good afternoon. Thank you so much for taking the question. Haviv, maybe one for you on CapEx and how you're thinking about your long-term revenue growth. You've always had this slide in your capital management call deck where you show revenue supported. I think you have for 2026, you have $30 billion for 2030 at $45 billion. I know you're constantly evaluating your plans and you talked about presenting various scenarios on the August call. But I'm curious, is the $30 billion for 2026 and $45 billion for 2030, are those still kind of the base case scenarios for you, or has there been any change post conversations with customers?
Haviv Ilan: So, Toshiya first, I do want to leave something for August. So I think it's going to be just a better environment to go provide this information. We'll also provide supporting materials and we'll or updated presentation where you'll see, as I said, the different scenarios and how we see them. And to me, it's step-by-step. Right now when I think about how we establish our CapEx plan, we need to think about what the next peak wants to do. We'll discuss that. We'll discuss different scenarios of revenue leading to the next peak and what will CapEx do accordingly. And as a result, what free cash flow per share will be. Again, I don't want to give the whole a pitch right now, but I think it's going to be important for investors to join and hear our latest update.
Toshiya Hari: Understood.
Dave Pahl: Follow-on [indiscernible]
Toshiya Hari: I do. Thanks, Dave. Just a question on Embedded Processing. Revenue was down sequentially and the year-over-year decline actually accelerated. Analog, we've seen some stabilization. So I'm just curious what you're seeing in the Embedded Processing side. Is this purely volume pressure, or is there a pricing or competitive component here as well? I think operating margins for that business came in a little bit as well sequentially. So just curious. Thank you.
Haviv Ilan: Yes, let me start first on the high-level embedded -- the embedded business. So when I look at the underneath beyond the numbers, it's getting stronger. Our product portfolio is improving. And when I look at the -- at this decade, the -- just the opportunity for that business to be a major contributor for TI's growth of free cash flow per share is very high. So I'm very encouraged by the progress of the business. Now regarding the cycle, cycle first, embedded as a little bit of a different structure compared to analog. It's mainly composed of industrial and automotive. So it has less exposure into a personal electronics enterprise or communication equipment. And these two markets kind of pick later, right. So if you look at the embedded business versus analog, it picked a year-after kind of middle of 2023 versus the middle of 2022 for the analog business. In addition to that, the embedded business today, although as Rafael mentioned, it's being changed, was mainly supported from foundry wafers during the upcycle and we felt more limitation over there compared to our internal supply capacity. And so, now when these supply issues are resolved, we are seeing customers just adjusting their inventory. That's what I believe is happening and therefore, embedded is seeing that sharper correction. But again, when I look at it from the from the top, embedded is strengthening and I think it will continue to serve us very well moving forward.
Rafael Lizardi: Let me just add on the operating profit question or angle that you had. Just as a reminder, as Haviv said, traditionally embedded has relied on external wafers, but we now have -- we're bringing them in and we have -- the Lehi factory is disproportionately will serve embedded, and therefore, embedded has taken a disproportionate amount of the fixed-cost charges there. But just like that is put right now, it will be a tailwind. It's a headwind now, it will be a tailwind in the future as we qualify more and more parts, embedded parts as well as analog at that Lehi factory.
Toshiya Hari: It's very clear. Thank you so much.
Dave Pahl: Have a great day. Next caller, please.
Operator: Thank you. Our next question comes from the line of Harlan Sur with JPMorgan. Please proceed with your question.
Harlan Sur: Yes. Thank you for taking my question and great to have you on the call, Haviv. Maybe to follow up on the embedded question, right, because this business grew 3% last year versus your analog business, which was down 15%? Yes, year-to-date, it's down about as much as your peers or I would argue slightly better. You've articulated the positive strategy changes previously, right, more catalog, broad market focus. So bottom-line, again, over the past few years, it seems like you've made good improvements in this business. So as the team moves embedded more to internal manufacturing combined with the strategy shift, maybe, Haviv can you just comment on the design-win momentum? What areas are you particularly doing well in? And I'm not sure, Rafael, how should we think about the improvements in embedded margins as you move what was once mostly outsourced to internal manufacturing.
Haviv Ilan: Yes. Let me start and I'll let Rafael add some more color. But again, as you mentioned, the embedded business has gone through change in the last four, five years and Amichai has done a great job to position the business such that it benefits our competitive advantages, thinking about manufacturing and technologies of shifting really from almost like 80% external to when done, maybe the opposite, 80% internally building a higher breadth of products or not less concentration of revenue per socket and us expanding our product portfolio, utilizing the reach of our market channels. Think about the large sales team of TI, think about TI.com, and the more Catalog is the product, the better fit to our strategy. So in that sense, that is moving well. In terms of design in momentum, again, it's mainly an industrial and automotive business. So very high visibility on the automotive side. But as you also know, it takes time. So I'm encouraged with the design-in momentum. Our funnel increased tremendously when I compare it to the analog side because every funnel of every supplier grows, but we've seen a disproportional growth of our design-in momentum for embedded versus previous year and also versus analog just in terms of the rates. And I will give some examples. We see good momentum in real-time control, think about EVs, onboard chargers, think about traction inverters, a very good momentum in connectivity, automotive, and beyond. Think about car entries, tire pressure monitoring, and other and body-related opportunities in the automotive market. I can continue with a -- the kind of our more application-specific products like our radar systems. We have great position and growing position in radar winning a lot of new business, both with the Tier-1s and the OEMs. This is a -- from imaging radar for the front to the corner radar to even parking assist and also in-cabin sensing, that radar is taking a bigger and bigger part in the automotive market. And many other examples on the industrial side, here the number of end equipment is really vast hundreds of end equipment, but this is where our catalog MCUs that we are really reviving the presence of TI and building a new portfolio based on our MSP family is doing very well in winning new business and across-the-board, across the markets, utilizing our channel advantage. So I can go on and on here, but again, just evidence of my excitement of what this business can do for us in the second half of this decade. Rafael?
Rafael Lizardi: Yes, I'll just add on your question on fall-throughs for embedded, of course, we don't give guidance separate for the segment. So the 75% to 85% gross margin fall-through ex-depreciation that I talked about earlier applies to both.
Haviv Ilan: Yes.
Rafael Lizardi: Outside of -- if we didn't have Lehi and I'll address that in a second, we didn't have that, I would say generally analog would be at the higher end of that range and better would be at the lower end. But for the next year, two or three because Lehi, all those costs are -- all those fixed costs are already there, including people, we are going to have some nice tailwind and all of the -- a good portion of that will go to embedded. But over the longer timeframe, 75% to 85% ex-depreciation is a good guide to use.
Dave Pahl: Yes, follow-on Harlon?
Harlan Sur: Yes. In terms of channel reach, right, we haven't heard you guys talk about ti.com in quite some time. I think the last data point we've got was it drove about $2 billion in sales in calendar 2022 and it sort of has this additional benefit from a business planning perspective of being a really good sort of leading indicator of demand inflections. As you've sort of potentially past the bottom of sort of the current cycle here, wondering if there's been any notable movement or trends in ti.com. And maybe from a longer-term perspective, like what initiatives has the team put in place to sort of further improve the customer pull to ti.com from a mid to longer-term perspective?
Haviv Ilan: Yes. Let me start more in the mid to longer term and then let Dave add some more color on how it looks versus the cycle. So in terms of the investment in tI.com, yes, they are continuing. These are very strategic and important investments for us. We believe there is a huge opportunity to digitize what we call the last mile or that interface between us and the customers. There are many, many customers, still a long tail of customers that we can't see today. But as they move to ti.com, we can supply with them with more information, we can even provide an opportunity to place backlog electronically, directly with TI. And in that sense, the importance for us is to just know our customers better, understand the end equipment, and provide the relevant product portfolio to serve their growth and win market share, right? So that data is to us very, very important that the direct connectivity with the customer is important. To do just that, we are investing in IT systems. We are investing in warehouses or if you will, logistics to serve these customers just in time as they needed and that is part of the way customers would opt to TI and just connect directly to us. Now in terms of the short-term, Dave, maybe you can talk a little bit about what we're seeing there through the cycle.
Dave Pahl: Yes. And as we would -- have expected, orders that are placed through ti.com are down significantly from its peak, just, I think just telling of where we are with availability of product. But the great thing with ti.com is customers connect through APIs and put their planning systems on that. When they do have a shortage, they can look into our inventory, they can see it, some have even automated that process and have products shipped in many cases the same day. So we think the long-term strategic value of ti.com is much higher than the transaction that will cross it here in the short-term. So, thank you, Harlan. We can go to the next caller, please.
Operator: Thank you. Our next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
Joseph Moore: Great. Thank you. I wonder just as you kind of think about this longer-term strategy, you've got well over 200 days of inventory, you have relatively low factory utilization. Like do you think this means we won't have shortages down the road that people can look at the capacity that you have, the inventory that you have and they won't have the need to accumulate inventory? Is that part of the thinking? Or do you think it's just inevitable that we'll get back to that at some point?
Haviv Ilan: Again, the investment first in capacity ahead of the demand and then in inventory is done to really improve customer service, right. And we believe it's important to keep that not only now when it's kind of easy and the -- we have a market cycle at you can call it at a low-point. The test for our company would be at the next up-cycle, okay, not only in upcycle, it is -- you can model, Joe, any upcycle that you want, but we want to be supporting our customers at the highest level even if the cycle looks like a very steep one. And we model, for example, the COVID cycle as a similar one and that's what drives our investments. I think it's very, very important to sell your customers ahead of the competition at times like that because that's the opportunity to gain share and we are going to be prepared for that opportunity. Having said that, all that is done in a very thoughtful way. Inventory is being built at the right part where we have this diversity and longevity position such that we don't risk the scrap of the inventory. And I'm pleased with the progress we've made, but the test will come and I'm sure it will come one day at the next up-cycle. I don't know if you want to add anything, Dave.
Dave Pahl: That's good. Joe, do you have a follow-up?
Joseph Moore: Yes. I mean, just to follow up on that, to that, to the extent that your competition is doing things more the way they traditionally have and probably will see boom-bust cycles, what happens in that next upturn if they can't get parts from three of your competitors, is there a way you can keep them from accumulating inventory of TI components, even though they shouldn't need to. I mean, that seems like it's part of kind of the industry behavior in the past. Just how focused are you on trying to dampen that?
Haviv Ilan: Yes. Well, again, I think our capacity and the inventory level that we have built are such that we tend to provide good or very high customer service levels, right. So our intention is to maintain lead times through the cycle. We -- it depends what cycle you throw, you throw at us. There is always going to be that one cycle or that steep cycle that maybe we won't be able to do it. But we have modeled the company in such a way that in most a demand situation, we would be able to maintain a good customer or hike customer service levels through the cycle, which hopefully will keep the lead times short and which I'm pretty sure we will encourage customers not to hoard inventory. That has to be proven, but that's the way we want to prepare for the future.
Dave Pahl: Yes.
Joseph Moore: Very helpful. Thank you.
Dave Pahl: And if I added one thing, I'd just say that I spent eight years in sales, a joke I never once took a double order and so trying to control customer behavior when things get short, people want to build more inventory, right? And so that's just the behavior that I think that will be in our industry for the foreseeable future, but we can gain share in those periods of time and that's the advantage of having the capacity in place. So that said, we'll go to the next call -- or next and last caller, please.
Operator: Thank you. Our last question comes from the line of Chris Caso with Wolfe Research. Please proceed with your question.
Chris Caso: Thank you. Yes, thanks. Good evening. The question is on your comment -- earlier comments on China. It sounds like that rebounded fairly robustly in the first quarter. Could you give some more color on what you're seeing within China? And then do you think -- do you feel that those Chinese customers are still burning their inventory? Are you still undershipping demand there?
Haviv Ilan: Yes, thanks for the question. So first, I would say that in China, it's a -- there is a very distinct signal that customers have walked down their inventories. And we've seen that you know spreading through a time with the market. If you think about the asynchronous behavior that we have described of the different markets, we saw the same in China. The personal electronics business picked in China somewhere in 2021, enterprise and industrial sometimes in 2022, and then automotive picked sometimes in 2023. So you saw that peak spread over three years, which I think is the reason we saw such an elongated decline of seven quarters in a row and we went backwards to our history and it's been one of the longest, if not the longest cycle we have seen. But I can see clearly that it's mainly played out. Of course, we will always find pockets and a few sectors on the industrial -- in the industrial market that are still going through that, but it's very clear that once you start to shift to end demand, you will see such behavior of, in our case 20% sequential growth and that momentum is being built across the markets. All markets did very well in China, growing between 15% to 20% something percent, okay. So very robust, coherent and that's like a recovery looks like. Now we haven't seen that across the other markets. I will even tell you that areas like you know Europe and Japan are in an early phase and hopefully, it doesn't take seven quarters per geography, but China was kind of the first into the upcycle, the beginning of COVID, the first one to correct on the down and now to me, the first one kind of raising a very strong sequential growth with momentum. So that's the way I would summarize it without trying to imply that we'll see the same behavior in each and every other market.
Dave Pahl: Do you have a follow-on, Chris?
Chris Caso: I do. Thanks. And just a quick follow-up and I'm sure this is another thing you'll address on the August call, but you narrowed the range for depreciation next year down a little bit. Last quarter, you talked about CapEx kind of being around this $5 billion level per year. It was down sequentially in the second quarter. Is $5 billion still a reasonable way of looking CapEx this year?
Haviv Ilan: Yes. There is no news here strategically, but Rafael, maybe do you want to guide on CapEx?
Rafael Lizardi: No, absolutely no. This year, $5 billion, what you saw in second quarter is just little puts and takes on a quarterly basis, but for 2024, $5 billion of CapEx and the depreciation numbers I gave are reflective of that.
Dave Pahl: Okay.
Haviv Ilan: So let me wrap up with what we've said previously. At our core, we are engineers. Our technology is the foundation of our company, but ultimately, our objective and the best metric to measure progress and generate value for owners is the long-term growth of free cash flow per share. While we strive to achieve our objective, we'll continue to pursue our three ambitions. First, we will act like owners. We will own the company for decades. We will adapt and succeed in a world that's ever-changing and we will be a company that we are personally proud to be part of and we would want as our neighbor. When we are successful, our employees, customers, communities, and owners all benefit. Thank you, and have a good evening.
Operator: And this concludes today's conference and you may disconnect your lines at this time. Thank you for your participation. |
GOOG | 2 | 2,024 | 2024-07-23 19:05:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
Jim Friedland : Thank you. Good afternoon everyone and welcome to Alphabet's Second Quarter 2024 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler, and Ruth Porat. Now, I'll quickly cover the Safe Harbor. Some of the statements that we make today regarding our business, operations, and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors. We undertake no obligation to update any forward-looking statement. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise. And now I'll turn the call over to Sundar.
Sundar Pichai : Thank you, Jim. And hello, everyone. I'm really pleased with our results this quarter. They showed tremendous ongoing momentum in Search and great progress in Cloud with our AI initiatives driving new growth. Search had another excellent quarter. And in terms of product innovation, we are seeing great progress with AI overviews. In Q2, Cloud reached some major milestones. Quarterly revenues crossed the $10 billion mark for the first time, at the same time pass the $1 billion mark in quarterly operating profit. Year-to-date, our AI infrastructure and generative AI solutions for Cloud customers have already generated billions in revenues and are being used by more than 2 million developers. As I spoke about last quarter, we are uniquely well-positioned for the AI opportunity ahead. Our Research and Infrastructure leadership means, we can pursue an in-house strategy that enables our product teams to move quickly. Combined with our model building expertise, we are in a strong position to control our destiny, as the technology continues to evolve. Importantly, we are innovating at every layer of the AI stack, from chips to agents and beyond, a huge strength. We are committed to this leadership long-term. This was underscored by the announcements we made at I/O, Cloud Next, and Google Marketing Live, and we'll touch on many of them here. Today, I'll start with Search, then move to our AI momentum more generally, followed by Cloud, YouTube, and some closing thoughts. Let's dive in. Over the past 25 years, we have continued to reimagine and expand Google Search across many technological shifts. With AI, we are delivering better responses on more types of search queries and introducing new ways to search. We are pleased to see the positive trends from our testing continue as we roll out AI overviews, including increases in search usage, and increased user satisfaction with the results. People who are looking for help with complex topics are engaging more and keep coming back for AI overviews. And we see even higher engagement from younger users, aged 18 to 24, when they use search with AI overviews. As we have said, we are continuing to prioritize approaches that send traffic to sites across the web. And we are seeing that ads appearing either above or below AI overviews, continue to provide valuable options for people to take action and connect with businesses. Beyond AI overviews, AI expands the types of queries we are able to address and opens up powerful new ways to search. Visual search via Lens is one. Soon you'll be able to ask questions by taking a video with Lens. And already we have seen that AI overviews in Lens, leads to an increase in overall visual search usage. Another example is Circle to Search, which is available today on more than 100 million Android devices. We are seeing tremendous momentum from our AI investments. More than 1.5 million developers are now using Gemini across our developer tools. And we recently unveiled new models that are more capable and efficient than ever. Gemini now comes in 4 sizes, with each model designed for its own set of use cases. It's a versatile model family that runs efficiently on everything from data centers to devices. At 2 million tokens, we offer the longest context window of any large-scale foundation model to-date, which powers developer use cases that no other model can handle. Gemini is making Google's own products better. All six of our products with more than 2 billion monthly users now use Gemini. This means that Google is the company that's truly bringing AI to everyone. Gemini is powering incredibly helpful features in search, workspace, Google messages, and more. At I/O, we showed new features coming soon to Gmail and to Google Photos. Soon you'll be able to ask photos questions like, what did I eat at that restaurant in Paris last year? For a glimpse of the future, I hope you saw Project Astra at I/O. It shows multimodal understanding and natural conversational capabilities. We've always wanted to build a universal agent and it's an early look at how they can be helpful in daily life. Our AI product advances come from our long-standing foundation of research leadership, as well as our global network of infrastructure. In Q2, we announced our first data center and cloud region in Malaysia, and expansion projects in Iowa, Virginia, and Ohio. Our TPUs are a key bet here, too. Trillium is the sixth generation of our custom AI accelerator, and it's our best performing and most energy efficient TPU to-date. It achieves a near 5 times increase in peak compute performance per chip and a 67% more energy efficient compared to TPU v5e. And the latest Nvidia Blackwell platform, will be coming to Google Cloud in early 2025. We continue to invest in designing and building robust and efficient infrastructure to support our efforts in AI, given the many opportunities we see ahead. Of course, as we do this, we'll continue to create capacity by allocating resources towards our highest priorities. We are relentlessly driving efficiencies in our AI models. For example, over the past quarter, we have made quality improvements that include doubling the core model size for AI overviews, while at the same time improving latency and keeping cost per AI overviews served flat. And we are focused on matching the right model size to the complexity of the query in order to minimize impact on cost and latency. Separately on our real estate investments, we are taking a measured approach to match the current and future needs of our hybrid workforce, as well as our local communities. Next, Google Cloud. We continue to see strong customer interest, winning leading brands like Hitachi, Motorola Mobility, and KPMG. Our deep partnership with Oracle significantly expanded our joint offerings to the large customer base. Our momentum begins with our AI infrastructure, which provides AI startups like Essential AI, with leading cost performance for models and high-performance computing applications. We continue to drive fundamental differentiation with new advances since Cloud Next. This includes Trillium, which I mentioned earlier, and A3 Mega powered by Nvidia H100 GPUs, which doubles the networking bandwidth of A3. Our enterprise AI platform, Vertex, helps customers such as Deutsche Bank, Kingfisher, and the US Air Force build powerful AI agents. Last month, we announced a number of new advances. Uber and WPP are using Gemini Pro 1.5 and Gemini Flash 1.5 in areas like customer experience and marketing. We broaden support for third-party models, including Anthropic's Claude 3.5 Sonnet and open source models like Gemma 2, Llama and Mistral. We are the only cloud provider to offer grounding with Google Search, and we are expanding grounding capabilities with Moody's, MSCI, ZoomInfo, and more. Our AI-powered applications portfolio is helping us win new customers and drive upsell. For example, our conversational AI platform is helping customers like Best Buy and Gordon Food Service. Gemini for Workspace helps click therapeutics analyze patient feedback as they build targeted digital treatments. Our AI-powered agents are also helping customers develop better quality software, find insights from their data, and protect their organization against cybersecurity threats using Gemini. Software engineers at Wipro are using Gemini code assist to develop, test, and document software faster. And data analysts at Mercado Libre are using BigQuery and Looker to optimize capacity planning and fulfill shipments faster. Cyber security risks continue to accelerate and the number of breaches continue to grow, something we all see in the news every day and that our [Mandiant teams] (ph) help manage. Our strong track record of uptime, quality control and reliability made Google Cloud the trusted security choice for organizations like Fiserv and Marriott International. In Q2, we infused AI throughout our security portfolio, helping TELUS strengthen its proactive security posture. Turning next to YouTube, YouTube is focused on a clear strategy, connecting creators with a massive audience and enabling them to build successful businesses through ads and subscriptions, while helping advertisers reach their desired audience. We had a great brand cast this quarter, and Philip will say more. I'm pleased at the progress here. YouTube has remained number one in US Streaming watch time, according to Nielsen. Views of YouTube shots on connected TVs more than double last year. And we are making it easier for creators to add captions and turn regular videos into shots. Next, on Android and Pixel. We joined Samsung for their Galaxy Unpacked event a few weeks ago, and we shared that Samsung's new devices will include the latest AI-powered Google updates on Android. It was a great event. I'm looking forward to our Made by Google event happening in August. We'll have lots to share around Android and the Pixel portfolio of devices. Our Pixel line is doing well. We recently introduced the new Pixel 8a, powered by our latest Google Tensor G3 chip. It provides beautiful AI experiences like Circle to Search, Best Take, and a Gemini-powered AI assistant. In other bets, I'm really pleased with the progress Waymo's making, a real leader in the space and getting rave reviews from users. Waymo's served more than 2 million trips to-date and driven more than 20 million fully autonomous miles on public roads. Waymo's now delivering well over 50, 000 weekly paid public rides, primarily in San Francisco and Phoenix. And in June, we removed the waitlist in San Francisco, so anyone can take a ride. Fully autonomous testing is underway in other Bay Area locations without a human in the driver's seat. Before I close, I want to acknowledge that today is Ruth's final earnings call. Let me take a moment to thank her for all she has done for Google and Alphabet as our longest-serving CFO. I'm excited to continue to work with her in her new role. And I look forward to welcoming our newly appointed CFO, Anat Ashkenazi. She starts next week, and you'll hear from her on our call next quarter. Thanks as always to our employees and partners everywhere for a great Q2. With that, over to you, Philip.
Philipp Schindler : Thanks, Sundar, and hello, everyone. Starting with performance, Google Services delivered revenues of $73.9 billion for the quarter, up 12% year-on-year. Search and other revenues grew 14% year-on-year, led by growth in the retail vertical, followed by financial services. YouTube ads revenues were up 13% year-on-year driven by growth and brand as well as direct response. Network revenues declined 5% year-on-year. In subscriptions, platforms, and devices, year-on-year revenues increased 14%, driven again by strong growth in YouTube subscriptions. For the rest of my remarks, I want to double click on two topics. First, how we're applying AI across the marketing process to deliver an even stronger ads experience. Second, YouTube's position as the leading multi-format platform. So let me start by sharing some of the ways we are applying AI to bring more performance benefits to even more businesses. Q2 brought several major opportunities to meet and learn from users, developers, creators, and customers. From I/O to Brandcast, Google Marketing Live and Can, a growing number of our customers and partners are looking to understand how to successfully incorporate AI into their businesses. This quarter, we announced over 30 new ads features, and products to help advertisers leverage AI and keep pace with the evolving expectations of customers and users. Across Search, PMax, DemandGen, and Retail, we're applying AI to streamline workflows, enhance creative asset production, and provide more engaging experiences for consumers. Listening to our customers, retailers in particular have welcomed AI-powered features to help scale the depth and breadth of their assets. For example, as part of a new and easier-to-use merchant center, we've expanded Product Studio, with tools that bring the power of Google AI to every business owner. You can upload a product image from the AI with something like, feature this product with Paris skyline in the background and Product Studio will generate campaign ready assets. I also hear great feedback from our customers on many of our other new AI-powered features. We're beta testing, virtual try on and shopping ads and plan to roll it out widely later this year. Feedback shows this feature gets 60% more high-quality views than other images and a higher click-out to retailer sites. Retailers love it because it drives purchasing decisions and fewer returns. Our AI-driven profit optimization tools have been expanded to performance max and standard shopping campaigns. Advertisers use profit optimization and smart bidding see a 15% uplift in profit on average compared to revenue-only bidding. Lastly, DemandGen is rolling out to Display in Video 360 and Search Ads 360 in the coming months with new generative image tools that create stunning high-quality image assets for social marketers. As we said at GML, when paired with Search or PMax, DemandGen delivers an average of 14% more conversions. The use cases we're seeing across the industry show the incredible potential of these AI-enabled products to improve performance. Let me briefly share two examples with you. Luxury jewelry retailer Tiffany leveraged DemandGen during the holiday season and saw 2.5% brand lift in consideration and actions, such as adding items to cards and booking appointments. The campaign drove a 5.6 times more efficient cost per click compared to social media benchmarks. Our own Google marketing team used DemandGen to create nearly 4,500 ad variations for a Pixel 8 campaign shown across YouTube, Discover, and Gmail, delivering twice the click-through rate at nearly a quarter of the cost. In addition to strengthening our ads products for customers, we continue to evolve our existing systems and products with improved models delivering further performance gains. In just six months, AI-driven improvements to quality, relevance, and language understanding have improved Broad Match performance by 10% for advertisers using Smart Bidding. Also, advertisers who adopt PMax to Broad Match and Smart Bidding in their Search campaigns, see an average increase of over 25% more conversions or value at a similar cost. We'll continue to listen to our customers and use their feedback to drive innovation across our products. As you can hear, I continue to be excited about the AI era for ads. Now let's turn to YouTube. I've talked before about our approach to making YouTube the best place to create, watch and monetize. First, the best place to create. What sets YouTube apart from every other platform are the creators and the connection they have with their fans. Audiences tuning in to watch their favorite creators continue to grow. For example, two weeks ago, Mr. Beast's channel hit more than 300 million subscribers. Next, the best place to watch. Our long-term investment in CTV continues to deliver. Views on CTV have increased more than 130% in the last three years. According to Nielsen, YouTube is the Number #1 most watched streaming platform on TV screens in the US for the 17th consecutive month. Zooming out, when you look not just at streaming, but at all media companies and their combined TV viewership, YouTube is the second most watched after Disney. And this growth is happening in multiple verticals, including sports, which has seen CTV watch time on YouTube grow 30% year-over-year. Lastly, the best place to monetize. CTV on YouTube is continuing to benefit from a combination of strong watch time growth, viewer and advertiser innovation and a shift in brand advertising budgets from linear TV to YouTube. Our largest advertisers across verticals, including retail, entertainment, telco and home and personal care, are partnering with creators on ads and organic integrations. Verizon, for example, worked with a YouTube creator and Verizon customer to show them many ways that plans and offerings can be customized to fit people’s lives. Using AI-powered formats, they created sketches in multiple lengths and orientations to serve the right creative to the right viewer and drive people to their site. Verizon's creator ads had a 15% lower CPA and a 38% higher conversion rate versus other ads. Turning to Shorts. Last quarter, I shared that in the US, the monetization rate of YouTube Shorts relative to in-stream viewing is showing a healthy rate of growth. Again, this quarter, we continue to see an improvement in Shorts monetization, particularly in the US. We are also seeing a very encouraging contribution from brand advertising on Shorts, which we launched on the product in Q4 last year. Lastly, a few words on shopping. Last year, viewers watched 30 billion hours of shopping-related videos, and we saw a 25% increase in watch time for videos that help people shop. While it is early days, shopping remains a key area of investment. At GML, we rolled out several product updates to YouTube shopping, helping creators sell products to their viewers. These updates included; product tagging where creators can tag products in their videos for viewers to discover and purchase, product collections and a new affiliate hub, a one-stop shop for creators to find deals and promotional offers from brands and track their affiliate earnings. With that, I'll finish by saying a huge thank you to Google's everywhere for their extraordinary commitment and to our customers and partners for their continued collaboration and trust. And Ruth, thanks for your amazing leadership and partnership over all these years. Now for one last time, it's over to you.
Ruth Porat : Thank you, Philipp, and thanks, Sundar, for those kind words. We had another strong quarter, driven in particular by performance in Search and Cloud, as well as the ongoing efforts to durably reengineer our cost base. My comments will be on year-over-year comparisons for the second quarter unless I state otherwise. I will start with results at the Alphabet level followed by segment results and conclude with our outlook. For the second quarter, our consolidated revenues were $84.7 billion, up 14% or up 15% in constant currency. Search remained the largest contributor to revenue growth. In terms of expenses, total cost of revenues was $35.5 billion, up 11%. Other cost of revenues was $22.1 billion, up 14%, with the increase driven primarily by content acquisition costs, followed by depreciation as well as the impact of the Canadian digital services tax, which was applied retroactively. Operating expenses were $21.8 billion up 5%, primarily reflecting an increase in R&D partially offset by a decline in G&A with sales and marketing essentially flat to the second quarter last year. The increase in R&D was driven primarily by compensation which was affected by lapping a reduction in valuation-based compensation liabilities in certain other bets in the second quarter last year followed by depreciation. The largest single factor in the year-on-year decline in G&A expenses was lower charges related to legal matters. Operating income was $27.4 billion, up 26% and our operating margin was 32%. Net income was $23.6 billion and EPS was $1.89. We delivered free cash flow of $13.5 billion in the second quarter and $60.8 billion for the trailing 12 months. As a reminder, last year, we had a timing benefit in the second and third quarters from a $10.5 billion deferred cash tax payment made in the fourth quarter, which depressed reported free cash flow growth this quarter, and we'll do so again next quarter. We ended the quarter with $101 billion in cash and marketable securities. Turning to segment results. Within Google Services, revenues were $73.9 billion, up 12%. Google Search and other advertising revenues of $48.5 billion in the quarter were up 14%, led again by growth in retail, followed by the financial services vertical. YouTube advertising revenues of $8.7 billion were up 13% driven by brand followed by direct response advertising. Network advertising revenues of $7.4 billion were down 5%. Subscription platforms and devices revenues were $9.3 billion up 14%, primarily reflecting growth in YouTube subscription revenues. TAC was $13.4 billion, up 7%. Google Services operating income was $29.7 billion up 27% and the operating margin was 40%. Turning to the Google Cloud segment. Revenues were $10.3 billion for the quarter, up 29%, reflecting first significant growth in GCP, which was above growth for cloud overall and includes an increasing contribution from AI. And second, strong Google Workspace growth, primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $1.2 billion and an operating margin of 11%. As to our Other Bets for the second quarter, revenues were $365 million and the operating loss was $1.1 billion. Turning to our outlook for the business. With respect to Google Services, First, within advertising. The strong performance of search was broad-based across verticals. In YouTube, we are pleased with the growth in the quarter. We had healthy watch time growth continued to close the monetization gap in Shorts and had continued momentum in Connected TV, with brand benefiting in part from an ongoing shift in budgets from linear television to digital. As we look forward to the third quarter, we will be lapping the increasing strength in advertising revenues in the second half of 2023, in part from APAC based retailers. Turning to subscriptions, platforms and devices. First, we continue to have significant growth in our subscriptions business which drives the majority of revenue growth in this line. However, there was a sequential decline in the year-on-year growth rate, as we anniversaried the impact of a price increase for YouTubeTV in the second quarter last year. The impact will persist through the balance of the year. Second, with regard to platforms. We are pleased with the performance in play driven by an increase in buyers. Finally, with respect to devices. The most important point as we look forward is that our Made by Google launches have been pulled forward into the third quarter from the fourth quarter last year benefiting revenues in Q3 this year. Turning to cloud, which continued to deliver very strong results. For the first time, Cloud crossed $10 billion in quarterly revenues and $1 billion in quarterly operating profit. As Sundar noted year-to-date, our AI infrastructure and generative AI solutions for cloud customers have already generated billions in revenues and are being used by more than 2 million developers. We're particularly encouraged that the majority of our top 100 customers are already using our generative AI solutions. We continue to invest aggressively in the business. Turning to margins. The margin expansion in Q2 versus last year reflects our ongoing efforts to durably reengineer our cost base, as well as revenue strength. Our leadership team remains focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure. Once again headcount declined quarter-on-quarter, which reflects both actions we have taken in the first half of the year and a much slower pace of hiring. Looking ahead, we expect a slight increase in headcount in the third quarter, as we bring on new graduates. As we have discussed previously, we’re continuing to invest in top engineering and technical talent, particularly in cloud and technical infrastructure. Looking forward, we continue to expect to deliver full-year 2024 Alphabet operating margin expansion relative to 2023. However, in the third quarter operating margins will reflect the impact of both the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure, as well as the increase in cost of revenues due to the pull-forward of hardware launches into Q3. With respect to CapEx, our reported CapEx in the second quarter was $13 billion, once again driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. Looking ahead, we continue to expect quarterly CapEx throughout the year to be roughly at or above the Q1 CapEx of $12 billion keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx. With regard to other bets, we continue to focus on improving overall efficiencies, as we invest for long-term returns. Waymo is an important example of this, with its technical leadership coupled with progress on operational performance. As you will see in the 10-Q, we have chosen to commit to a new multi-year investment of $5 billion. This new round of funding, which is consistent with recent annual investment levels will enable Waymo to continue to build the world's leading autonomous driving technology company. To close, this is my 56th and last earnings call, 37 of them at Alphabet. So I have a few closing thoughts of gratitude. I've been so proud to be at Google and Alphabet as CFO and to work with some of the smartest people in the world every day. I think, we have accomplished a lot in the last nine plus years, and I am confident that progress will continue. Of course, I'm not going far and I'm honored to have my new role, which I've been slowly working my way into during the past 11 months and I look forward to continuing to work with Sundar, and our great team. Being CFO of one of the most important companies in the world has been the opportunity and responsibility of a lifetime. Google's Mission of advancing technology and bringing information to people throughout the world is as relevant today as it was when I worked on its IPO. Technology has been a catalyst for economic growth throughout human history. The people on this call know that if a technological advancement is not the focus of every business and government, they will be left behind. Underpinning this is the need for sound and responsible investment. That has never been more important than today and certainly, that is Google and Alphabet's focus. I want to end by thanking Googlers around the world for the innovation and commitment that has enabled us to deliver such extraordinary products and services globally. I also want to thank our investors and analysts for your long-term support and your feedback. Thank you. Sundar, Philipp and I will now take your questions.
Operator: Thank you. [Operator Instructions] Your first question comes from Brian Nowak with Morgan Stanley. Your line is now open.
Brian Nowak: Thanks for taking my questions. First, thank you Ruth for all the help and significant impact over the past decade. The first one, it is a little bit of a jump ball, I guess for Sundar, Philipp or Ruth. I guess we're sort of 18 months this fever pitch around the GenAI focus in the world. Maybe from any of your perspective, can you just sort of talk to us about areas where you've seen faster than expected traction or testing adoption of some of the AI, generative AI capabilities versus slower than expected traction and testing from a Google perspective. And then, Ruth I appreciate all the comments about structurally reengineering the OpEx base. Are there any more tangible examples of areas you can talk to us about where you still see further ways to drive more efficiency across the company. Thanks.
Sundar Pichai: Brian, thanks. I'll take the first part. I think it's a good question. Obviously, I think there is a time curve in terms of taking the underlying technology and translating it into meaningful solutions across the Board, both on the consumer and the enterprise side. Definitely, on the consumer side, I'm pleased, as I said in my comments earlier in terms of how for a product like Search, which is used at that scale over many decades. How we've been able to introduce it in a way that it's additive and enhances the overall experience and this positively contributing there. I think across our consumer products, we've been able -- I think we are seeing progress on the organic side. Obviously monetization is something that we would have to earn on top of it. The enterprise side, I think we are at a stage where definitely there are a lot of models. I think roughly, the models are all kind of converging towards a set of base capabilities. But I think where the next wave is, working to build solutions on top of it. And I think there are pockets, be it coding, be it in customer service, et cetera, where we are seeing some of those use cases seeing traction, but I still think there is hard work there to completely unlock those.
Ruth Porat: And on your second question first, thank you for your comments. Look, the reason we've consistently used the term, the phrase that we're focused on durably reengineering our cost base is because these are deep work streams. They are not tactical fixes, and we continue to build on them. And so the main areas that we've talked about are around product and process prioritization around organizational efficiency and structure. Both of those are reflected in the headcount and the fact that headcount is down year-on-year. And across all of those -- as I said, across our entire leadership team, we remain focused on continuing to execute against them. So in terms of the most recent examples, as we talked about last quarter with the combination of the devices and services product area with the platforms and ecosystems product area, we announced that back in April. And what we discussed last quarter and what we're seeing is that unifying teams across these organizations, helps with product execution and what we're really focused on is really adding to velocity and efficiency. So kind of the gift that keeps giving. And then more broadly, all of the work streams that we've talked to you about before, we continue to remain focused on. A big one, very important one, is all of the efficiency efforts, the work streams around technical infrastructure and improving efficiency there. We are also working on the use of AI across Alphabet. We are working on continuing to build on what we've done with our centralized procurement organization. We are continuing to optimize our real estate portfolio. And so again this is across our leadership team. These are efforts that all build to this phrase durably reengineering our cost base.
Brian Nowak: Great. Thank you both.
Operator: Our next question comes from Doug Anmuth with JPMorgan. Your line is now open.
Doug Anmuth: Thanks for taking my questions. One for Ruth and one for Sundar. Ruth you've now had Google Services operating margins roughly 40% for the past two quarters. Just as you create more capacity to help offset the future investments, is it reasonable to think that you could sustain at those kind of levels going forward? And then, Sundar just as it relates to AI overviews, you talked about the positive trends there. Can you just help us understand where you are, how far along in rolling-out AI overviews and then any more color around kind of click-through rates and monetization levels relative to your traditional searches. Thanks.
Ruth Porat: So in terms of the Google services operating margin, it did reflect all the work that we are doing on durably reengineering the cost base. It also reflected the benefit of strong revenue performance in search. And so what I tried to lay out in the comments, as we look forward to the third quarter is operating margins will reflect the increases in depreciation and expenses associated with higher levels of our investment in technical infrastructure. It will also reflect higher expenses associated with the Pixel launch, due to the pull forward. So those are important factors. I would say, overall company-wide, it is important to note that we do expect to continue to deliver full year '24 Alphabet operating margin expansion relative to 2023, but I did want to highlight those important points as we look forward to Q3.
Sundar Pichai: And Doug, thanks. On the AI overview, we are -- we have rolled it out in the US and we are -- will be through the course of the year, definitely scaling it up both to more countries. And also, we have taken a conservative start focused on quality, making sure the metrics are healthy and so on, but you will see us expand the use cases around it, and we'll touch definitely more queries. All the feedbacks we have seen are positive. And on the monetization side, I think Philipp has touched upon it. Maybe Philipp, anything more you want to add there?
Philipp Schindler: Yes, look, innovation and improvements to the user experience on search have historically opened up new opportunities for advertisers. We talked about this before we saw this when we navigated from desktop to mobile for example. And we can see GenAI obviously expand the types of questions we can help people with, as Sundar mentioned. And as we said before, people are finding ads either above or below AI overviews helpful. We have a solid baseline here from which we can innovate and as you have probably noticed at GML, we announced that soon we'll actually start testing Search and Shopping ads in AI overviews for users in the US, and they will have the opportunity to actually appear within the overview in a section clearly labeled as sponsored, when they're relevant to both the query and the information in the AI overview, really giving us the ability to innovate here and take this to the next level.
Doug Anmuth: Thank you. Best of luck, Ruth, in your new role.
Ruth Porat: Thank you.
Operator: Our next question comes from Michael Nathanson with Moffett. Please go ahead.
Michael Nathanson: Thanks. I have two, one for Sundar and one for Philipp. Sundar, on decision this week to not deprecate cookies. I know it's been a long journey. Can you talk a bit about what we should expect in terms of new experience in Chrome and why the company makes a decision not to go down the path on deprecating cookies. And then Philipp, I know it's only one quarter, but it's interesting that Search is growing faster than YouTube, which surprised some of us. But can you talk about what factors you think are kind of differences in growth rates between these markets? And is there anything on the AI front that you could see maybe reaccelerating YouTube growth, as you've seen happen with Search. Thanks so much.
Sundar Pichai: And Michael on cookies, Look I think, obviously we are super committed to improving privacy for users in chrome and there was the whole focus around privacy sandbox and we remain committed on the journey, but on third-party cookies, given the implications across the ecosystems and considerations and feedback across so many stakeholders. We now believe user choice is the best path forward there and we'll both improve privacy by giving users choice and we'll continue our investments in privacy enhancing technologies, but it is obviously an area we will be taking feedback from the players in the ecosystem and we are committed to being privacy first as well.
Philipp Schindler: And on the second part of your question, maybe Ruth, you want to jump in first and then I take the rest if needed.
Ruth Porat: Absolutely. So Look, as we both noted, search revenues really reflected broad based growth across verticals. That was led by retail followed by financial services. I think your question really goes to the heart of the year-on-year growth comparison. And as both Philipp and I noted, we are really pleased with YouTube, the YouTube team all that was done, it was driven by brand followed by direct response, and they have very strong ongoing operating metrics, which Philipp will comment on. I think the important point to note, and I tried to tease out in opening comments, was that the deceleration in this year-on-year revenue growth for the second quarter versus the first quarter, primarily reflected the tougher comparison versus the first quarter because at that point, as you probably recall, YouTube was lapping negative year-on-year growth in Q1 last year. And then also Q1 benefited from the extra from leap year. And so what you are also seeing here is with YouTube, we were [anniversaring] (ph) the ramp in APAC based retailers that began in the second quarter last year and foreign exchange headwinds as well that we noted. And so it's -- there are some timing issues going on. And what we are trying to highlight is the underlying operating strength. Back to you, Philipp.
Philipp Schindler: Yes, that was very comprehensive. Nothing really to add from my side here.
Sundar Pichai: The only thing I would say, adding to Brian's first question on areas where things are maybe taking longer. I think, look we are all building multimodal models. At least Gemini has been natively multimodal from the ground up. But most of the use cases today that have been unlocked have been around the tech side. So in terms of getting real generative audio, video experience is working well. I think there is still – it is going to take some time. But over time, obviously it will be deeply relevant to YouTube and so it's an area I'm excited about in the future.
Michael Nathanson: Okay. Thanks a lot. And best to you. Thanks.
Operator: Your next question comes from Eric Sheridan with Goldman Sachs. Your line is now open.
Eric Sheridan: Thanks so much. And I'll echo the thanks for Ruth, for all the insights and partnership over the years on these earnings calls. Sundar maybe first for you, in terms of Cloud and bringing AI to the enterprise, I wanted to know if you go a little bit deeper in terms of how you are seeing AI actually get adopted implemented, what it potentially could mean for the strategic positioning of the cloud business and the potential for AI workloads to be a stimulant to revenue growth for Cloud first. And then following up the last set of questions on YouTube are really about the macro or the ad environment. What do you guys, as a team, continue to learn about the subscription side of YouTube and the appetite for consumers to engage with a broader array of media products at the subscription layer. Thanks.
Sundar Pichai: Thanks Eric. Look, on the Cloud and AI stuff, obviously, it is something which I think will end up being a big driver over time. I mentioned in my opening remarks, already if you take a look at our AI infrastructure and generative AI solutions for cloud across everything we do, be it compute on the AI side, the products we have through Vertex AI, Gemini for Workspace and Gemini for Google Cloud, et cetera, we definitely are seeing traction. People are deeply engaging with Gemini models across Vertex and AI studio. We now have over 2 million developers playing around with these things, and you are definitely seeing early use cases. But I think we are in this phase, where we have to deeply work and make sure on these use cases, on these workflows. We are driving deeper progress on unlocking value, which I'm very bullish will happen, but these things take time. So -- but if I were to take a longer-term outlook, I definitely see a big opportunity here. And I think particularly for us, given the extent to which we are investing in AI, our research infrastructure leadership, all of that translates directly. And so I'm pretty excited about the opportunity space ahead.
Ruth Porat: And then on your second question with respect to subscriptions, I am implicit in your question, how strong is it, as I noted in opening comments, that overall line subscriptions platforms and devices delivered healthy growth and that was led by subscriptions. And as we've said on many calls here in a row, the subscription revenue growth continued to be quite strong. It was driven by subscriber growth in both YouTube TV and YouTube Music premium. And then the other component within that line is Google One that also delivered strong subscriber and revenue growth. I think the heart of your question is really around YouTube and that is the heart of the revenues in that line. So it continues to be very strong. We see a lot of take up in it, strong subscriber growth, really pleased with it. We did note that growth on that line decelerated due to anniversarying the YouTube TV price increase. But at the heart of it, our people interested in the subscription offerings and it’s the take of significant. We're really pleased with it.
Eric Sheridan: Thank you.
Operator: Our next question comes from Ross Sandler with Barclays. Your line is now open.
Ross Sandler: Hi, everybody. Just two questions on the AI CapEx. So it looks like from the outside at least, the hyperscaler industry is going from kind of an under bill situation this time last year to better meeting the demand with capacity right now to potentially being overbuilt next year if these CapEx growth rates keep up. So do you think that's a fair characterization? And how are we thinking about the return on invested capital with this AI CapEx cycle. And then related to that, do you think that the AI industry is close to or far away from hitting some kind of wall on foundation model improvement in AI training, based on like lack of availability of new data to train on. Just your thoughts on that would be great. Thank you.
Sundar Pichai: Thanks Ross. I think great questions. Look, I -- obviously, we are at an early stage of what I view as a very transformative area and in technology when you are going through these transitions, aggressively investing upfront in a defining category, particularly in an area in which in a leveraged way cuts across all our core areas our products, including Search, YouTube and other services, as well as fuels growth in Cloud and supports the innovative long-term Bets and Other Bets is definitely something for us makes sense to lean in. I think the one way I think about it is when we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over investing. We clearly -- these are infrastructure, which are widely useful for us. They have long useful lives and we can apply it across, and we can work through that. But I think not investing to be at the frontier, I think definitely has much more significant downside. Having said that, we obsess around every dollar we put in. Our teams are -- work super hard, I'm proud of the efficiency work, be it optimization of hardware, software, model deployment across our fleet. All of that is something we spend a lot of time on, and that's how we think about it. To your second question on whether -- how do the scaling loss hold. Are we hitting on some kind of wall or something? Look, I think we are all pushing very hard, and there is going to be a few efforts, which will scale up on the compute side and push the boundaries of these models. What I would tell is regardless of how that plays out, you still think there is enough optimizations we are all doing, which is driving constant progress in terms of the capabilities of the models. And more importantly, taking them and translating into real use cases across the consumer and enterprise side, I think on that frontier. I think there is still a lot of progress to be had. And so we are pretty focused on that as well.
Ross Sandler: Thank you.
Operator: Our next question comes from Stephen Ju with UBS. Your line is now open.
Stephen Ju: Okay. Thank you so much. So Sundar, I guess to ask the AI question a different way. As we talk to some of the model builders out there, it looks like the initial use cases are more on the cost savings or efficiency side. But when do we -- when do you think we'll start thinking about products that can help revenue generation for the Fortune 500, Fortune 1000 companies, which is probably something that can hopefully create greater value over time versus just cutting costs? And Philipp, listening to what will be, I guess Ruth's final comments on Q2 on these public calls. And thank you, by the way Ruth, for all the help. I couldn't help but notice that the bigger factors were brand followed by direct response. And if we continue to think that the one you bring up first is the larger factor and tying this into your prior commentary about shopping being an important consideration. When do you think we'll start talking about direct response being a much bigger contributor to YouTube's growth versus brand? Thank you.
Sundar Pichai: On the first part of the question look I think the technology's horizontal enough, it can apply on both sides. If you take a use case like improving the customer service experience, it is part of it which is driving efficiencies, and you can look at it from a cost standpoint, but you could also be overall improving the experience, improving conversion, driving the funnel better. And so increasing basket size if you are a retail e-commerce player, et cetera. So we are seeing people experiment across both sides. And so I think, you will see it played across both sides. Philipp, on the second one?
Philipp Schindler: Yes. On the second one, look on the direct response side, as you know it is about driving and converting commercial intent and customers are obviously benefiting from including video in their AI-powered campaigns, it could be PMax, it could be DemandGen and obviously using our automated tools to enhance and create video creatives. And we are very, very optimistic about this path. On average advertisers who run both image and video ads with DemandGen campaigns see 6% more conversions per dollar than those running image only ads and discovery. And this is just one little example of how this can obviously boost your performance business. So that's a big part. The brand side, as you know Google AI continues to make it easier for brands to show up next to the content where viewers are obviously the most engaged. And they're finding it, as you can see from the numbers, a very effective way to drive awareness and consideration. And we are also quite excited about some of the recent launches on YouTube shopping side, if you want to put that into the direct response bucket.
Stephen Ju: Okay. Thank you.
Operator: And our last question comes from Justin Post with Bank of America. Your line is now open.
Justin Post: Great. I'll ask a couple of areas. First on the cloud acceleration, would you characterize that as new AI demand helping drive that year-to-date? Or is that more of a rebound in just general compute and other demand or is AI really moving this forward and helping drive acceleration. And then I wanted to ask about your internal cost savings which has been really strong. How are you using AI internally to help cut costs? Are you seeing better efficiencies with your engineers? And just would love to hear about how you are applying AI to cut your own costs? Thank you.
Ruth Porat: Great. Thank you for that. So overall we are -- as both Sundar and I said, we are very pleased with the results in Cloud. And there is clearly a benefit as the Cloud team is engaging broadly with customers around the globe with AI related solutions, AI infrastructure solutions and the generative-AI solutions. I think we noted that we're particularly encouraged that the majority of our top 100 customers are already using our generative AI solution. So it is clearly adding to strength of the business on top of all that they are doing. And just to be really clear, the results for GCP, the growth rate for GCP is above the growth for cloud overall. And then I'll turn it to Sundar on the cost saving point, but just one point we are really pleased as well that Cloud's margin improved as it did. And in part, that reflects the revenue strength that they delivered and all of the efficiency efforts that I've already spoken about. But looking ahead in Q3, we do expect the same seasonal pattern that you saw last year with respect to margin and we are continuing to invest in the business.
Sundar Pichai: Look, I think specifically, if the question is about engineers and coding, et cetera, we definitely want to be on the cutting edge there. I think, we are making these tools available to some of the most [line of] (ph) productive engineers and demanding engineers out there, and they are definitely kicking the tires hard. And -- but I would say, it's still all in very early stages. I think particularly when it comes to writing high-quality secure code, but I think all the learnings what we are gaining here will translate into our models and products, and that's the virtuous cycle, which I'm excited by. So there's a lot more to come.
Justin Post: Great, thank you.
Operator: Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
Jim Friedland: Thanks everyone for joining us today. We look forward to speaking with you again on our third quarter 2024 call. Thank you and have a good evening.
Operator: Thank you everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
GOOGL | 2 | 2,024 | 2024-07-23 19:05:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
Jim Friedland : Thank you. Good afternoon everyone and welcome to Alphabet's Second Quarter 2024 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler, and Ruth Porat. Now, I'll quickly cover the Safe Harbor. Some of the statements that we make today regarding our business, operations, and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors. We undertake no obligation to update any forward-looking statement. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise. And now I'll turn the call over to Sundar.
Sundar Pichai : Thank you, Jim. And hello, everyone. I'm really pleased with our results this quarter. They showed tremendous ongoing momentum in Search and great progress in Cloud with our AI initiatives driving new growth. Search had another excellent quarter. And in terms of product innovation, we are seeing great progress with AI overviews. In Q2, Cloud reached some major milestones. Quarterly revenues crossed the $10 billion mark for the first time, at the same time pass the $1 billion mark in quarterly operating profit. Year-to-date, our AI infrastructure and generative AI solutions for Cloud customers have already generated billions in revenues and are being used by more than 2 million developers. As I spoke about last quarter, we are uniquely well-positioned for the AI opportunity ahead. Our Research and Infrastructure leadership means, we can pursue an in-house strategy that enables our product teams to move quickly. Combined with our model building expertise, we are in a strong position to control our destiny, as the technology continues to evolve. Importantly, we are innovating at every layer of the AI stack, from chips to agents and beyond, a huge strength. We are committed to this leadership long-term. This was underscored by the announcements we made at I/O, Cloud Next, and Google Marketing Live, and we'll touch on many of them here. Today, I'll start with Search, then move to our AI momentum more generally, followed by Cloud, YouTube, and some closing thoughts. Let's dive in. Over the past 25 years, we have continued to reimagine and expand Google Search across many technological shifts. With AI, we are delivering better responses on more types of search queries and introducing new ways to search. We are pleased to see the positive trends from our testing continue as we roll out AI overviews, including increases in search usage, and increased user satisfaction with the results. People who are looking for help with complex topics are engaging more and keep coming back for AI overviews. And we see even higher engagement from younger users, aged 18 to 24, when they use search with AI overviews. As we have said, we are continuing to prioritize approaches that send traffic to sites across the web. And we are seeing that ads appearing either above or below AI overviews, continue to provide valuable options for people to take action and connect with businesses. Beyond AI overviews, AI expands the types of queries we are able to address and opens up powerful new ways to search. Visual search via Lens is one. Soon you'll be able to ask questions by taking a video with Lens. And already we have seen that AI overviews in Lens, leads to an increase in overall visual search usage. Another example is Circle to Search, which is available today on more than 100 million Android devices. We are seeing tremendous momentum from our AI investments. More than 1.5 million developers are now using Gemini across our developer tools. And we recently unveiled new models that are more capable and efficient than ever. Gemini now comes in 4 sizes, with each model designed for its own set of use cases. It's a versatile model family that runs efficiently on everything from data centers to devices. At 2 million tokens, we offer the longest context window of any large-scale foundation model to-date, which powers developer use cases that no other model can handle. Gemini is making Google's own products better. All six of our products with more than 2 billion monthly users now use Gemini. This means that Google is the company that's truly bringing AI to everyone. Gemini is powering incredibly helpful features in search, workspace, Google messages, and more. At I/O, we showed new features coming soon to Gmail and to Google Photos. Soon you'll be able to ask photos questions like, what did I eat at that restaurant in Paris last year? For a glimpse of the future, I hope you saw Project Astra at I/O. It shows multimodal understanding and natural conversational capabilities. We've always wanted to build a universal agent and it's an early look at how they can be helpful in daily life. Our AI product advances come from our long-standing foundation of research leadership, as well as our global network of infrastructure. In Q2, we announced our first data center and cloud region in Malaysia, and expansion projects in Iowa, Virginia, and Ohio. Our TPUs are a key bet here, too. Trillium is the sixth generation of our custom AI accelerator, and it's our best performing and most energy efficient TPU to-date. It achieves a near 5 times increase in peak compute performance per chip and a 67% more energy efficient compared to TPU v5e. And the latest Nvidia Blackwell platform, will be coming to Google Cloud in early 2025. We continue to invest in designing and building robust and efficient infrastructure to support our efforts in AI, given the many opportunities we see ahead. Of course, as we do this, we'll continue to create capacity by allocating resources towards our highest priorities. We are relentlessly driving efficiencies in our AI models. For example, over the past quarter, we have made quality improvements that include doubling the core model size for AI overviews, while at the same time improving latency and keeping cost per AI overviews served flat. And we are focused on matching the right model size to the complexity of the query in order to minimize impact on cost and latency. Separately on our real estate investments, we are taking a measured approach to match the current and future needs of our hybrid workforce, as well as our local communities. Next, Google Cloud. We continue to see strong customer interest, winning leading brands like Hitachi, Motorola Mobility, and KPMG. Our deep partnership with Oracle significantly expanded our joint offerings to the large customer base. Our momentum begins with our AI infrastructure, which provides AI startups like Essential AI, with leading cost performance for models and high-performance computing applications. We continue to drive fundamental differentiation with new advances since Cloud Next. This includes Trillium, which I mentioned earlier, and A3 Mega powered by Nvidia H100 GPUs, which doubles the networking bandwidth of A3. Our enterprise AI platform, Vertex, helps customers such as Deutsche Bank, Kingfisher, and the US Air Force build powerful AI agents. Last month, we announced a number of new advances. Uber and WPP are using Gemini Pro 1.5 and Gemini Flash 1.5 in areas like customer experience and marketing. We broaden support for third-party models, including Anthropic's Claude 3.5 Sonnet and open source models like Gemma 2, Llama and Mistral. We are the only cloud provider to offer grounding with Google Search, and we are expanding grounding capabilities with Moody's, MSCI, ZoomInfo, and more. Our AI-powered applications portfolio is helping us win new customers and drive upsell. For example, our conversational AI platform is helping customers like Best Buy and Gordon Food Service. Gemini for Workspace helps click therapeutics analyze patient feedback as they build targeted digital treatments. Our AI-powered agents are also helping customers develop better quality software, find insights from their data, and protect their organization against cybersecurity threats using Gemini. Software engineers at Wipro are using Gemini code assist to develop, test, and document software faster. And data analysts at Mercado Libre are using BigQuery and Looker to optimize capacity planning and fulfill shipments faster. Cyber security risks continue to accelerate and the number of breaches continue to grow, something we all see in the news every day and that our [Mandiant teams] (ph) help manage. Our strong track record of uptime, quality control and reliability made Google Cloud the trusted security choice for organizations like Fiserv and Marriott International. In Q2, we infused AI throughout our security portfolio, helping TELUS strengthen its proactive security posture. Turning next to YouTube, YouTube is focused on a clear strategy, connecting creators with a massive audience and enabling them to build successful businesses through ads and subscriptions, while helping advertisers reach their desired audience. We had a great brand cast this quarter, and Philip will say more. I'm pleased at the progress here. YouTube has remained number one in US Streaming watch time, according to Nielsen. Views of YouTube shots on connected TVs more than double last year. And we are making it easier for creators to add captions and turn regular videos into shots. Next, on Android and Pixel. We joined Samsung for their Galaxy Unpacked event a few weeks ago, and we shared that Samsung's new devices will include the latest AI-powered Google updates on Android. It was a great event. I'm looking forward to our Made by Google event happening in August. We'll have lots to share around Android and the Pixel portfolio of devices. Our Pixel line is doing well. We recently introduced the new Pixel 8a, powered by our latest Google Tensor G3 chip. It provides beautiful AI experiences like Circle to Search, Best Take, and a Gemini-powered AI assistant. In other bets, I'm really pleased with the progress Waymo's making, a real leader in the space and getting rave reviews from users. Waymo's served more than 2 million trips to-date and driven more than 20 million fully autonomous miles on public roads. Waymo's now delivering well over 50, 000 weekly paid public rides, primarily in San Francisco and Phoenix. And in June, we removed the waitlist in San Francisco, so anyone can take a ride. Fully autonomous testing is underway in other Bay Area locations without a human in the driver's seat. Before I close, I want to acknowledge that today is Ruth's final earnings call. Let me take a moment to thank her for all she has done for Google and Alphabet as our longest-serving CFO. I'm excited to continue to work with her in her new role. And I look forward to welcoming our newly appointed CFO, Anat Ashkenazi. She starts next week, and you'll hear from her on our call next quarter. Thanks as always to our employees and partners everywhere for a great Q2. With that, over to you, Philip.
Philipp Schindler : Thanks, Sundar, and hello, everyone. Starting with performance, Google Services delivered revenues of $73.9 billion for the quarter, up 12% year-on-year. Search and other revenues grew 14% year-on-year, led by growth in the retail vertical, followed by financial services. YouTube ads revenues were up 13% year-on-year driven by growth and brand as well as direct response. Network revenues declined 5% year-on-year. In subscriptions, platforms, and devices, year-on-year revenues increased 14%, driven again by strong growth in YouTube subscriptions. For the rest of my remarks, I want to double click on two topics. First, how we're applying AI across the marketing process to deliver an even stronger ads experience. Second, YouTube's position as the leading multi-format platform. So let me start by sharing some of the ways we are applying AI to bring more performance benefits to even more businesses. Q2 brought several major opportunities to meet and learn from users, developers, creators, and customers. From I/O to Brandcast, Google Marketing Live and Can, a growing number of our customers and partners are looking to understand how to successfully incorporate AI into their businesses. This quarter, we announced over 30 new ads features, and products to help advertisers leverage AI and keep pace with the evolving expectations of customers and users. Across Search, PMax, DemandGen, and Retail, we're applying AI to streamline workflows, enhance creative asset production, and provide more engaging experiences for consumers. Listening to our customers, retailers in particular have welcomed AI-powered features to help scale the depth and breadth of their assets. For example, as part of a new and easier-to-use merchant center, we've expanded Product Studio, with tools that bring the power of Google AI to every business owner. You can upload a product image from the AI with something like, feature this product with Paris skyline in the background and Product Studio will generate campaign ready assets. I also hear great feedback from our customers on many of our other new AI-powered features. We're beta testing, virtual try on and shopping ads and plan to roll it out widely later this year. Feedback shows this feature gets 60% more high-quality views than other images and a higher click-out to retailer sites. Retailers love it because it drives purchasing decisions and fewer returns. Our AI-driven profit optimization tools have been expanded to performance max and standard shopping campaigns. Advertisers use profit optimization and smart bidding see a 15% uplift in profit on average compared to revenue-only bidding. Lastly, DemandGen is rolling out to Display in Video 360 and Search Ads 360 in the coming months with new generative image tools that create stunning high-quality image assets for social marketers. As we said at GML, when paired with Search or PMax, DemandGen delivers an average of 14% more conversions. The use cases we're seeing across the industry show the incredible potential of these AI-enabled products to improve performance. Let me briefly share two examples with you. Luxury jewelry retailer Tiffany leveraged DemandGen during the holiday season and saw 2.5% brand lift in consideration and actions, such as adding items to cards and booking appointments. The campaign drove a 5.6 times more efficient cost per click compared to social media benchmarks. Our own Google marketing team used DemandGen to create nearly 4,500 ad variations for a Pixel 8 campaign shown across YouTube, Discover, and Gmail, delivering twice the click-through rate at nearly a quarter of the cost. In addition to strengthening our ads products for customers, we continue to evolve our existing systems and products with improved models delivering further performance gains. In just six months, AI-driven improvements to quality, relevance, and language understanding have improved Broad Match performance by 10% for advertisers using Smart Bidding. Also, advertisers who adopt PMax to Broad Match and Smart Bidding in their Search campaigns, see an average increase of over 25% more conversions or value at a similar cost. We'll continue to listen to our customers and use their feedback to drive innovation across our products. As you can hear, I continue to be excited about the AI era for ads. Now let's turn to YouTube. I've talked before about our approach to making YouTube the best place to create, watch and monetize. First, the best place to create. What sets YouTube apart from every other platform are the creators and the connection they have with their fans. Audiences tuning in to watch their favorite creators continue to grow. For example, two weeks ago, Mr. Beast's channel hit more than 300 million subscribers. Next, the best place to watch. Our long-term investment in CTV continues to deliver. Views on CTV have increased more than 130% in the last three years. According to Nielsen, YouTube is the Number #1 most watched streaming platform on TV screens in the US for the 17th consecutive month. Zooming out, when you look not just at streaming, but at all media companies and their combined TV viewership, YouTube is the second most watched after Disney. And this growth is happening in multiple verticals, including sports, which has seen CTV watch time on YouTube grow 30% year-over-year. Lastly, the best place to monetize. CTV on YouTube is continuing to benefit from a combination of strong watch time growth, viewer and advertiser innovation and a shift in brand advertising budgets from linear TV to YouTube. Our largest advertisers across verticals, including retail, entertainment, telco and home and personal care, are partnering with creators on ads and organic integrations. Verizon, for example, worked with a YouTube creator and Verizon customer to show them many ways that plans and offerings can be customized to fit people’s lives. Using AI-powered formats, they created sketches in multiple lengths and orientations to serve the right creative to the right viewer and drive people to their site. Verizon's creator ads had a 15% lower CPA and a 38% higher conversion rate versus other ads. Turning to Shorts. Last quarter, I shared that in the US, the monetization rate of YouTube Shorts relative to in-stream viewing is showing a healthy rate of growth. Again, this quarter, we continue to see an improvement in Shorts monetization, particularly in the US. We are also seeing a very encouraging contribution from brand advertising on Shorts, which we launched on the product in Q4 last year. Lastly, a few words on shopping. Last year, viewers watched 30 billion hours of shopping-related videos, and we saw a 25% increase in watch time for videos that help people shop. While it is early days, shopping remains a key area of investment. At GML, we rolled out several product updates to YouTube shopping, helping creators sell products to their viewers. These updates included; product tagging where creators can tag products in their videos for viewers to discover and purchase, product collections and a new affiliate hub, a one-stop shop for creators to find deals and promotional offers from brands and track their affiliate earnings. With that, I'll finish by saying a huge thank you to Google's everywhere for their extraordinary commitment and to our customers and partners for their continued collaboration and trust. And Ruth, thanks for your amazing leadership and partnership over all these years. Now for one last time, it's over to you.
Ruth Porat : Thank you, Philipp, and thanks, Sundar, for those kind words. We had another strong quarter, driven in particular by performance in Search and Cloud, as well as the ongoing efforts to durably reengineer our cost base. My comments will be on year-over-year comparisons for the second quarter unless I state otherwise. I will start with results at the Alphabet level followed by segment results and conclude with our outlook. For the second quarter, our consolidated revenues were $84.7 billion, up 14% or up 15% in constant currency. Search remained the largest contributor to revenue growth. In terms of expenses, total cost of revenues was $35.5 billion, up 11%. Other cost of revenues was $22.1 billion, up 14%, with the increase driven primarily by content acquisition costs, followed by depreciation as well as the impact of the Canadian digital services tax, which was applied retroactively. Operating expenses were $21.8 billion up 5%, primarily reflecting an increase in R&D partially offset by a decline in G&A with sales and marketing essentially flat to the second quarter last year. The increase in R&D was driven primarily by compensation which was affected by lapping a reduction in valuation-based compensation liabilities in certain other bets in the second quarter last year followed by depreciation. The largest single factor in the year-on-year decline in G&A expenses was lower charges related to legal matters. Operating income was $27.4 billion, up 26% and our operating margin was 32%. Net income was $23.6 billion and EPS was $1.89. We delivered free cash flow of $13.5 billion in the second quarter and $60.8 billion for the trailing 12 months. As a reminder, last year, we had a timing benefit in the second and third quarters from a $10.5 billion deferred cash tax payment made in the fourth quarter, which depressed reported free cash flow growth this quarter, and we'll do so again next quarter. We ended the quarter with $101 billion in cash and marketable securities. Turning to segment results. Within Google Services, revenues were $73.9 billion, up 12%. Google Search and other advertising revenues of $48.5 billion in the quarter were up 14%, led again by growth in retail, followed by the financial services vertical. YouTube advertising revenues of $8.7 billion were up 13% driven by brand followed by direct response advertising. Network advertising revenues of $7.4 billion were down 5%. Subscription platforms and devices revenues were $9.3 billion up 14%, primarily reflecting growth in YouTube subscription revenues. TAC was $13.4 billion, up 7%. Google Services operating income was $29.7 billion up 27% and the operating margin was 40%. Turning to the Google Cloud segment. Revenues were $10.3 billion for the quarter, up 29%, reflecting first significant growth in GCP, which was above growth for cloud overall and includes an increasing contribution from AI. And second, strong Google Workspace growth, primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $1.2 billion and an operating margin of 11%. As to our Other Bets for the second quarter, revenues were $365 million and the operating loss was $1.1 billion. Turning to our outlook for the business. With respect to Google Services, First, within advertising. The strong performance of search was broad-based across verticals. In YouTube, we are pleased with the growth in the quarter. We had healthy watch time growth continued to close the monetization gap in Shorts and had continued momentum in Connected TV, with brand benefiting in part from an ongoing shift in budgets from linear television to digital. As we look forward to the third quarter, we will be lapping the increasing strength in advertising revenues in the second half of 2023, in part from APAC based retailers. Turning to subscriptions, platforms and devices. First, we continue to have significant growth in our subscriptions business which drives the majority of revenue growth in this line. However, there was a sequential decline in the year-on-year growth rate, as we anniversaried the impact of a price increase for YouTubeTV in the second quarter last year. The impact will persist through the balance of the year. Second, with regard to platforms. We are pleased with the performance in play driven by an increase in buyers. Finally, with respect to devices. The most important point as we look forward is that our Made by Google launches have been pulled forward into the third quarter from the fourth quarter last year benefiting revenues in Q3 this year. Turning to cloud, which continued to deliver very strong results. For the first time, Cloud crossed $10 billion in quarterly revenues and $1 billion in quarterly operating profit. As Sundar noted year-to-date, our AI infrastructure and generative AI solutions for cloud customers have already generated billions in revenues and are being used by more than 2 million developers. We're particularly encouraged that the majority of our top 100 customers are already using our generative AI solutions. We continue to invest aggressively in the business. Turning to margins. The margin expansion in Q2 versus last year reflects our ongoing efforts to durably reengineer our cost base, as well as revenue strength. Our leadership team remains focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure. Once again headcount declined quarter-on-quarter, which reflects both actions we have taken in the first half of the year and a much slower pace of hiring. Looking ahead, we expect a slight increase in headcount in the third quarter, as we bring on new graduates. As we have discussed previously, we’re continuing to invest in top engineering and technical talent, particularly in cloud and technical infrastructure. Looking forward, we continue to expect to deliver full-year 2024 Alphabet operating margin expansion relative to 2023. However, in the third quarter operating margins will reflect the impact of both the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure, as well as the increase in cost of revenues due to the pull-forward of hardware launches into Q3. With respect to CapEx, our reported CapEx in the second quarter was $13 billion, once again driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. Looking ahead, we continue to expect quarterly CapEx throughout the year to be roughly at or above the Q1 CapEx of $12 billion keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx. With regard to other bets, we continue to focus on improving overall efficiencies, as we invest for long-term returns. Waymo is an important example of this, with its technical leadership coupled with progress on operational performance. As you will see in the 10-Q, we have chosen to commit to a new multi-year investment of $5 billion. This new round of funding, which is consistent with recent annual investment levels will enable Waymo to continue to build the world's leading autonomous driving technology company. To close, this is my 56th and last earnings call, 37 of them at Alphabet. So I have a few closing thoughts of gratitude. I've been so proud to be at Google and Alphabet as CFO and to work with some of the smartest people in the world every day. I think, we have accomplished a lot in the last nine plus years, and I am confident that progress will continue. Of course, I'm not going far and I'm honored to have my new role, which I've been slowly working my way into during the past 11 months and I look forward to continuing to work with Sundar, and our great team. Being CFO of one of the most important companies in the world has been the opportunity and responsibility of a lifetime. Google's Mission of advancing technology and bringing information to people throughout the world is as relevant today as it was when I worked on its IPO. Technology has been a catalyst for economic growth throughout human history. The people on this call know that if a technological advancement is not the focus of every business and government, they will be left behind. Underpinning this is the need for sound and responsible investment. That has never been more important than today and certainly, that is Google and Alphabet's focus. I want to end by thanking Googlers around the world for the innovation and commitment that has enabled us to deliver such extraordinary products and services globally. I also want to thank our investors and analysts for your long-term support and your feedback. Thank you. Sundar, Philipp and I will now take your questions.
Operator: Thank you. [Operator Instructions] Your first question comes from Brian Nowak with Morgan Stanley. Your line is now open.
Brian Nowak: Thanks for taking my questions. First, thank you Ruth for all the help and significant impact over the past decade. The first one, it is a little bit of a jump ball, I guess for Sundar, Philipp or Ruth. I guess we're sort of 18 months this fever pitch around the GenAI focus in the world. Maybe from any of your perspective, can you just sort of talk to us about areas where you've seen faster than expected traction or testing adoption of some of the AI, generative AI capabilities versus slower than expected traction and testing from a Google perspective. And then, Ruth I appreciate all the comments about structurally reengineering the OpEx base. Are there any more tangible examples of areas you can talk to us about where you still see further ways to drive more efficiency across the company. Thanks.
Sundar Pichai: Brian, thanks. I'll take the first part. I think it's a good question. Obviously, I think there is a time curve in terms of taking the underlying technology and translating it into meaningful solutions across the Board, both on the consumer and the enterprise side. Definitely, on the consumer side, I'm pleased, as I said in my comments earlier in terms of how for a product like Search, which is used at that scale over many decades. How we've been able to introduce it in a way that it's additive and enhances the overall experience and this positively contributing there. I think across our consumer products, we've been able -- I think we are seeing progress on the organic side. Obviously monetization is something that we would have to earn on top of it. The enterprise side, I think we are at a stage where definitely there are a lot of models. I think roughly, the models are all kind of converging towards a set of base capabilities. But I think where the next wave is, working to build solutions on top of it. And I think there are pockets, be it coding, be it in customer service, et cetera, where we are seeing some of those use cases seeing traction, but I still think there is hard work there to completely unlock those.
Ruth Porat: And on your second question first, thank you for your comments. Look, the reason we've consistently used the term, the phrase that we're focused on durably reengineering our cost base is because these are deep work streams. They are not tactical fixes, and we continue to build on them. And so the main areas that we've talked about are around product and process prioritization around organizational efficiency and structure. Both of those are reflected in the headcount and the fact that headcount is down year-on-year. And across all of those -- as I said, across our entire leadership team, we remain focused on continuing to execute against them. So in terms of the most recent examples, as we talked about last quarter with the combination of the devices and services product area with the platforms and ecosystems product area, we announced that back in April. And what we discussed last quarter and what we're seeing is that unifying teams across these organizations, helps with product execution and what we're really focused on is really adding to velocity and efficiency. So kind of the gift that keeps giving. And then more broadly, all of the work streams that we've talked to you about before, we continue to remain focused on. A big one, very important one, is all of the efficiency efforts, the work streams around technical infrastructure and improving efficiency there. We are also working on the use of AI across Alphabet. We are working on continuing to build on what we've done with our centralized procurement organization. We are continuing to optimize our real estate portfolio. And so again this is across our leadership team. These are efforts that all build to this phrase durably reengineering our cost base.
Brian Nowak: Great. Thank you both.
Operator: Our next question comes from Doug Anmuth with JPMorgan. Your line is now open.
Doug Anmuth: Thanks for taking my questions. One for Ruth and one for Sundar. Ruth you've now had Google Services operating margins roughly 40% for the past two quarters. Just as you create more capacity to help offset the future investments, is it reasonable to think that you could sustain at those kind of levels going forward? And then, Sundar just as it relates to AI overviews, you talked about the positive trends there. Can you just help us understand where you are, how far along in rolling-out AI overviews and then any more color around kind of click-through rates and monetization levels relative to your traditional searches. Thanks.
Ruth Porat: So in terms of the Google services operating margin, it did reflect all the work that we are doing on durably reengineering the cost base. It also reflected the benefit of strong revenue performance in search. And so what I tried to lay out in the comments, as we look forward to the third quarter is operating margins will reflect the increases in depreciation and expenses associated with higher levels of our investment in technical infrastructure. It will also reflect higher expenses associated with the Pixel launch, due to the pull forward. So those are important factors. I would say, overall company-wide, it is important to note that we do expect to continue to deliver full year '24 Alphabet operating margin expansion relative to 2023, but I did want to highlight those important points as we look forward to Q3.
Sundar Pichai: And Doug, thanks. On the AI overview, we are -- we have rolled it out in the US and we are -- will be through the course of the year, definitely scaling it up both to more countries. And also, we have taken a conservative start focused on quality, making sure the metrics are healthy and so on, but you will see us expand the use cases around it, and we'll touch definitely more queries. All the feedbacks we have seen are positive. And on the monetization side, I think Philipp has touched upon it. Maybe Philipp, anything more you want to add there?
Philipp Schindler: Yes, look, innovation and improvements to the user experience on search have historically opened up new opportunities for advertisers. We talked about this before we saw this when we navigated from desktop to mobile for example. And we can see GenAI obviously expand the types of questions we can help people with, as Sundar mentioned. And as we said before, people are finding ads either above or below AI overviews helpful. We have a solid baseline here from which we can innovate and as you have probably noticed at GML, we announced that soon we'll actually start testing Search and Shopping ads in AI overviews for users in the US, and they will have the opportunity to actually appear within the overview in a section clearly labeled as sponsored, when they're relevant to both the query and the information in the AI overview, really giving us the ability to innovate here and take this to the next level.
Doug Anmuth: Thank you. Best of luck, Ruth, in your new role.
Ruth Porat: Thank you.
Operator: Our next question comes from Michael Nathanson with Moffett. Please go ahead.
Michael Nathanson: Thanks. I have two, one for Sundar and one for Philipp. Sundar, on decision this week to not deprecate cookies. I know it's been a long journey. Can you talk a bit about what we should expect in terms of new experience in Chrome and why the company makes a decision not to go down the path on deprecating cookies. And then Philipp, I know it's only one quarter, but it's interesting that Search is growing faster than YouTube, which surprised some of us. But can you talk about what factors you think are kind of differences in growth rates between these markets? And is there anything on the AI front that you could see maybe reaccelerating YouTube growth, as you've seen happen with Search. Thanks so much.
Sundar Pichai: And Michael on cookies, Look I think, obviously we are super committed to improving privacy for users in chrome and there was the whole focus around privacy sandbox and we remain committed on the journey, but on third-party cookies, given the implications across the ecosystems and considerations and feedback across so many stakeholders. We now believe user choice is the best path forward there and we'll both improve privacy by giving users choice and we'll continue our investments in privacy enhancing technologies, but it is obviously an area we will be taking feedback from the players in the ecosystem and we are committed to being privacy first as well.
Philipp Schindler: And on the second part of your question, maybe Ruth, you want to jump in first and then I take the rest if needed.
Ruth Porat: Absolutely. So Look, as we both noted, search revenues really reflected broad based growth across verticals. That was led by retail followed by financial services. I think your question really goes to the heart of the year-on-year growth comparison. And as both Philipp and I noted, we are really pleased with YouTube, the YouTube team all that was done, it was driven by brand followed by direct response, and they have very strong ongoing operating metrics, which Philipp will comment on. I think the important point to note, and I tried to tease out in opening comments, was that the deceleration in this year-on-year revenue growth for the second quarter versus the first quarter, primarily reflected the tougher comparison versus the first quarter because at that point, as you probably recall, YouTube was lapping negative year-on-year growth in Q1 last year. And then also Q1 benefited from the extra from leap year. And so what you are also seeing here is with YouTube, we were [anniversaring] (ph) the ramp in APAC based retailers that began in the second quarter last year and foreign exchange headwinds as well that we noted. And so it's -- there are some timing issues going on. And what we are trying to highlight is the underlying operating strength. Back to you, Philipp.
Philipp Schindler: Yes, that was very comprehensive. Nothing really to add from my side here.
Sundar Pichai: The only thing I would say, adding to Brian's first question on areas where things are maybe taking longer. I think, look we are all building multimodal models. At least Gemini has been natively multimodal from the ground up. But most of the use cases today that have been unlocked have been around the tech side. So in terms of getting real generative audio, video experience is working well. I think there is still – it is going to take some time. But over time, obviously it will be deeply relevant to YouTube and so it's an area I'm excited about in the future.
Michael Nathanson: Okay. Thanks a lot. And best to you. Thanks.
Operator: Your next question comes from Eric Sheridan with Goldman Sachs. Your line is now open.
Eric Sheridan: Thanks so much. And I'll echo the thanks for Ruth, for all the insights and partnership over the years on these earnings calls. Sundar maybe first for you, in terms of Cloud and bringing AI to the enterprise, I wanted to know if you go a little bit deeper in terms of how you are seeing AI actually get adopted implemented, what it potentially could mean for the strategic positioning of the cloud business and the potential for AI workloads to be a stimulant to revenue growth for Cloud first. And then following up the last set of questions on YouTube are really about the macro or the ad environment. What do you guys, as a team, continue to learn about the subscription side of YouTube and the appetite for consumers to engage with a broader array of media products at the subscription layer. Thanks.
Sundar Pichai: Thanks Eric. Look, on the Cloud and AI stuff, obviously, it is something which I think will end up being a big driver over time. I mentioned in my opening remarks, already if you take a look at our AI infrastructure and generative AI solutions for cloud across everything we do, be it compute on the AI side, the products we have through Vertex AI, Gemini for Workspace and Gemini for Google Cloud, et cetera, we definitely are seeing traction. People are deeply engaging with Gemini models across Vertex and AI studio. We now have over 2 million developers playing around with these things, and you are definitely seeing early use cases. But I think we are in this phase, where we have to deeply work and make sure on these use cases, on these workflows. We are driving deeper progress on unlocking value, which I'm very bullish will happen, but these things take time. So -- but if I were to take a longer-term outlook, I definitely see a big opportunity here. And I think particularly for us, given the extent to which we are investing in AI, our research infrastructure leadership, all of that translates directly. And so I'm pretty excited about the opportunity space ahead.
Ruth Porat: And then on your second question with respect to subscriptions, I am implicit in your question, how strong is it, as I noted in opening comments, that overall line subscriptions platforms and devices delivered healthy growth and that was led by subscriptions. And as we've said on many calls here in a row, the subscription revenue growth continued to be quite strong. It was driven by subscriber growth in both YouTube TV and YouTube Music premium. And then the other component within that line is Google One that also delivered strong subscriber and revenue growth. I think the heart of your question is really around YouTube and that is the heart of the revenues in that line. So it continues to be very strong. We see a lot of take up in it, strong subscriber growth, really pleased with it. We did note that growth on that line decelerated due to anniversarying the YouTube TV price increase. But at the heart of it, our people interested in the subscription offerings and it’s the take of significant. We're really pleased with it.
Eric Sheridan: Thank you.
Operator: Our next question comes from Ross Sandler with Barclays. Your line is now open.
Ross Sandler: Hi, everybody. Just two questions on the AI CapEx. So it looks like from the outside at least, the hyperscaler industry is going from kind of an under bill situation this time last year to better meeting the demand with capacity right now to potentially being overbuilt next year if these CapEx growth rates keep up. So do you think that's a fair characterization? And how are we thinking about the return on invested capital with this AI CapEx cycle. And then related to that, do you think that the AI industry is close to or far away from hitting some kind of wall on foundation model improvement in AI training, based on like lack of availability of new data to train on. Just your thoughts on that would be great. Thank you.
Sundar Pichai: Thanks Ross. I think great questions. Look, I -- obviously, we are at an early stage of what I view as a very transformative area and in technology when you are going through these transitions, aggressively investing upfront in a defining category, particularly in an area in which in a leveraged way cuts across all our core areas our products, including Search, YouTube and other services, as well as fuels growth in Cloud and supports the innovative long-term Bets and Other Bets is definitely something for us makes sense to lean in. I think the one way I think about it is when we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over investing. We clearly -- these are infrastructure, which are widely useful for us. They have long useful lives and we can apply it across, and we can work through that. But I think not investing to be at the frontier, I think definitely has much more significant downside. Having said that, we obsess around every dollar we put in. Our teams are -- work super hard, I'm proud of the efficiency work, be it optimization of hardware, software, model deployment across our fleet. All of that is something we spend a lot of time on, and that's how we think about it. To your second question on whether -- how do the scaling loss hold. Are we hitting on some kind of wall or something? Look, I think we are all pushing very hard, and there is going to be a few efforts, which will scale up on the compute side and push the boundaries of these models. What I would tell is regardless of how that plays out, you still think there is enough optimizations we are all doing, which is driving constant progress in terms of the capabilities of the models. And more importantly, taking them and translating into real use cases across the consumer and enterprise side, I think on that frontier. I think there is still a lot of progress to be had. And so we are pretty focused on that as well.
Ross Sandler: Thank you.
Operator: Our next question comes from Stephen Ju with UBS. Your line is now open.
Stephen Ju: Okay. Thank you so much. So Sundar, I guess to ask the AI question a different way. As we talk to some of the model builders out there, it looks like the initial use cases are more on the cost savings or efficiency side. But when do we -- when do you think we'll start thinking about products that can help revenue generation for the Fortune 500, Fortune 1000 companies, which is probably something that can hopefully create greater value over time versus just cutting costs? And Philipp, listening to what will be, I guess Ruth's final comments on Q2 on these public calls. And thank you, by the way Ruth, for all the help. I couldn't help but notice that the bigger factors were brand followed by direct response. And if we continue to think that the one you bring up first is the larger factor and tying this into your prior commentary about shopping being an important consideration. When do you think we'll start talking about direct response being a much bigger contributor to YouTube's growth versus brand? Thank you.
Sundar Pichai: On the first part of the question look I think the technology's horizontal enough, it can apply on both sides. If you take a use case like improving the customer service experience, it is part of it which is driving efficiencies, and you can look at it from a cost standpoint, but you could also be overall improving the experience, improving conversion, driving the funnel better. And so increasing basket size if you are a retail e-commerce player, et cetera. So we are seeing people experiment across both sides. And so I think, you will see it played across both sides. Philipp, on the second one?
Philipp Schindler: Yes. On the second one, look on the direct response side, as you know it is about driving and converting commercial intent and customers are obviously benefiting from including video in their AI-powered campaigns, it could be PMax, it could be DemandGen and obviously using our automated tools to enhance and create video creatives. And we are very, very optimistic about this path. On average advertisers who run both image and video ads with DemandGen campaigns see 6% more conversions per dollar than those running image only ads and discovery. And this is just one little example of how this can obviously boost your performance business. So that's a big part. The brand side, as you know Google AI continues to make it easier for brands to show up next to the content where viewers are obviously the most engaged. And they're finding it, as you can see from the numbers, a very effective way to drive awareness and consideration. And we are also quite excited about some of the recent launches on YouTube shopping side, if you want to put that into the direct response bucket.
Stephen Ju: Okay. Thank you.
Operator: And our last question comes from Justin Post with Bank of America. Your line is now open.
Justin Post: Great. I'll ask a couple of areas. First on the cloud acceleration, would you characterize that as new AI demand helping drive that year-to-date? Or is that more of a rebound in just general compute and other demand or is AI really moving this forward and helping drive acceleration. And then I wanted to ask about your internal cost savings which has been really strong. How are you using AI internally to help cut costs? Are you seeing better efficiencies with your engineers? And just would love to hear about how you are applying AI to cut your own costs? Thank you.
Ruth Porat: Great. Thank you for that. So overall we are -- as both Sundar and I said, we are very pleased with the results in Cloud. And there is clearly a benefit as the Cloud team is engaging broadly with customers around the globe with AI related solutions, AI infrastructure solutions and the generative-AI solutions. I think we noted that we're particularly encouraged that the majority of our top 100 customers are already using our generative AI solution. So it is clearly adding to strength of the business on top of all that they are doing. And just to be really clear, the results for GCP, the growth rate for GCP is above the growth for cloud overall. And then I'll turn it to Sundar on the cost saving point, but just one point we are really pleased as well that Cloud's margin improved as it did. And in part, that reflects the revenue strength that they delivered and all of the efficiency efforts that I've already spoken about. But looking ahead in Q3, we do expect the same seasonal pattern that you saw last year with respect to margin and we are continuing to invest in the business.
Sundar Pichai: Look, I think specifically, if the question is about engineers and coding, et cetera, we definitely want to be on the cutting edge there. I think, we are making these tools available to some of the most [line of] (ph) productive engineers and demanding engineers out there, and they are definitely kicking the tires hard. And -- but I would say, it's still all in very early stages. I think particularly when it comes to writing high-quality secure code, but I think all the learnings what we are gaining here will translate into our models and products, and that's the virtuous cycle, which I'm excited by. So there's a lot more to come.
Justin Post: Great, thank you.
Operator: Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
Jim Friedland: Thanks everyone for joining us today. We look forward to speaking with you again on our third quarter 2024 call. Thank you and have a good evening.
Operator: Thank you everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
CMCSA | 2 | 2,024 | 2024-07-23 11:22:10 | Operator: Good morning, ladies and gentlemen, and welcome to Comcast's Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Please note, this conference call is being recorded. I will now turn the call over to Executive Vice President, Investor Relations, Ms. Marci Ryvicker. Please go ahead, Ms. Ryvicker.
Marci Ryvicker: Thank you, operator, and welcome, everyone. Joining us on today's call are, Brian Roberts, Mike Cavanagh, Jason Armstrong, and Dave Watson. I will now refer you to Slide 2 of the presentation accompanying this call, which can also be found on our Investor Relations website, which contains our safe harbor disclaimer. This conference call may include forward-looking statements subject to certain risks and uncertainties. In addition, during this call, we will refer to certain non-GAAP financial measures. Please see our 8-K and trending schedule issued earlier this morning for the reconciliations of these non-GAAP financial measures to GAAP. With that, I'll turn the call over to Mike.
Mike Cavanagh: Thank you, Marci, and good morning, everyone. Before I hand it over to Jason, I'd like to comment on three key elements from the quarter. One, broadband; two, parks; and three, the NBA. So, first is broadband, where the competitive intensity that we've seen for the past several quarters and which is particularly felt in the market for price-conscious consumers remains essentially unchanged, but throughout this period, our broadband strategy has been consistent and we remain confident in our plan. We are focused on generating healthy broadband revenue growth by striking the right balance between rate and volume and relying heavily on market segmentation that I'll speak to in a minute. As a result, in the second quarter, ARPU grew 3.6%, which was within our historical range of 3% to 4%. Despite the competitiveness of the recent past, we've maintained a market-leading base of 32 million broadband customers by refining our go-to-market approach to create options that fit each of our customers' lifestyles and budgets. Providing the best products with flexibility and choice at different value points, has served us extremely well for many years and remains the core of our playbook. Of particular note, this quarter, we launched our suite of NOW products, which are high-quality internet, mobile and streaming TV offerings designed to be incredibly simple with attractive all-in pricing with no contracts or credit checks. These are great options for the price-conscious segment and especially for those impacted by the end of the government's ACP program. While we are pleased with our enhancement to our offerings for the price-conscious segment, the reality is that the vast majority of our customer base subscribes to more premium products, where we feel great about our market position relative to fiber, which is our true long-term competitor. We are investing in additional network capacity, multi-gig speeds and in-home WiFi technology to capitalize on the Internet consumption trends we are seeing. One of the most important metrics we monitor is the magnitude of data traffic flowing across our network. And again, we saw a double-digit year-over-year growth this quarter, with broadband-only households consuming over 700 gigabytes of data each month. And our customers continue to take faster speeds, with around 70% of our residential subscribers receiving speeds of 500 megabits per second or higher and one-third getting a gigabit or more. These positive consumer trends play to our strengths and will only accelerate with the shift of live sports to streaming, which together with entertainment on streaming accounts for nearly 70% of our network traffic today. My final thought on broadband is the importance of bundling with mobile, with 90% of Xfinity Mobile smartphone traffic traveling over our WiFi network. These two products work seamlessly together to benefit our customers from both the products' experience and financial value standpoint. We are very pleased with the momentum we saw in wireless this quarter, where our line additions were again above 300,000 and nicely up year-over-year. Our new converged offers resulted in better overall yield and awareness as well as higher multi-line attach rates and we are excited for some of the new mobile offers tied to the Olympics, which will be introduced to the market in just a few days. Now, let's turn to parks, where our results were down in both revenue and EBITDA when compared to last year's record performance, with two-thirds of the decline driven by lower attendance at our domestic parks. We attribute this to a number of factors. First, is what now appears to be a COVID recovery pull-forward of a magnitude we hadn't previously appreciated. I think it's important to zoom out and look at how this business has trended over the past few years. Going back to 2022 and 2023, parks were clearly the early beneficiaries of substantial rebounds in tourism and travel after the pandemic, resulting in a surge in demand that contributed to us reaching record results for both of those years. More recently, other travel options, including cruises and international tourism, given the strength of the dollar, have experienced their own surge in demand, which caused visitation rates at our parks to normalize. The second factor affecting attendance at our domestic parks is the timing of our investments in new attractions, where we are light in Florida in advance of next year's opening of Epic and our lapping of Super Nintendo World in Hollywood is creating some headwinds for us as well. While the parks results are below our original expectations for the year, we still view parks as a terrific long-term growth business for us. We couldn't be more excited about the opening of Epic Universe in 2025, as we've been releasing new details about Epic's Five Immersive Worlds, the consumer reaction has been tremendous. And recently, we opened an Epic Universe Preview Center in Orlando and the foot traffic and guest enthusiasm have been off the charts. So, we look forward to Epic Universe having a meaningful impact by driving incremental attendance, longer visits and higher per-cap spending once the park opens in 2025. Finally, let me talk about the NBA. Our expectation is that soon an 11-year rights deal between ourselves and the NBA will be announced. We don't believe that the resolution of matching rights will affect the package that we expect to be awarded. This package, which begins with the 2025-2026 season includes: 100 NBA games each regular season across NBC and Peacock, which is more than any other media partner and more regular season games than each existing partner has under the current rights deal; for playoffs, we will have first and second round games each year, exclusively on our national platforms and six NBA conference final series over the course of the term of the deal, which is more playoff games on average each year, than any other media partner; and exclusively for Peacock will be approximately 50 national regular season and post-season games, including National Monday Night games and doubleheaders. Additional elements of the NBA package include the annual NBA All-Star Game and All-Star Saturday Night each season, the season opening NBA tip-off doubleheader each season, a special doubleheader on the MLK holiday, and Select NBA games in every NBA All-Star game on Telemundo. Beyond the NBA itself, we're excited that our package includes WNBA, where starting in the spring of 2026, we'll have more than 50 WNBA regular season and first round playoff games each season across Peacock, NBC and USA, and we'll also have games in seven WNBA Conference semifinals and three WNBA Final series; for USA Basketball, we'll have the rights to USA men's and women's games leading up to the Olympics and FIBA World Cup; Sky Sports will air all of NBCUniversal's NBA and WNBA games in its markets; and finally, Xfinity will be the NBA and WNBA's marketing partner in the video category. Now, I'd like to take a moment to explain why we're so excited to partner with the NBA. First, it brings in a broad, diverse and youthful audience that is culturally relevant and further expands NBCUniversal's tremendous reach across broadcast and streaming. This new fan base will also allow us to create new entertainment content that will work beyond the basketball season with exciting opportunities for companion programming and marketing collaborations that tap into the NBA's pop culture appeal. Second, the nine-month basketball season completes our year-round calendar for sports, which already includes the NFL, Olympics, Premier League, NASCAR, PGA Tour, Big Ten and World Cup, and our NBA package will establish much-watched Sunday, Monday and Tuesday night traditions on NBC and Peacock. Third, we are uniquely able to drive strong value with the NBA in multiple ways: first, by growing ad sales, by selling NBA ad inventory package with the rest of our marquee programming; second, by acquiring and monetizing subscribers both on Linear and Peacock; and third, by optimizing NBCUniversal programming investment across sports, entertainment and news. The NBA's decision to partner with us is a testament to our breadth and reach, our operational excellence in sports and innovation, and our decades of experience delivering world-class content to consumers. Much like our long-standing relationships with the NFL and the Olympics, we look forward to putting the weight of our entire company behind our partnership with the NBA for decades to come. Before I hand it over to Jason, I want to share one final thought. In just a few short days, we have the honor of kicking off the 2024 Olympic Games in Paris. This will be NBCUniversal's 18th Olympic Games as a US broadcaster, dating back to 1936 when we first covered the historic event on NBC Radio. It is one of the great moments of pride for our company, and I want to thank the 3,000 people working to bring all of the action, excitement and incredible stories to our viewers across the country. Jason, over to you.
Jason Armstrong: Thanks, Mike, and good morning, everybody. I'll start with our consolidated results on Slide 3. Total revenue decreased 2.7% to $29.7 billion. Within these results, our six major growth drivers, including residential broadband, wireless, business services connectivity, theme parks, streaming and premium content at our studios, generated over $16 billion in revenue, well over half of our total company revenue and grew at a mid-single-digit rate over the past 12 months. Keep in mind that in the second quarter of last year, we had one of our most successful quarterly theatrical results in our history, which included two of 2023's top-five grossing films at the worldwide box office, The Super Mario Bros. Movie and Fast X, and as such created a difficult comparison this quarter. If we exclude our studio results, total revenue would have been consistent with the prior year. Total EBITDA was consistent at $10.2 billion, and free cash flow was $1.3 billion. Free cash flow was impacted this quarter by higher-than-usual cash taxes, which were up $2 billion over last year's level and were impacted by a tax payment associated with our Hulu stake and other tax-related matters. As you'll recall, we received a minimum floor payment for Hulu at the end of last year. During the second quarter, we returned $3.4 billion of capital to shareholders, including $2.2 billion in share repurchases, and over the last 12 months, we have reduced our share count by over 6%, contributing to our adjusted EPS growth of 7%. Now, let's go through our business results, starting on Slide 4, with Connectivity & Platforms. As usual, I will refer to our year-over-year growth on a constant-currency basis. Revenue for total Connectivity & Platforms was consistent at $20.2 billion, as strong growth in our connectivity businesses was offset by declines in video and voice revenue. Residential connectivity revenue grew 6%, comprised of 3% growth in domestic broadband, 17% growth in domestic wireless, and 14% growth in international connectivity. Business services connectivity revenue also grew 6%. In domestic broadband, our revenue growth was again driven by strong ARPU growth, which increased 3.6% this quarter, well within our historical range as our team continues to effectively balance rate and volume through customer segmentation. The environment for broadband subscribers remains intensely competitive, which when combined with traditional negative seasonality in the second quarter, led to 120,000 subscriber losses. Related to this, I would like to spend a minute on ACP. It has been well-documented that the government ended all funding for the ACP program in June. Consistent with our approach to normal promotional roll-offs, we were proactive and prepared for this action early in the quarter, communicating with our ACP customer base and migrating many of these customers to different products and price levels. While this had a bit of an impact on ARPU in the quarter, we still feel very comfortable that we will remain well within our historical 3% to 4% ARPU growth range for the remainder of the year. In terms of subscribers, we saw minimal impact from the end of ACP this quarter. Looking ahead, we expect the bulk of our ACP-related subscriber activity to happen in the third quarter, including losses associated with non-pay churn. While it's too early to assess the full impact, we are encouraged with the response we see from these customers to-date. Outside of ACP, we are seeing the same level of competitive intensity and expect an offset from seasonal tailwinds as the third quarter is typically a seasonally stronger quarter compared to the second. Turning to domestic wireless, revenue growth was mainly driven by service revenue, with some modest growth in equipment revenue this quarter as well. Customer lines increased 20% year-over-year, reaching 7.2 million in total, including 322,000 line additions this quarter. The acceleration in line additions compared to the prior several quarters was driven by some early success with new pricing plans launched in April, targeted at multi-line customers, as well as continued traction with our Buy One, Get One line offer. And you will see us continue to test new ways to capitalize on the significant opportunities we see ahead for us in wireless, in terms of both increasing the penetration of our domestic residential broadband customer base, which currently sits at 12%, as well as selling additional lines per account. Wireless continues to be a key growth area for us and one in which we are striking the right balance in delivering exceptional value to our customers, bundling to enhance our opportunities in broadband, and continuing to drive profitability higher. International connectivity revenue was mainly driven by broadband, which accounts for over two-thirds of our international revenue and grew at a mid-teens rate, reflecting strong ARPU growth. The remainder is wireless, which grew due to both additional lines and ARPU growth, but at a lower rate due to the variability in handset sales. Business services connectivity revenue growth of 6% reflects steady growth in small businesses with even faster growth in mid-market and enterprise. While the SMB market remains competitive, we are competing aggressively by delivering best-in-class products and services and growing revenue through ARPU growth, driven by higher adoption of additional products that expand our relationship with our SMB customers, like Mobile, Security Edge, Connection Pro, and WiFi Pro, as well as through targeted rate opportunities. At the mid-market and enterprise level, our revenue growth is primarily fueled by the increase in our customers, driven by the investments we have made in this space to build sales and fulfillment, as well as expanding our capabilities in managed services, wide area networking, and cyber cybersecurity. Finally, video and other revenue declined in the quarter. The high single-digit decline in our video revenue is a function of continued customer losses, coupled with slower domestic ARPU growth versus last year, and the lower other revenue mainly reflects the continued customer losses in wireline voice. Connectivity & Platform's total EBITDA increased 1.6%, with margin up 90 basis points, reflecting a decline in overall expenses driven by the continued mix-shift to our higher-margin connectivity businesses, coupled with ongoing expense management. As I have previously mentioned in prior quarters and think is worth noting here, is that the only expense line item that had a meaningful increase over last year was direct product costs, which are success-based and tied to growth in our connectivity businesses. Breaking out our Connectivity & Platforms EBITDA results further, residential EBITDA increased 1.1%, with margins improving 100 basis points to 39.9%, and business services EBITDA growth rebounded nicely this quarter, returning to a mid-single-digit rate, while margin declined 70 basis points to 57%, reflecting the investments in sales and fulfillment we are making to scale in the mid-market and enterprise space. Now, let's turn to Content & Experiences on Slide 5. Revenue decreased 7.5% to $10.1 billion, and EBITDA decreased 11% to $1.9 billion. I'll detail these results further, starting with theme parks. Revenue decreased 11% and EBITDA declined 24% in the quarter compared to last year's record level for a second quarter. As Mike highlighted, two-thirds of the decline was driven by our domestic parks, due to lower attendance compared to last year, largely reflecting two factors; normalization in demand post-COVID, combined with the timing of our domestic attractions. This is the first full quarter comparison to the highly successful opening of Super Nintendo World in Hollywood early last year, which drove that park's record results in the second quarter of last year. And we haven't launched a major new attraction in Orlando since VelociCoaster in 2021 in anticipation of Epic Universe, which we originally planned to open this year. On the international side, underlying growth at our park in Osaka continues, partially offset by foreign currency as well as some softness at Universal Beijing due to the local macroeconomic environment. To reiterate, we couldn't be more bullish about the long-term trajectory of parks. In addition to Epic Universe, we have a fantastic slate of new attractions and experiences on the horizon, Donkey Kong Country in Osaka and a Fast and Furious Roller Coaster in Hollywood, as well as the Universal Horror Unleashed in Las Vegas and our Universal Kids Resort coming to Texas. Now let's turn to media, where revenue increased 2% and EBITDA was up 9%, driven by Peacock. Peacock revenue grew 28%, with 9% growth in advertising and 61% growth in distribution, driven by the 38% year-over-year increase in our paid subscriber base to 33 million. On a sequential basis, we held subscribers fairly steady. As we noted, during our last earnings call, our focus in the second quarter was on subscriber retention due to the lack of new tentpole content in the quarter. This timing and content also contributed to some relief in our expenses, which helped drive year-over-year Peacock EBITDA improvement of $300 million. We are pleased with the progress we are making, with media EBITDA for the first half of the year up nearly 3% as the improvement at Peacock outweighed the pressure at our TV networks. As we look to the second half of the year, we expect continued modest growth in overall media EBITDA, but with some variation in the degree of year-over-year improvement between the quarters, driven by the timing of sports, entertainment launches and marketing. Beginning in the third quarter, we are loaded with incremental content, including the Olympics, Sunday Night Football, which will have an additional game fall into the third quarter, as well as Peacock's exclusive NFL game from Brazil and the return of Big Ten. Given the timing of this content, EBITDA growth will be skewed to the fourth quarter. At studios, revenue decreased 27% and EBITDA decreased 51%, reflecting both the timing of our film slate and a tough comparison relative to last year's second quarter, which included the tremendously successful Super Mario Bros. movie as well as Fast X. We have said our film slate is weighted to the back-half of the year, which we believe will drive better year-over-year performance, and we're off to a strong start. Despicable Me 4 had a terrific opening weekend earlier this month, making the Despicable Me series of movies the first animated franchise in history to cross the $5 billion mark. And Twisters is off to a strong start, landing at number one at the box office this past weekend. And we're excited about our upcoming titles, including Wild Robot in September and Wicked in November. I'll wrap up with free cash flow and capital allocation on Slide 6. As I mentioned earlier, we generated $1.3 billion in free cash flow this quarter, which includes a $2 billion increase in cash taxes over last year's level. Total capital spending declined 10% compared to last year with the $3.4 billion in spending reflecting the significant investments we continue to make to support our growth drivers, such as expanding our footprint and further strengthening our domestic broadband network, scaling our streaming business and supporting the continued build of our Epic Universe Theme Park ahead of its opening in 2025. Turning to return of capital. For the quarter, we returned a total of $3.4 billion to shareholders. This includes share repurchases of $2.2 billion and dividend payments of $1.2 billion. Notably, since we restarted our buyback program just three years ago, we have reduced our share count by 16% and returned just under $50 billion to shareholders through a combination of buybacks and dividends, prudently balancing investments we've made in the business around our six core growth drivers, protecting a strong balance sheet and providing strong capital returns to shareholders. Now, let me turn it over to Brian for some closing remarks. Brian?
Brian Roberts: Thanks. And just to tie everything together what Mike and Jason have just said and as our results continue to show, I really believe we are dealing with the competitive landscape shifts exceptionally well and that's because we have a great team across the company that knows how to execute and innovate. We have the scale, balance sheet and relevancy to compete with anyone. So, if you think about what we're doing to position ourselves for growth, we've expanded our broadband network by 1.2 million new homes passed in the last 12 months, the most in the company's history, and we put plan to continue to do that. We're upbeat about the long-term in parks despite this quarter and are about to finish building the biggest, most technologically advanced theme park to hit the US market in decades with Epic Universe next year. And as you've seen recently, instead of engaging in a process to buy content companies, we have focused primarily on organic opportunities like the NBA, one of the most coveted sports franchises across the globe, which will help drive growth for us well into the future. With that, let's hand it over to Marci to take your questions.
Marci Ryvicker: Thanks, Brian. Operator, we are ready to open the line for questions, please.
Operator: Thank you. We'll now begin the question-and-answer session. [Operator Instructions] Our first question today is coming from Ben Swinburne from Morgan Stanley. Your line is now live.
Ben Swinburne: Thank you. Good morning. And Mike, thanks for all the detail on the NBA contract. Appreciate that. I wanted to ask about parks and broadband. Maybe, Jason, on broadband, you made some comments about ACP and how Dave and the team are managing it, it seems like it's going well. It seems like you were implying third quarter losses might be down from Q2. I don't want to put words in your mouth, but you talked about an offset around seasonality, I was just wondering if maybe you could revisit that in a little bit about how you guys are managing it from a product and marketing point of view in the third quarter. And presumably, that's the end, we can move on beyond 3Q, we can put ACP behind us, so wanted to ask about that. And then, on parks, thank you for all the color. When you guys look at your pacing data, which I imagine you've got months ahead of you that you can see, is there any -- do you see any churn, or should we be thinking about year-on-year pressure on this segment moving at least through the end of the year and into next year as we get ready for Epic? Any more color on sort of what the outlook looks like would be appreciated. Thanks so much.
Dave Watson: Hey, Ben, this is Dave. I'm going to jump in a little bit on the ACP part first. So, on -- I think it's important to just cover a little bit of context and then we'll get to the outlook in view of Q3. Most of the enrolled ACP customers as we said before have been with us and they are on a postpaid basis, so I think that's an important thing to remember. And our strategy has been consistent. We've been looking to help the ACP customers stay connected through a variety of options, starting with Internet Essential. And since 2011, we've connected millions in the largest, most comprehensive private sector Internet adoption program in the country. The good news is that our ACP customers are eligible to switch to our IE, Internet Essential tiers that we have, and we have a couple. In addition, we have Xfinity Mobile and we have good offers through this transition and to help them save money on their monthly bills. The Internet Essential customer, the plus tier, customers could take a free line of Xfinity Mobile for a year and ACP customers who add Xfinity Mobile can get an additional free unlimited line for a year. So -- and then we just started with NOW Internet, NOW Mobile, and so nothing material on that, but I think it puts us in good position as we complete the transition. We spent -- as Jason said, we've spent a lot of time thinking about this, been very proactive, prepared for this, and in many ways, it's similar to the promotional role activity that we've managed for decades, so we're used to that. On the -- from a subscriber viewpoint, also as Jason said, we saw a minimal impact in ACP in Q2. Looking forward, we expect the bulk of the ACP subscriber-related activity to happen in the third quarter, including losses associated with non-paid churn. Very focused on retention. It's early, but the biggest impact I think we're going to see will be on the non-pay side, and as we're just getting into the beginning of the non-pay cycles. Encouragingly, we're not seeing much voluntary churn in this group. So, our goal, we'd like to get through the ACP impact as quickly as possible, and right now we're planning to take a reserve on incremental non-pay activity in the third quarter, but again, it is too early to quantify and we just won't know until we're further through the cycle. So, we have a normal disconnect process that we managed for a long period of time, and again, this is the post-pay universe that we have managed through. So, we'll -- that is our view. I think it will be primarily within Q3, but encouraged by at least the voluntary churn aspect. Jason?
Jason Armstrong: Yeah. I think Dave said it perfectly, as you think about third quarter, Ben, I think unpacking it and similar to what we saw in the second quarter, the competitive environment remains intense, but it's stable. It's sort of no worse, no better than we've seen over the past couple of quarters, I think that's the starting point. Second, as we pointed out, it's a quarter where we do get seasonal tailwinds, the same things that were headwinds in the second quarter largely become tailwinds in the third quarter. And then there's ACP that works against that where we will see an impact. As Dave said, the intention is to be largely through the impact by the end of the third quarter between actions we've seen and then a reserve we will take. And so, that's the thing we have to make sure we're executing very well against, but as Dave said, the early trends on that, whether it's voluntary churn or trends we've seen so far in non-pay and building non-pay and reserves around that are encouraging.
Ben Swinburne: Great.
Mike Cavanagh: And, Ben, it's Mike on parks. So, to hit on that again and appreciate the question, I think we covered a lot in the earlier remarks, but I'll start where Brian last finished, which is, we couldn't be more excited about and confident in the long-term trajectory of the parks business, particularly as we look ahead to next year with Epic Universe, which is truly -- looking truly unbelievable. And then, other attractions coming, Hollywood is going to get a Coaster and Donkey Kong Country into Osaka in the latter part of this year. Timing, TBD on both of those. But in the near term, I think the domestic attendance challenge that was -- what drove two-thirds of the poor comparison, the factors causing that, which is really the COVID pull-forward that we talked about and the timing of attractions, particularly in Hollywood lapping Super Nintendo, and in Florida, the fact that we originally planned to have Epic opened this year, but with COVID pushed it back, and so have a lull in the action. We haven't started a new big attraction since VelociCoaster in 2021. So, as a result of that, I think the factors, even though we're excited about Hollywood Horror Nights in the second half of the year and a little bit of moving past the lapping, I think the trends that we are experiencing likely continue until we get to -- until we get to Epic opening up sometime next year.
Ben Swinburne: Thank you, guys.
Marci Ryvicker: Thanks, Ben. Operator, next question, please.
Operator: Certainly. Next question is coming from Craig Moffett from MoffettNathanson. Your line is now live.
Craig Moffett: Hi, thank you. Good morning. A little bit more on ACP, if I could. Mike, could you just give us any early insight you've got on the delinquency rate for people that are 30 days or 60 days past due, just so we can sort of get a sense of what non-pays may look like? And then, presumably, there was some impact, certainly, there was in the first quarter, of just lower gross adds in the category because new enrollments were shut off and somebody moving across the street, for example, would lose it at their old address, but not be able to get it at their new one. Do you have any estimate for how much ACP impact there might have been in the gross add category? And then, just two -- one just simple housekeeping question. You typically report cable margins on the conference call, in the script. I didn't hear it, maybe I missed it, but I'm wondering if you could tell us what cable margins were in the quarter.
Mike Cavanagh: I'll let Dave handle the ACP question, Craig. It's Mike.
Dave Watson: Hey, Craig, Dave. So, in terms of delinquency rates, there's nothing. We're watching, it's just -- we have a normal process that we manage through based on due dates and voices and it goes anywhere from two to three months. There's nothing at this point to report on at this stage. We watch it closely. Other than to go back to what I said, been very proactive, and I think it we're helped by experience and promotional roles and the fact that we tried to put customers into packages that made sense for them proactively. So, there's a lot of work that went into that ahead of time, but nothing at this stage and we'll give more as we go. In terms of -- the question in terms of lower gross adds impacts on connects, it was not material that we saw in Q2. So maybe just a little bit in terms of things that we said, but yeah, it wasn't a substantial impact in Q2 and we think the bulk of what we're seeing is really going to be on the non-pay side, which will occur in Q3.
Jason Armstrong: Hey, Craig, let me hit the margin question real quick. So, I would say, the way we're looking at the business is really across Connectivity & Platforms. So, looking at it that way and managing the business that way. But to unpack it, legacy cable margin, if you wanted to look at it that way, the margin was up 110 basis points in the quarter, so really strong operating improvement to up to 48.4%.
Craig Moffett: Okay. Thanks. Could I squeeze in one more and just [Technical Difficulty] your thinking is right now about BEAD and whether we might see more capital investment on the BEAD side?
Dave Watson: Yeah, this is Dave. BEAD, we're looking at it very closely. It is going to be worked out on a state-by-state basis. We're optimistic in a lot of cases, but we'll have to look for the guidelines and the specifics tied to it. Nothing at this point would suggest we're going to be beyond the capital intensity that we've already given out. I think with all -- I mean, we're optimistic. One of the points that Brian mentioned, the 1.2 million that we've done in the last 12 months is astounding. And the machine is really going. So, we're leaning in, going for it, but BEAD will be on a state-by-state basis.
Marci Ryvicker: Operator, we are now ready for the next question.
Operator: Certainly. Next question is coming from Jessica Reif Ehrlich from Bank of America. Your line is now live.
Jessica Reif Ehrlich: Thank you. I have an NBA question and also one on advertising. The benefits, as you outlined, are pretty obvious of getting the NBA, but it does come at a significant price. I was hoping if you could walk us through how you expect to make a positive financial return and maybe elaborate a little more on what role Peacock will play since there's a clear benefit there. But how does it affect -- how does this new deal impact programming spend for other areas including general entertainment? And then, as part of Peacock, maybe you could talk about like the StreamSaver, the bundle with Netflix and Apple TV, and the response you've had? And then, on advertising, the upfront is now done. Maybe you can talk about a little bit about the unique selling position you've had relative to others and what the volume is overall on pricing, et cetera, just what you're seeing in the overall market?
Mike Cavanagh: Sure. Hey, Jessica, it's Mike. So, I think I've essentially covered everything that I wanted to cover and can cover at this stage on NBA in the prepared remarks. Obviously, when the NBA makes its ultimate announcements, we'll -- that will be another moment where we can go deeper. But just to the point generally is that we are looking at the NBA as we all said as some of the premier content that is culturally relevant, excellent audience, widens out the calendar year for us across Peacock and NBC, can do a lot with the demographics that follow the NBA around other programming. So, when you think about the business case for it, when you look at the long-term and as we are managing the media business, broadcast and Peacock as one, I think the unique reach that we have and ability for a sport like the NBA to reach so far with our existing broadcast business and use, as I said earlier, plenty of exclusive games for Peacock to drive excellent acquisition in Peacock and we've talked about before using NBA. And as we've talked about before, sports has been a great source of acquisition for us in Peacock and a great source of value to the consumer. But what's very interesting to us is how significant the viewership is of sports viewers on Peacock of things other than sports. So, when you take a zoom out and think about the total picture of what we're trying to do, which is to bring our excellent TV media assets into the future, I think you can -- we view the NBA as an excellent piece in that puzzle and it will allow us to rebalance programming from other areas. Obviously, we'll fill a few nights on NBC with this content versus other content, and we'll use this to do acquisition spend in Peacock and lighten up in some other places. But the long-term goal for Peacock is to have a service that is a balance of sports, entertainment, and news. And so our content teams are now very focused on that new audience and what we're going to be able to do to drive entertainment content with the advantage of being linked closely to the NBA and to the audience that follows it. And then, on advertising, so second quarter, pretty -- only a slight step down from the first quarter, but clearly we had a much heavier load of sports in the first quarter than the second quarter, and so that -- adjusting for that, I'd say again that the advertising market remains pretty stable, and we feel very well-positioned for the second half of the year with the Olympics coming up starting this Friday, elections, and a great slate of content coming to NBC and Peacock. In terms of the upfront, we're pleased with our results. Total volume for us is going to be basically in line with last year as is linear price. We got well over $1 billion in upfront volume for Peacock again, which -- a nice growth over what we had last year. And so, if you step back, we'd say the overall upfront market was pretty solid. We moved quickly given our strength of our assets to secure the volume that we got. So, we feel we were a success in this more challenging upfront given the arrival of so many of the new players, especially in the AVOD and SVOD space. So that's the report on the upfronts, but we're moving forward and feel like the team did quite a good job.
Marci Ryvicker: Thanks, Jessica. Operator, next question, please.
Operator: Our next question today is coming from John Hodulik from UBS. Your line is now live.
John Hodulik: Great. Thanks. Maybe on the cable side, a little bit better trends in both video and wireless. On the video side, what's driving the improvement there? Do you expect it to continue? And are you seeing any effects of the launch of the NOW brand? And then, in wireless, you guys talked about some new pricing and promotion, but do you guys think you're benefiting at all from some of the ACP losses on the prepaid side? I don't know if you guys saw yesterday, Verizon announced they sort of turned off 400,000 subscribers. I think we'll see something similar with the rest of the wireless companies. But do you think this underlying growth is sustainable, or do you think that ACP is somehow boosting the growth at this point? Thanks.
Dave Watson: Hey, John, Dave. So, in terms of video, as Jason said, it's -- our video losses are lower than the ones -- last year, it's tied. We did take a slightly less rate increase this year than last year. And the key for us in video is just positioning video with broadband and that video does help in that regard. We've seen positive churn in terms of video, reimagining video around the NOW TV product and IP and that has been steady. It's still early, but has been helpful. So, video, I think for the right segment, we offer a lot of value and we continue to position it, I think, very well with broadband. But difficult -- and still in terms of some of the fees and things that we have, but I think an important category for us. So on -- in terms of the Mobile side, NOW Mobile is not material at this point, way too early. The acceleration in line adds over Q1 driven by the early success of the new pricing plans, really competitive now in multi-line pricing. Launched in April, we targeted it for a while, now it's scaling, and it's really got traction, as well as the Buy One, Get One line offer to our base. So, wireless is such an important part of our overall strategy and key that it's 12% penetration, we've got great runway ahead. Business Mobile is just getting going and it's a great position for us in terms of convergence. I think, we're uniquely positioned in terms of ubiquitous offers across our entire footprint, and mobile will be front and center as we approach the Olympics and we will have a great offer with broadband, with mobile, being able to tie all this together, so very excited with it. The comment -- just one other part in terms of what happened in terms of Verizon's unpacking that, the only thing I'll say is, I think it's an important distinction that our ACP customers are postpaid versus their prepaid. It's a different group, a different dynamic. And so, not really -- we're just getting going on our NOW products. And so, it's very, very early on. Excited about that. And I think we're introducing it at a very good moment, but it's not material at this stage.
Marci Ryvicker: Thanks, John. Operator, we're ready for the next question.
Operator: Certainly. Next question is coming from Jonathan Chaplin from New Street. Your line is now live.
Jonathan Chaplin: Thanks, guys. I guess for Jason, two quick ones on content costs in the connectivity business. They came in quite a bit lower than we expected, and I'm wondering if you can give us a little bit more color on what's driving the trend there and how sustainable it is. And then, we're trending a little bit lower than guidance on CapEx so far this year. I'm wondering if that's just timing-related if it picks up in the back half of the year. And then, Mike, I'm not sure if you -- I heard you loud and clear on having sort of said what you can on the NBA deal. I'm wondering if you can just give us a little bit of context around the timing of costs and revenues though. When -- I recognize it's forward-looking, but when should we expect to see the costs from the new contracts start to hit? Thank you.
Jason Armstrong: Thanks, Jonathan. Why don't I start with CapEx, Dave will hit content costs, and then Mike with NBA. So, on CapEx, you're right, we've had some variability this year. I would say, relative to the initial guidance we gave both on the Content & Experiences side, where we talked about this is the final significant year of Epic spending and then we get relief beyond this. And then, on the Connectivity & Platform side, which I think is probably where more of your question was, we gave a capital intensity envelope as we entered the year. We also said intend to do 1.1 million-plus in terms of homes passed. We're obviously trending a little bit above that at this point, but still feel comfortable with the capital intensity envelope that we gave. And so, there are some timing aspects around equipment purchases within the year. I would say, still feel comfortable with the existing capital intensity envelope. And within that, doing more and more homes passed at a really efficient rate, I think that's a testament to how the team is executing here.
Dave Watson: Hey, Jonathan, Dave. So, just on the content cost side of things, that's also timing related. We -- in the sports side, well-known thing in terms of RSNs and -- but there are other timing-related things. Every contract with the programming partner is different, every relationship is different, so won't go into the specifics. But it is key that we focus on, for us flexibility, increasing market choice. We segment the marketplace both video and broadband, and together, and that is important that we're competitive in every segment. And at the end of the day, we're focusing on value. Combining linear streaming considerations on a case-by-case basis, but mostly at this point is timing related.
Mike Cavanagh: And Jonathan, it's Mike. On NBA, I wish it were sooner, but the contract doesn't start till the 2025-2026 season. So, it's fall of 2025 that we would start to bear the expense of the right side of it. And obviously, that is also as we build into that when we would begin to see the benefits of subscriber acquisition around the NBA.
Brian Roberts: And this is Brian. Just want to -- just to close out perhaps Mike's opening comments on the NBA. Doesn't -- opportunities like this come along very rarely when there's long-term relationships up for grabs. Inside and we'll have -- when it gets all announced, the detail that Mike described, we have probably more content than anybody and it's all, I think, at a value that we'll be able to, as one of the other questions asked, support and demonstrate. And one of our real advantages here is the way we're running the media business, and Mike created one group with our existing assets like NBC and our growing asset like Peacock, and putting that together is very appealing for the reach, for the consumer access, for the innovation that we'll have in the years ahead, and you'll see some of that innovation during the Olympics. There'll be a lot of content on NBC, but way more content on Peacock, and it allows for the trends that we're seeing in viewing behavior. So, it's a very exciting moment and I think we'll have more to say in the weeks ahead.
Marci Ryvicker: Thanks, Jonathan. Operator, next question, please.
Operator: Certainly. Next question is coming from Michael Ng from Goldman Sachs. Your line is now live.
Michael Ng: Hey, good morning. Thank you for the question. I just have two, one on business services and one on wireless. First on business services, I was just wondering if you could talk about some of the key initiatives or things that might be changing at Comcast business following Ed's appointment as President to more aggressively pursue the mid-market or enterprise? What are you seeing in terms of the competitive side within SMB? Is it just fixed wireless, or is there more to that? And then, on wireless, given the strong potential upgrade cycle on the back of AI smartphones and the iPhone 16, I was just wondering if you could talk about the Xfinity Mobile strategy to capitalize this -- on this from a promotional marketing perspective. What levers are you planning to pull this holiday to potentially lean into wireless to help the broadband business and wireless at large? Thanks.
Dave Watson: Got it. Thank you. This is Dave. So, a couple of things. Let me start with business. As you said, it is competitive in the small business categories, competitive in every category, but in particular, the small business one. There certainly is some fixed wireless that we've seen, and saw it in the Verizon results, pretty high percentage of the fixed wireless that are in the small business thing, and we're -- we look at that closely. We are intensely focused on our competitive playbooks and we're going to constantly compete for share. But we're also focused on revenue per relationship. And so, in the small business area, before getting into mid-market, we're doing a lot of product upgrades, adding value and speed, WiFi, security. And so, we made good progress and revenue focus around in small business. And it's such a huge opportunity for us and still in terms of small business. But Ed has stepped right in. It's a terrific team in the business services group that he's working with. And there really is, I think, a unique opportunity. When you look at the overall addressable market of $60 billion, less than 20% there, and a huge chunk of this will be mid-market and enterprise. And we're -- and you add on top of that international opportunities that we're beginning to coordinate and work well with Dana and the team at Sky. So, yeah, we really are seeing nice relationship growth in mid-market and enterprise. That's the starting point, but in addition to like all of our strategies, we're adding more products and attaching new products on these relationships, and going beyond just connectivity into a full managed relationship basis. So, Ed is driving that, and we're in a good competitive position for growth, and I think we have a good ability to increase ARPU across an increasing higher-end base of customers. So, on the mobile side of upgrade, it is -- every single upgrade moment pay close attention to that one too, and we're optimistic. We're in good position. We have a great trade-in program for mobile that we've had in place now for a while. And then, in addition to that, we go in and out in terms of subsidies on top of that trade-in program. And then, when good upgrade moments happen, we are the switching provider. So, when people -- we have great core rates and we have good handset offers and good position for it. So, being a switching provider, I think we are -- I think in a unique position to really take advantage of that. And when you look at things going into the optimism for Q3, one of the most important programs that we'll do, along with the handset upgrade initiative on mobile will be the Olympics. And the Olympics are such a unique opportunity for us to showcase the best broadband, the best mobile service offering, combining those two things together in such an attractive offer. On top of that is the greatest UI in the marketplace that helps you find whatever you want. So, really excited about that. Look for that in the next couple of days, but mobile will be front and center along with broadband when that happens.
Michael Ng: Great. Thanks, Dave.
Marci Ryvicker: Thanks, Mike. Operator, we have time for one last question.
Operator: Certainly. Our final question today is coming from Steven Cahall from Wells Fargo. Your line is now live.
Steven Cahall: Thanks. So, with mid-splits now reaching over 40% of the footprint, I was just wondering if you have an updated outlook on when you think you'll be at DOCSIS 4 for most of your broadband passings. And maybe within this you could just update us on where fiber overlap is, but also as you get through this network investment architecture that you laid out earlier this year, when you think about the capital intensity in C&P coming down and we'll start to see that benefit in growing free cash flow. So, timing on that, I think, would be really interesting. And then, how are you thinking about getting to just breakeven on Peacock? You talked about media EBITDA on a total basis growing in the first half and in the second half, too. It seems like if the Peacock losses keep getting better at this pace, you could be close to breakeven this time next year, but I know you've got NBA coming. So, just wondering if we could think about that benchmark quite yet. Thank you.
Dave Watson: Hey, Steven, this is Dave. Let me start and then hand it over on the Peacock side. So, we're 42% mid-split right now. We expect to be 50% by year-end. And the DOCSIS 4.0 that follows, multiple markets so far, it's early, no specifics in terms of the final rollout on that. But it really is tracking very well on top of the lot of new footprint expansions of 1.2 million over the last 12 months, this upgrade program is moving along very well, and it tracks to where the customers are, and our steady focus around the higher end. And one of the things that we see, we have the most effective and efficient build that's ubiquitous that is addressing speed, capacity, coverage and it helps us because as we're doing this, remember, we're virtualizing huge parts of the network and avoiding future node split. So, it's very efficient in helping us with the -- 70% of our customers are 500 megabits or higher, a third are taking a gig. And it's tracking to maybe one of the biggest tailwinds that is out there and that's the fact that our network consumption is still low double-digits increasing. And that's not stopping. And so, we're putting ourselves in position with a great upgrade program. And so that to me is, I think, a great advantage that we do have. In terms of competition, in terms of fiber, we're now 50% in terms of the overbuilt. We expect by the end of '25, that'll get to 60%. We'll probably go higher than that. We have a long track record of competing against fiber 20 years at this point. So, we do think fiber is quite frankly the longer-term competitor, keeping our eye on, compete fiercely against fixed wireless and every competitor, but we anticipate where they're building, what they're doing and keeping track of all of that. So, like our results -- and encouraged, when you look going into Q3, one of the reasons of optimism is that voluntary churn that continues to perform very well. And I think it's our superior network combined with better products and extreme focus on competition.
Jason Armstrong: Hey, Steven, I would just round that out on the capital intensity question, because I think embedded in that was sort of a long-term capital intensity question. If you look at what we're doing now, the path towards mid-splits, which as Dave mentioned, really good progress there, that kicking off DOCSIS 4.0 and then adding 1.2 million homes passed, which is a record for us in the last 12 months and doing that all within through the existing capital intensity envelope, which is one of, if not, the lowest in the industry. So, very good progress there. As you think about longer term, a lot of people ask this question in the context of is there the next big thing coming in terms of the network upgrade. We feel very comfortable between mid-splits and DOCSIS 4.0, that leading to multi-gig symmetrical speeds that, that is the network for the future. So, we don't see the next big thing coming. The one area that I'd point out, we'd love to do more homes passed. We've accelerated the rate from 800,000 in the past couple of years up to currently 1.2 million. We won't get capital intensity because of that. If those are good returns and things we should be doing, we'd love to do more there.
Mike Cavanagh: Steven, on Peacock and media EBITDA, I think you heard us right anyway, heard me right. I've been talking since I've been doing this that I don't really look at Peacock as standalone. I mean, it's an interesting exercise and I'm happy to share the numbers of what the loss is on Peacock as we're building it. But strategically to not pursue that path would leave the existing media business on a downward trend. So, I think we are thinking about it over multiple years. I'm very confident that what we're doing around Peacock and the media business together, operating together is going to put us on a path to optimize that business. And as you said, I think this is a year where we see the growth in Peacock offsetting the decline in some of our linear businesses, and that's basically a trend I would expect to see carry forward. There's going to be ebbs and flows. As Brian said, something like NBA is once in a generation almost to get an opportunity like that. So obviously, we'll make some adjustments and it might pause our trajectory the year we take it on board, but I think it's part and parcel of the idea that we're bringing the media business to a better future by investing behind Peacock and doing it together with all our assets, entertainment, sports and news as what our media business will look to be in the future. Well, thank you everybody. I think that's it. I stole Marci's line. Go ahead.
Marci Ryvicker: Thanks, Steve. This concludes our second quarter earnings call. Thanks for joining us.
Operator: Thank you. That does conclude today's question-and-answer session and today's conference call. A replay of the call will be available starting at 11:30 am Eastern Time today on Comcast Investor Relations website. Thank you for participating. You may all disconnect. |
NFLX | 2 | 2,024 | 2024-07-18 00:00:00 | Spencer Wang: Welcome to the Netflix Q2 2024 Earnings Interview. I'm Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Co-CEOs, Ted Sarandos and Greg Peters; and CFO, Spence Neumann. As a reminder, we'll be making forward-looking statements and actual results may vary. We'll now take questions from the sell-side community that have been submitted and we'll begin with a set of questions on our Q2 results and our forecast.
A - Spencer Wang: So the first question on our results come from Doug Anmuth of JPMorgan. So Spence, Doug asks, how -- can you provide some color on how churn is trending and perhaps share some color on what drove revenue growth in the quarter?
Spencer Neumann: Yes, sure. Thanks, Doug, and thanks, Spencer. We're pleased with our performance in Q2. There was strong performance across-the-board, good momentum across the business, strong revenue growth, member growth and profit growth. In terms of that member growth and churn, I'd say that the kind of outsized paid net-adds in the quarter was primarily driven by stronger acquisition, a little stronger than we expected, but also very healthy, continued healthy retention in the quarter and that's across all regions. In terms of growth generally, there's probably kind of three key factors that drove member growth. First, strong performance of our content slate, a wide variety of titles that delivered across genres and regions and I'm sure we'll talk more about that. There was some positive impact from paid sharing that continues. As we've said on recent calls, it's tougher and tougher to tease that out. We're clearly seeing healthy organic growth in the business, but we're also continuing to get better and better at translating improvements in our service into business value, including getting better and better at converting unpaid accounts. And at least on the paid member front, we're also probably benefiting from that attractive entry point in terms of price point and feature set for our ads plan. So you put all that together and it was a nice quarter for subscriber growth, but even more importantly, a nice quarter in terms of driving healthy revenue growth and healthy profit growth. So 17% reported revenue growth and margins that were up 5 percentage points year-over-year.
Spencer Wang: Thanks, Spence. Doug also has a follow-up question on the results. We noted -- or Netflix noted that India was our number two and number three country in terms of paid net-adds and percent revenue growth in the second-quarter. Do you feel like you're hitting more of an inflection point in that market? Or is that more about a very specific successful content slate in Q2?
Spencer Neumann: Ted, do you want to take it or?
Ted Sarandos: Yes. Well, look, I think India's growth is a story that we see around the world playing out very similarly. So you look at the concept, the product market fit is what drives our ability to attract members and retain members and monetize with them as well. So I feel like what's going on in the quarter has been this ongoing build. We had this great show here on Monday. Sanjay Leela Bhansali, SLB, is one of the most celebrated filmmakers in India and he took on this incredibly ambitious series and brought it to screen on Netflix, directed every episode, and it's our biggest drama series to date in India. So on-top of that, our original films and our licensed films as films in the pay-TV window immediately following theatrical have continued to thrill our members. So if we pick them well, we program well, we improve the product market fit, we improve engagement, we grow members, we grow revenue. It's the same formula I think everywhere else, everywhere we go and there's certainly plenty of room to grow in India as long as we keep throwing our audiences there.
Spencer Wang: Thank you, Ted. Our next question on the results relate to operating margin and the question comes from Jessica Reif Ehrlich of Bank of America. For Spence, how should we think about the pace of margin expansion going-forward and the drivers of the margin outperformance this year?
Spencer Neumann: Well, thanks, Jessica. Well, when we think about margin expansion, we're obviously pleased with how it's trending so-far. Our focus -- kind of stepping back, our focus is to sustain healthy revenue growth and grow margins each year. So we feel good about what we've been delivering. As you see in the letter, we're now targeting 26% full-year operating income margin, that's up from our prior guide of 25% and it's up 5 percentage points year-over-year assuming we kind of land there. But the amount of annual margin expansion as we look-forward, it could bounce around each year. And we've talked about this in recent quarters. It could bounce around because of foreign-exchange in a year where that moves or other business considerations. But we're committed to grow margins each year and we see a lot of room to continue to grow profit margin, absolute profit dollars and do that over an extended period of time for years to come.
Spencer Wang: Thank you, Spence. Our next question comes from Steven Cahall on -- from Wells Fargo and it's regarding free-cash flow. So the question is, Netflix has raised their full-year revenue and margin outlook, but did not change their free-cash flow forecast of approximately $6 billion. Is this just a pull-forward in cash content spend or is there anything else that is impacting your free-cash flow guidance?
Spencer Neumann: I'll take that. Nothing else impacting it. As we've noted -- as you noted, we continue to expect approximately $6 billion of free-cash flow for the year. There's always some uncertainty in terms of timing of things like content spend, sometimes timing of taxes. So that kind of keeps us right now holding at approximately $6 billion, but no other read-through beyond that.
Spencer Wang: Thank you, Spence. We have our quarterly question on paid sharing next from John Hodulik of UBS, which I'll direct to Greg. The question is, do you still have upside from the paid sharing initiative? And have you moved forward on mobile paid sharing? And if so, how big of an opportunity is this?
Greg Peters: Yes, Spence already gave some commentary on this quarter's performance, I'll talk about it sort of more from a long-term perspective. And as we said for a couple of quarters now, we're at the point where we really operationalize paid sharing. So it's just a standard part of our product experience. And we think about the improvements there. And to be clear, we do see still some significant areas for improvement there. But we see those as part of all the opportunities essentially we have to improve the product experience. So we're constantly prioritizing all those opportunities based on what we think is the expected value. And just to give you a sense of how wide that is, even things that we've been working on for over a decade like our sign-up flows or the user experience that a consumer has when they want to sign-up for Netflix. We have found multiple improvements just over the last couple of quarters in those flows, which have delivered material incremental revenue wins. So we're going to continue to look at all these opportunities. We're going to improve things for members and for the business. We'll iterate, we'll improve them. And we think of this as just a constantly improving value translation mechanism. So we want to take all the value that's created by Bela's teams in film and series. We got more live events, games and we want to translate that more effectively into revenue, so we can continue to invest and keep that flywheel spinning. And if we can keep improving that value translation mechanism each quarter and keep improving the entertainment offering that it operates on top of, those two things compound and drive the business, will drive the business through the rest of the year, will drive-through '25 and beyond. And that really allows us to more effectively get more of those 500 million plus and growing Smart TV households around the world that aren't currently members to sign-up. And it also drives our other levers of growth like plan optimization, extra member, ads revenues and pricing into more value. So I just -- I think about this as more of the constant work we are doing to improve for decades to come.
Spencer Wang: Thank you, Greg. I'll now move us along to a series of questions about advertising. And we'll start first with Barton Crockett of Rosenblatt and I'll point this question to Spence. You say that advertising is not a "primary" driver of revenue growth yet. Can you provide a little more clarity on what that means for both '24 and '25?
Spencer Neumann: Yes, sure. Thanks. So stepping back, I'd say we're very pleased with how we're scaling our ads business. We talked about that in our letter. We've been primarily focused on scaling reach. But if you think about even just the revenue portion of ads, it is growing nicely. The rate of growth, it just happens to be growing off of a relatively small base because we're starting from only 18 months into ads so to have the kind of a primary revenue impact across a business that has been primarily subscription for a long-time that just takes some time. So we're scaling well through reach, through engagement, through growing inventory and that represents opportunity for us over a multiyear trajectory to have a big and increasing revenue and profit impact on the business. So again stepping back, we feel really good about our position, our ability to sustain healthy revenue and profit growth. Ads is kind of one more tool in our tool chest there. We're doing the hard work now to improve our service across-the-board. So we finished the year strong in '24 and drive growth into '25 and beyond. We're small in every measure. We talk about it a lot. We're small in share of TV time. We're small in terms of penetration of connected TV homes. We're small in revenue market-share. And we're going to grow in those areas across-the-board and ads going to be a bigger piece of that puzzle. Just we won't have it be primary in '24, '25, but it contributes. It's a meaningful contributor. That's what we've said and that's what it is doing. And then when you get into '26 and beyond, it can be even more meaningful and hopefully becomes to the point where it is a primary contributor given all of that engagement and reach that we're building.
Spencer Wang: Thank you, Spence. A follow-up question on advertising comes from Ben Swinburne of Morgan Stanley and I will direct this to Greg. Looking into your advertising revenue ramp into 2025, what are the key areas that need to improve to bring in significantly more revenue? Can you talk about the opportunities and challenges scaling up your direct sales efforts and leveraging third-party sources of demand, primarily programmatically?
Greg Peters: Yes, we've said many times our priority -- number-one priority, first priority is scale, so we've been heavily focused on that. And the great news is we've seen great progress in that regard. We've been scaling our ads member base very quickly from zero two years ago to where we are today. And we're excited to say that we're on-track to achieve our critical scale goals for all of our ads countries in 2025. Clearly, we expect further growth beyond that, but that represents a great threshold to get to and then to build more scale and more attractiveness from there. So that allows us to shift more of our energy now on more effectively monetizing that rapidly-growing inventory. And there's sort of two main fronts here. One is our go-to-market capability. So we're adding more sales folks, we're adding more ads operation folks, building our capabilities to meet advertisers. A big component of that is giving advertisers more effective ways to buy Netflix. It's a big point of feedback that we heard from advertisers. So by adding demand sources that are already integrated into their processes and their systems, that just makes it easy for them to buy. And in some cases, that was a threshold item for them to buy in us, so we're going to expand the number of buyers as a result of that. And then the other big area of growth for us is the sort of product and technology stack. We mentioned we're building our own ad server now. We're excited to launch that in Canada this year and then the rest of our ads markets in '25. That unlocks a whole set of innovations that we expect that are focused on a better user experience for our members on those ad tiers and better advertiser features. So I think a lot about this is targeting relevance, more capabilities in that space as well as thinking about how do we do ROI, ROAS, incrementality measurements, all the things that we want. And ultimately, really this is about bringing what has been amazing about digital advertising in terms of targeting relevance, measurement, et cetera. And what we think is amazing about TV advertising, which is an incredible creative format, better creative format in many cases than digital as well as the ability to put those advertisements next to content to titles, stories that are impacting the social conversation, which is important for advertisers. So lots of work ahead. We've got years of work to do, but that's the line that we're moving forward with.
Spencer Wang: Thank you, Greg. From Steven Cahall, his question is, given what we think are pressures on AVOD CPMs and the 10 hours per account per month viewing time you disclosed at the upfront for ad-supported members, what's the likelihood that ad support ARM drops below ad-free member arm in the second-half? Would you consider raising the price of ad-supported tiers as an offset?
Greg Peters: Okay. So perhaps starting by just providing some clarification here, our engagement on our ads plans is very similar to what we see on our non-ads plans. That's close to the approximately two hours of viewing per member per day across all the plans that you can calculate globally from our engagement reports. You should think of that as roughly how our ads plan members are engaging as well. And then on terms of ads ARM, so ads ARM which is of course a combination of the subscription amount plus the ads revenue, currently because we've been scaling so rapidly, we are not -- we're racing behind essentially to fulfill all of that increasing inventory and we're lagging in that regard. So currently our ads ARM is lower than our non-ads ARM. And that's obviously we look at that as both -- it's a go do, but it's a revenue growth opportunity for us as we scale into that, that represents an opportunity to accelerate our revenue growth as well. So you mentioned price. We think about pricing for ads tier very similarly to how we would think about pricing for our non-ads tier. First of all, I just think it's worth noting that we love having an entry price that's lower. That means we are more accessible for more people in our ads markets. That's a great thing because they get access to all the amazing storytelling that we are doing there. But in terms of raising that price, we think about it similar to how we think about pricing in general, which is where it's our job to increase the value that we are delivering all of our members. We've got more amazing film, more series, the live events that are coming, more games. And when we have signals from our members, this is the amount of acquisition that we've got going on, engagement, what our retention and churn looks like, then we find the right moment to ask our members to pay a bit more to keep that flywheel spinning. And we'll think about that in the ads context just like we would in the non-ads context.
Spencer Wang: Thank you, Greg. John Hodulik from UBS asks, can you provide an update on the CTV ad environment and update us on initial feedback from advertisers on your ad tech initiative. What features do you expect to add with the ad tech build? And anything you can tell us about the costs associated with it?
Greg Peters: Sure. Well, there's a lot of excitement amongst advertisers to -- about the work that we're doing. I'd say the primary one and again one that we're responding to, which is sort of very tactical and immediate is being able to provide advertisers more ways to buy on Netflix. So those demand sources is something we heard very clearly from advertisers that it was either a real improvement for them or it was a necessary point for them to be able to buy on Netflix. So then beyond that, we hear lots of enthusiasm for the things I mentioned before, increasing ads relevancy, targeting personalization, better measurement, incrementality, all these things that we'll be building over the next several years, lots of excitement about that. The biggest negative feedback we get is that we aren't there right now. So advertisers want us to have all those features in place today. We would love to have all of those features in place today for sure. So we're -- got the hard work ahead of us of building those as quickly as we possibly can and closing that gap as soon as we can. But this is -- it's years ahead of us to go-ahead and keep building these things. And quite frankly, as we build those features, I am quite certain that there'll be more that will come onto the roster that advertisers will be asking for us and more that we'll be excited about doing.
Spencer Wang: Thank you, Greg. And our next question is for Ted, coming from Rich Greenfield of LightShed Partners...
Spencer Neumann: Hey, Spencer.
Spencer Wang: Yes.
Spencer Neumann: Spencer, sorry to interrupt you. We didn't really answer the kind of cost thing unless I missed it. Did I missed that in terms -- sort of I can chime in, if you like. All of what Greg talked about in terms of investing in the business, suffice it to say that is all embedded in our margin guidance. So we're -- we make trade-offs all-the-time with the business where our expenses are up 7% year-to-date where if you kind of step-back, we're on track to be -- you can do the math, it's probably north of $28 billion in total expenses across our business for the year and we're still expecting to deliver five percentage points of margin improvement. So we try to run the business like owners, make smart trade-offs and invest into growth like live, like ads, like games, like product innovation and ads as part of that, both for this year as well as into next year where again we expect to drive revenue growth and increase our margins while investing into ads?
Greg Peters: Thanks, Spence [Multiple Speakers]
Spencer Wang: Yes, thanks for keeping us on this, Spence. So next question is for Ted coming from Rich Greenfield of LightShed Partners. Is your recent agreement to stream two NFL games on Christmas Day signaling that you need live sports to build a robust advertising business or are you trying to create a regular cadence of high-profile live events to bring advertisers onto Netflix platform who will then spend across your broad array of entertainment content?
Ted Sarandos: Thank you, Rich. It's a great question. And let me back up a minute. We're in live because our members love it and it drives a ton of engagement and it drives a ton of excitement. And those two things are very valuable. So the good thing is that advertisers like that too and they like it for the exact same reason, the excitement and the engagement. So everyone's interests here are perfectly aligned in that way. What we signaled to the world when we went live with the Chris Rock: Selective Outrage special last year-ago is that this company, Netflix, who you love for on-demand viewing of your favorite TV shows and movies is also -- I say also going to surprise you with amazing exclusive buzzy live entertainment. And since then, we've launched a golf tournament with the great -- the biggest stars in PGA golf and Formula 1 drivers; a tennis match with two like generational titans of professional tennis, Nadal and Alcaraz; a live comedy with Katt Williams; an entire week of groundbreaking live talk show episodes from John Mulaney; that epic roast of Tom Brady, our biggest live stream yet. And still to come, we've got a live show with Joe Rogan. We have this hot dog eating grudge match between Chestnut and Kobayashi that people are remarkably excited about. We have this long-awaited boxing match between Mike Tyson and Jake Paul in November. And on Christmas Day, not just one, but two great NFL football games. So I would call that a really fast ramp and it leads right into weekly live coverage of WWE. So it's that thrilling excitement, engaged, watching that people are really thrilled about and we're thrilled about and that we're thrilled that our advertisers are excited about it too.
Spencer Wang: Thank you, Ted. Rich has a part two to this question, not surprisingly, how do you thread the needle on licensing sports to drive advertising spend without becoming beholden to leagues at renewal?
Ted Sarandos: Well, hopefully exactly the way we're doing it by making these Netflix events, not necessarily taking on a lot of tonnage from any one league, but actually making these games -- events like having two NFL football games on Christmas Day and two great games, the Chiefs and the Steelers and the Ravens and the Texans, they're both going to be great games and it really creates a lot of real excitement with the service and it's one day of football. So when I look at that and I think along those lines, you'd see how we solved for that in our WWE deal, which was economics that we like and live with and can grow into and contemplate with that expansion of cost and viewing would be over the -- over in that case as long as 20 years if we wanted to be. So I think it's really not a matter of -- there's an automatic disconnect between you can't do sports and net profit. It's very difficult to have big league sports and profit until -- when you offer them entire seasons. But when you offer them in this event model that we're building on, we're really excited about our opportunity to do that without the risk that you're talking about right now. So -- and then beyond that, we are in love with the kind of very profitable storytelling version of sports. So if you can't wait for those football games on Christmas Day, you can watch Receiver right now. It just started on July 10th on Netflix, which is part of that storytelling version of sports.
Spencer Wang: Thank you. Thank you, Ted. Our next question comes from Kannan Venkateshwar of Barclays. It's a question regarding our engagement. So Ted, could you speak to the underlying engagement health at Netflix and what are you seeing there?
Ted Sarandos: Yes. Look, I think I talked about this a bit on the last call as well, but competition for entertainment is super intense and we compete for every second of view time we get. So beyond that, kind of the competitive intensity that's always been out there, we also anticipated some headwinds in our engagement because of paid sharing. Remember, we're taking folks who were watching Netflix and not paying-off the service. So we thought our engagement would go down. We took a deep-dive into how that was impacting and how we could isolate that impact and look at it as owner households, so those folks who were not impacted by paid sharing at all. And what we saw was in last quarter is that engagement was holding steady, so that much of the engagement headwind was coming from that. And I look then -- but now we look-forward a quarter. Now I'm not going to get in the habit of releasing this as a new metric every quarter, but looking at that same segment again, that segment's engagement is actually not just steady, but up year-on-year. So we're very excited about that. I think it's a very healthy sign of engagement growth. And even with all of that, so beating down the headwinds of that and beating down competition, we're still about 10% of TV time in every country we operate in. So still lots of room to grow, but very pleased with our engagement, but not fully satisfied.
Spencer Wang: Thank you, Ted. Our next question comes from Ben Swinburne of Morgan Stanley. Your primary competitor for more passive home entertainment engagement increasingly looks to be YouTube. What are you doing in terms of programming and product to try and take share from YouTube in the future? Or is this not a focus? Are there key verticals like kids programming where you see YouTube as particularly advantaged? Perhaps Ted, you and Greg can tag team on this one.
Ted Sarandos: Yes, sure. Looking at the Nielsen data that just released for June, what you see there is Netflix and YouTube are the clear leaders in direct-to-consumer entertainment. So our two service -- us and YouTube represent about 50% of all streaming to the TV in the US and we use the US only because that's where we have the data. So really what we're focused on here is focusing ourselves on that other 80% of total TV time that isn't going to either us or YouTube. So that's a ton -- even that's both streaming continuing to expand, which it did in June, so that share of TV time grew against linear. And as linear continues to give, I think there's a lot of opportunity for us to grow as long as we keep executing well. Now we clearly do compete with YouTube in certain segments of their business and we certainly compete with them for time and attention, but our services also feed each other really well. So remember, our shows are the most-watched and talked about and award nominated. We just came out of 107 Emmy nominations for our slate this year yesterday. And so our teasers and trailers and behind-the-scenes clips and all those kind of things are incredibly popular on YouTube. So in that way, we kind of feed each other pretty nicely. Greg, I don't know if you want to add anything?
Greg Peters: Sure. I think it's also important to note that Netflix fulfills an important and differentiated need for both consumers who really want -- they want amazing spectacle movies and TV shows as well as an important need for creators who want partners that can share in the risk that's inherent in bringing those stories to life. So you think about shows like Stranger Things or Wednesday, Heartstopper, Outer Banks, these shows create amazing view and fandom in especially with younger audiences. So it's not just one generation. And it's really hard to imagine how that kind of big creative bet would happen and be possible within YouTube's model. So to Ted's point, it is very competitive out there. And we also feel confident that our model works. It works well for our consumers, it works well for creators and it works well for our business and helps us generate significant operating margin.
Spencer Wang: Thank you, Ted and Greg. Our next question comes from Maria Ripps of Canaccord. Netflix's CTO, Elizabeth Stone, recently appeared on a podcast where she said that Netflix is exploring how to integrate generative AI into the platform to improve the member experience. Do you think that technology could have more of a potential impact on the content creation or discovery side? How do you think about the relative impact on engagement from improving discovery versus content? Greg, over to you for this one.
Greg Peters: Yes, we've been using similar technologies, AI and ML for many years to improve the discovery experience and drive more engagement through those improvements. We think the generative AI has tremendous potential to improve our recommendations and discovery systems even further. We want to make it even easier for people to find an amazing story that's just perfect for them in that moment. But I think it's also worth noting that the key to our success stacks, right, it's quality at all levels. So it's great movies, it's great TV shows, it's great games, it's great live events and a great and constantly improving recommendation system that helps unlock all of that value for all of those stories. Ted, you want…
Ted Sarandos: Yes, it begs the question about the impact on creative with AI going-forward, which is hard to predict obviously. But I would say this, I think that AI is a great -- is going to generate a great set of creator tools, a great way for creators to tell better stories. And one thing that's sure, if you look-back over 100 years of entertainment, you can see how great technology and great entertainment work hand-in-hand to make -- to build great big businesses. You can look no further than animation. When animation didn't get cheaper, it got better in the move from hand-drawn to CG animation and more people work in animation today than ever in history. So I'm pretty sure that there's a better business and a bigger business in making content 10% better than it is making it 50% cheaper. So remember, I think that shows and movies, they win with the audience when they connect. And it's when the -- it's in the beauty of the writing, it's in the chemistry of the actors, it's in the plot, the surprise and the plot twist, all those things. And I'm not saying that audiences don't notice all these other things, but I think they largely care mostly about connecting with the storytelling. And I'd say they probably don't care much about budgets and arguably maybe not even about the technology to deliver it. So my point is they're looking to connect. So we have to focus on how to tell on the quality of the storytelling. There's a lot of filmmakers and a lot of producers experimenting with AI today. They're super excited about how useful a tool it can be. And we got to see how that develops before we can make any meaningful predictions of what it means for anybody. But our goal remains unchanged, which is telling great stories.
Spencer Wang: Thank you, Ted and Greg. We now have a question from Ben Swinburne regarding our product. And the question for Greg is, can you dimensionalize the opportunity from a new homepage? You said that this is the biggest update in a decade, which sounds meaningful. What are the primary areas of improvement you're targeting with this?
Greg Peters: Yes, it's hard to know exactly at this moment how much benefit that new homepage will derive. I think it's worth noting that it's less about the improvements that we're going to deliver initially, but it's more about creating a structure that allows us to evolve and advance more freely than the current structure does. And in terms of what are the pain points, what are we trying to solve, a lot of this is getting to the increase in diversity of entertainment that we are now offering. So we've been amazing at film and series for a long period of time, but now increasingly, we're adding live events into it -- live events like the Brady roast, which was incredible, but it's a sort of one-off event that we have to create demand for. It's live events like WWE, which are consistent and repeating that we want to make sure that fans of that experience have an easy way to access those things. We're increasingly promoting games as well into our service. So what we found is we need to create structures that allow us to flexibly go from one-type of content and entertainment to another in terms of how we're promoting and connecting those. So there's things like that. There's also things like we want to increasingly recognize that we're doing -- even in the same content type, we're doing different jobs for our users in different moments. And that could be Sunday afternoon family movie time, that'd be a great experience if we want to provide exactly the right discovery and choosing experience for versus maybe late on Thursday night when you're coming home and you just want to get into the next episode of the series that you're currently cruising through. So it's that kind of flexibility we want to provide. This is -- our expectation is that this new structure will allow us to deliver as the old structure did for a decade, multiple repetitive material benefits to users in terms of engagement, which lead into retention and then revenue. But again, that will be a long iterative journey and mostly we're trying to take that first step and set us up for that.
Ted Sarandos: And less technical too, Greg, it's -- the UI is beautiful.
Greg Peters: There we go. We like beauty as well…
Ted Sarandos: It is -- it really is.
Spencer Wang: Thank you. Next question is from Jason Helfstein of Oppenheimer. What have been the early results from phasing out the basic tier in a handful of your markets? And how does that tie-back to success in selling ads? Greg, would you want to take that one?
Greg Peters: Sure. As you've seen us do multiple times before, we spent a lot of energy on the right product experience for doing this migration. And then what we do is we roll it out and we test it and we see how that goes and I let our members tell us if we did a good job there or not, we make whatever changes in iterations before we then scale it out and roll it even further. And I think it's worth noting here that we feel like in this migration, we've got a very strong offering for our members. Essentially, we're providing them a better experience, two streams versus one. We've got higher definition, we've got downloads. And, of course, all at a lower price, $6.99 in the United States. We think that represents a tremendous entertainment value and it includes ads. And for members who don't want that ads experience, they, of course, can choose our ads free standard or premium plans as well. And then in terms of performance, I'll just let our actions speak for ourselves. When those things go well, we typically roll it out and that's -- we've had the confidence to move forward with that change in the U.S. and France. So that's an indicator of how it's going.
Spencer Wang: Thank you, Greg. Next question comes from Eric Sheridan from Goldman Sachs. The question is regarding gaming. Can you provide any update on your gaming initiative and user engagement and your ability to scale your gaming efforts?
Greg Peters: Sure. Games is a big market. So it's almost $150 billion ex-China and Russia and not including ad revenue, which we aren't participating in our current model. And we're getting close to three years into our gaming initiative. And we're happy with the progress that we've seen. We've had set ourselves pretty aggressive engagement growth targets. And we've met those -- exceeded those in many cases. In 2023, we tripled that engagement. We're looking good in our engagement growth in '24 and we've set even aggressive -- more aggressive growth goals for '25 and '26. But worth noting that engagement and that impact on our overall business at the current scale, it's still quite small. And it's also probably worth noting that the investment level in games relative to our overall content spend is also quite small and we've calibrated the growth in investment with the growth in business impact. So we're being disciplined about how we scale that. So now obviously the job is to continue to grow that engagement to the place where it has a material impact on the business. And I think you've seen this trajectory with us before, whether it's been a new content genre like unscripted or film or maybe getting the content mix right for a particular country, you can think about Japan or India, which we're now in an amazing place through the hard work of our teams there. We continually iterate, we refine our programming based on the signals we get from our members. And if you look over several years with that model, we can make a huge amount of progress. We've launched over 100 games so far. We've seen what works, what doesn't work. We're refining our program to do more of what is working with the 80-plus games that we currently have in development. And one of those things that really is working is connecting our members with games based on specific Netflix IP that they love. And this is an area that we've been able to move in quickly in a particular space, which is interactive narrative games. These are easier to build. And we place those in a narrative hub that we call Netflix stories. Q2, we launched Virgin River and Perfect Match. Starting this month in July, we're going to launch about one new title per month into Netflix stories. And this is amazing IP like Emily in Paris and Selling Sunset. And we have lots more, including very different types of games yet to come in the quarters and years ahead.
Ted Sarandos: Yes. I just want to chime in for a second, Greg, if you don't mind. This is why I'm really excited about the opportunity in games, which is the way that it's pretty rare for the content -- new content vertical like this to actually complement or draft off of each other. So every once in a while, we get something like Squid Game: The Challenge following the Squid Game with the scripted series. But I think our opportunity here to serve super fandom with games is really fun and remarkable. I think the idea of being able to take a show and give the super fan a place to be in between seasons and even beyond that to be able to use the game platform to introduce new characters, the new storylines or new plot twist events. Now you could do those kind of things and then they can then materialize in the next season or in the sequel to the film. It's a really great opportunity and a rare one where one-and-one equals three here. And to kind of replicate some of the success we've seen building fandom and with live events and consumer products, this actually fits really nicely into that. So I'm really excited to see where this goes.
Spencer Wang: Thank you, Ted. Thank you, Greg. Our last question comes from Jessica Reif Ehrlich of Bank of America. The question is regarding content spend. Ted, you have targeted $17 billion in cash content spend this year. You're increasing your sports spending within that. How should we think about your spending on entertainment or non-sports entertainment and what's the overall content spending growth going-forward?
Ted Sarandos: Well, thanks for the question. I would like to just back up a little bit and say that creating TV and films for a big global audience is a creative process. So -- and we're programming for more than 600 million people around the world who are watching us for a couple of hours a day every day. So we're -- we've got our work cut out for us. And that $17 billion, all those exciting things we talked about earlier are all tucked into that $17 billion and that $17 billion will grow as our revenue grows. It won't grow as fast as our revenue grows, but it will grow to accommodate that. And I think what's really important and where I think we have a real interesting advantage here is that we have these distributed creative teams all over the world. So what's great about that is they are very tightly wound into the creative ecosystem in all these different countries, the star systems, the producer systems and more importantly, the culture, what fans in those countries really love. So we've got all these folks working at the same time so that in this creative process, which does have hot streaks and cold streaks, they can be operating pretty simultaneously to create a very steady cadence of big exciting hits. We certainly compete with Hollywood to make the best and most popular programming in the world. But we're also doing that in India, in Spain, in France, in Italy, in Germany, in Korea and Japan, all over Southeast Asia and Mexico and Colombia, Spain, Argentina and the U.K. And the program that create -- the programming that we create in those countries, all -- again, all part of that 17 bill are all designed to thrill the local audience. And when they really, really thrill the local audience, there is a possibility and sometimes a probability that they could find a gigantic audience all over the world, including in North-America. So the team in EMEA, particularly in the UK, is doing a remarkable job of this right now. So they have been able to deliver big global hits, but they've been sensational in country. So Baby Reindeer and The Gentleman, both landed with Emmy nominations yesterday and have been sensations in the US, but they are a phenomenon in the UK. So more than 50% of all of our members in the UK have watched or watching Baby Reindeer and The Gentleman. Similarly with One Day, our original film Scoop. So those things that are thrilling the world are super serving the British audience. The same thing just came out of Paris or out of France with under Paris, which was 90 million views, 157 million view hours around the world, more than half of every French member loves this movie. Same thing with The Asunta Case in Spain. More than 50% watching in Spain and big watching all over the world. Queen of Tears in Korea is another example that's happening in APAC right now. So this kind of like super serving local audiences, creating global content around the world, gives us an efficiency that I think is getting better and better and a muscle that's getting stronger and stronger that I'm really excited about. And how does that play-out, our slate coming up is unbelievable. So in -- as we've currently forecast, what we're going to deliver for the rest of this year and what we're going to deliver into the net -- in through '25 just for -- just before the end of this year, we've got Squid Game return, we've got Emily in Paris return. You've got a new season of Selling Sunset, Lincoln Lawyer, The Diplomat, Virgin River, Love is Blind. Ryan Murphy has an incredible new season of Monsters that tells the Erik and Lyle Menendez story. That's all just coming up before the end-of-the year. And then looking-forward over the next -- through '25, you've got new seasons of Wednesday and Stranger Things and Night Agent. We're in production on One Piece. So there's a ton of excitement there just in our series. This week, we kicked-off the finale of Cobra Kai, which is going to blow your mind. August 8th, we've got the finale of Umbrella Academy kicking off and a brand-new series that we're also thrilled about. Susan Beer's Perfect Couple with -- this has got Nicole Kidman and just a really fun, fun thriller. Nobody Wants This from Kristen Bell and Brody, Black Doves, a beautiful show out-of-the UK. Beauty in Black from Tyler Perry, No Good Deed which is bringing Ray Romano and Lisa Kudrow back to TV, A Classic Spy with Ted Danson. From Brazil, we have Senna. From Colombia, we've got Hundred Years of Solitude. And then, of course, all those live events I talked to you about. And our movie slate is fantastic with Rebel Ridge, Will & Harper, The 688, The Piano Lesson, Carry-On. These are -- we have got a lot packed into that. Our goal and our mission here is we have to spend the next billion dollars of programming better than anyone else in the world and there's no one better at doing it than Netflix. So we're excited.
Greg Peters: Spencer, how do you not get excited about that and then also get excited about that we're going to do all that while growing content spend slower than revenue. That's a lot of stuff going on. Thanks, Ted.
Ted Sarandos: It's all in. It's all in there.
Greg Peters: And a hot dog contest too, Spencer, don't forget that.
Spencer Wang: All right. Well, I'm going to leave it at that since it sounds like we're going to have a lot to watch. So we all need a little bit more time. So we'll end the Q2 call here. So thank you, Ted, Greg and Spence for joining us today. Thank you, investors and analysts for dialing into our call and we look forward to chatting with you next quarter. Thank you very much. |
PEP | 2 | 2,024 | 2024-07-11 11:00:07 | Operator: Good morning, and welcome to PepsiCo’s 2024 Second Quarter Earnings question-and answer-session. Your lines have been placed on listen-only until it’s your turn to ask a question. Today's call is being recorded and will be archived at www.pepsico.com. It is now my pleasure to introduce Mr. Ravi Pamnani, Senior Vice President, Investor Relations. Mr. Pamnani, you may begin.
Ravi Pamnani: Thank you, operator. Good morning, everyone. I hope everyone has had a chance this morning to review our press release and prepared remarks, both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans and updated 2024 guidance. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today, July 11, 2024, and we are under no obligation to update. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to our second quarter 2024 earnings release and second quarter 2024 Form 10-Q available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. Joining me today are PepsiCo's Chairman and CEO, Ramon Laguarta; and PepsiCo's Executive Vice President and CFO, Jamie Caulfield. We ask that you please limit yourself to one question. And with that, I will turn it over to the operator for the first question.
Operator: Thank you. [Operator Instructions] Our first question comes from Dara Mohsenian with Morgan Stanley. Your line is open.
Dara Mohsenian: Hey, good morning, guys.
Ramon Laguarta: Good morning, Dara.
Dara Mohsenian: So, I just wanted to focus on the implied organic sales growth guidance in the back half of the year of mid-single digits to get to the approximate 4% guidance. You've obviously had a great longer term track record, Ramon, under your tenure, but in this softer U.S. consumer environment we've seen low single-digit growth in the last couple of quarters. So what gives you confidence at the corporate level you can get back there? And specifically. I wanted to dial down into Frito-Lay North America, which is presumably a piece of that. Obviously, a pretty soft volume result in Q2, you had taken some initial actions. So, help us understand the incremental actions from here. What gives you confidence you get a volume payback and a top line payback from that? And how sort of Frito-Lay North America fits into that -- that implied top line recovery also.
Ramon Laguarta: That's great, Dara. So I think it's an important area to focus. When we're saying at least four, we were talking more about around five in our minds. Now we're talking around four, so that's the pivot we're making. There is an adjustment and it is related to specifically the consumer in the U.S., and we can talk a little more. Now, why do we feel good about our guidance? And it cannot be disconnected from our earnings performance, because I think the work we've been doing on our productivity and our cost reduction gives us the optionality to reinvest back in half two in a way that we feel much more comfortable about the performance. So, a couple of, I would say, elements that give us confidence. Now, one is Quaker. Quaker, you're all familiar with the situation. We're recovering the supply chain by Q4, will be in almost 100% supply and obviously the business at that point will be growing materially, because we're just refilling the shelves and pipeline. So that should be out of the picture and it will be a positive impact for us. The second is mathematical, but it's lapping, and we think it -- obviously, the laps are much better in second half, and that has a -- gives us confidence that we can get back to a mid-single digit type of growth in the second half. The third element is international. International is an area we've been investing for the last few years materially, and is delivering for us. So first half of the year 7%, within that -- we will continue that same level of growth in the second half of the year, pluses on minuses around the world. But the portfolio is diverse enough, scale enough, profitable enough around multiple parts of the world that we believe that we can deliver. And then now in the U.S. there is clearly a consumer that is more challenged, and is a consumer that is telling us that in particular parts of the portfolio -- of our portfolio, they want more value to stay with our brands. That is not for all the consumers, it is some consumers, that is not for not all portfolio, it is some parts of the portfolio, and we have been working different tactics to give the consumer what they want, and we see that is working, and that's why we feel comfortable about -- given the oxygen that we have in the P&L that we'll be able to deploy in a very targeted way, thinking long-term about the category, making sure that has -- it has good ROI, that we'll be able to turn around the -- especially, what you were referring, the food business to positive volume, and with that, a higher level of net revenue. So that's how we're thinking about the second half. Again, we have green charts with some of the activities we've been executing. And July 4th has been very strong for us, and we feel good about the business. Now, the North America beverage business is also to be highlighted. It's a business that we said over time we want to stay with -- deliver profitable growth, make sure we compete well in the category, but at the same time improve our margins. We think we're executing the playbook well. Actually, we've been accelerating the profitable growth delivery of the business, and that it should continue in the second half. We're investing in advertising and marketing even more, in the platforms that are growing, and that's what, overall, if we put it all together, we feel good about the second half of the year and the momentum that we will start 2025 with that.
Operator: Thank you. One moment for our next question. Our next question comes from Bonnie Herzog with Goldman Sachs. Your line is open.
Bonnie Herzog: All right. Thank you. Good morning, everyone. I actually had a question on PBNA. Ramon, I know you just touched on a bit, but I'd be curious to hear. If you're satisfied with some of the progress you might be making to reinvigorate the business, and maybe what green shoots you are seeing within PBNA? And then, I guess, I'm hoping for some color on the initiatives you highlighted in terms of the disciplined commercial investments, should we assume this will also mean a potential step up in promos for PBNA? And do you maybe see a need for some brand repositioning? Are there structural opportunities? Essentially, what will be the drivers to reaccelerate growth at PBNA? Thanks.
Ramon Laguarta: Yes, it's good. Bonnie, I'll give you a couple of data points that I think are relevant. Gatorade, for example, has been gaining share. This year, year-to-date meaningfully is accelerating. That's a core part of our portfolio and a very profitable part of our portfolio. So that's one data point. We've been investing in Gatorade. Not so much on, as you were saying, promos and discount, but more on innovation, execution and branding. And that's paying back. The same with Propel. So all that functional hydration space, I think it's a focus for us. It's always been a focus, but now I think that part of the portfolio is working well. I think some of the G2DSD challenges that we had last year are behind us. I don't think we're all the way to perfection there, but much better service levels in this early part of the summer, which obviously -- that's when the category peaks and where we have to be ready for perfection. So that part is clear. If you think about the other brand, we've been talking for some time, Mountain Dew. Mountain Dew is on growth. Now it's back to growth. I think we made this strategic decision to have multiple flavors driving the brand and made Baja a structural part of the portfolio versus yes, an LTO, that's driving consumers into the brand, incremental consumers. And again, better levels of execution. So just some example. All the Zero part of the portfolio is booming, right? If you think about consumer trends, clearly we know where they're going, we know that internationally, and we know that's going to eventually happen here in the U.S. So Zero not only on colas, not only on soft drinks, but also on Gatorade, on cheese, on coffees, we're seeing that consumers are growing. And then the last part is our food service business is becoming stronger and we're being better at where the profitability is, which is on the fragmented restaurant, local restaurant, and where consumers have a lot of interaction every day. And that part of the portfolio, we've been investing. We're getting additional distribution. We know we're becoming a better execution company in that particular channel, and we're feeling good about that.
Operator: Thank you. One moment for our next question. Our next question comes from Lauren Lieberman with Barclays. Your line is open.
Lauren Lieberman: Great. Thanks so much. Ramon, I wanted to go back to Frito, if I may. Because you commented on some consumers, and being more value to stay with our brands. But one thing we've been doing a lot in trying to parse through the data that's available to us, and it looks like it’s the category -- the salty snack category as a whole is really pressured. It's not just your brands, and I know given your share, there's sort of one in the same, but it looks like there's a broader category issue. Again, some of the data we've looked at, it feels like the category is not proving terribly responsive to promotion. So I just was hoping you could comment on that, if that is or isn't consistent with what you're seeing? And how what you're going to be doing will be different? Because, again, what we've seen so far, it doesn't look like there's a lot of response and it feels like the category is proving more discretionary. So just love your thoughts on that? Thanks.
Ramon Laguarta: Yes. I think -- we feel that the issue is an issue of value, is not an issue of anything else. And we have a lot of data, obviously now how do you address that value gap versus what consumers want to do. I think it's the -- it's where the know-how will come. And the sweet spot for us is not to promote, but is to promote to who needs it, in the products that need it versus a blanket approach to promotion. So that's where we're investing a lot of time. I think we're much more capable from the insights and diagnostic point of view and also from our ability to execute more granularly all these interventions, be it digital, be it with particular channels or customers. To give you an example. We feel that the unsalted part of our portfolio, right? If you think about potato chips or tortilla chips, that needs some value reset and value intervention for some consumers. When we think about flavor potato chips or other parts of our portfolio. No, I mean consumers are staying in the category, are staying in our brands, and they're buying with pretty high frequency as in the past. There are other parts of the portfolio that are growing, growing very fast, especially the permissible part of what we call permissible portfolio positive choices, this is a -- when you think about brands like SunChips, PopCorners, Smartfood, or the Simply range of the Eaten Path, those brands are growing. And there it’s not about value, there I think it's more about and the way we're going to approach it’s more marketing, investment, awareness, execution, availability. So there's different tools that we'll be using to drive the category growth. To your point on, is it the category? Is it PepsiCo brands? I think given our massive participation in the category through many multiple brands, I think it's our responsibility to manage this category for the long-term, providing value to consumers in different ways and continue to have the savory snacks category growing above food structurally as we have done in the past. Now, there is nothing in terms of consumer -- long-term trends that tells us that that's not possible. I think it's a small adjustments in value and in execution and in investment in new innovation areas that will drive it, and we feel very strong about our ability to do that, not in the long-term, but actually in the short-term, in Q3 and Q4. And that's why our guidance reflects a little bit that inflection because we're already testing and executing some of these levers and we see the returns it has in volume and net revenue.
Operator: Thank you. One moment for our next question. Our next question comes from Bryan Spillane with BofA. Your line is open.
Bryan Spillane: Hey. Thanks, operator. Good morning, Ramon. Good morning, Jamie.
Ramon Laguarta: Hey, Bryan.
Bryan Spillane: Just wanted to circle back on Frito. And I guess stepping back, you're able to sort of reset the margins and fund it with just drilling deeper into some of the reservoirs of productivity other places in the organization. So I guess just if you can comment on two things related to that. One, given that you're tapping more productivity this year, does it -- how does that affect next year? Does that affect maybe not having as much productivity to flow through, or is that reservoir very deep. And then the second is, as we are thinking about Frito margins stepping back in the back half of the year, should we be thinking about that now as the new base to maybe grow off of gradually, or is that a major step down, and then you'd expect Frito to have another maybe step change up in the future?
Ramon Laguarta: Yes. So, Bryan, let me tell you, I think we've talked about this in the past. We're managing total PepsiCo operating margin and as you've seen, we keep improving the margin. This quarter was almost 100 bps of operating margin improvement, and it's been consistent for the last few years. We feel good about our productivity pipeline, it’s not tactical, it's super strategic and it's multiyear and it's based on automation, it's based on digitalization, simplification of the company, standardization, different service models to the business. So there is a whole portfolio of productivity ideas that are multiyear in nature and we don't think that we will slow down our productivity in the coming years. Now, as you think about our overall margin, international has continued to grow its margin. PBNA has been very vocal from our side that we want to have that business going -- moving into mid-teens, and we're delivered on that. And we've always said that the big value of Frito for us is not so much whether it's a 26 or 26.5 or 27.5, that is very relevant, I would say. It's always tremendous acquitted for us long-term, and the biggest value creation for Frito is to make sure that it grows at a 4% or 5% levels, and that is going to be our -- continues to be our strategic focus. How do we get Frito to continue to grow above the category, make the category very healthy in terms of growth, keep bringing consumers occasions and channel -- new opportunities for channel expansion to Frito, and that will continue to be our focus. We'll keep investing until we get it right. We're going to -- we feel good about getting it right rather soon. And that's the way we'll keep managing the overall profitability of the company. And Frito, PBNA, and international, in particular, with different sub-strategies, and obviously that triggers down to every market around the world when you talk about international, but we have very good playbook for every country and every line of business in every country, expectations on profitability and roadmaps to deliver that kind of growth.
Operator: Thank you. One moment for our next question. Our next question comes from Kaumil Gajrawala with Jefferies. Your line is open.
Kaumil Gajrawala: Hi. Good morning, everybody. Do you believe that the prices at Frito are too high, given the increases over recent years?
Ramon Laguarta: Do you think Kaumil? I think I kind of touched on the point earlier, but some parts of the portfolio need value adjustments, some parts of the portfolio don't. Some parts of the portfolio need to be -- for particular consumers we need some new entry price points and probably some new promotional kind of mechanics that don't spec for the consumer to invest so much cash in a purchase of salty, so there's adjustments that we have to make to -- for certain consumers some parts of the portfolio. I don't think the overall portfolio is -- needs a reset. I think this is going to be about granularity, it's going to be about good execution of that granularity, and that's what I think we're well prepared to do throughout the full value chain. So, yes, there is some value to be given back to consumers after three or four years of a lot of inflation. Our cost allows us to do that wherever we choose to do. And that will be one of the interventions that we'll be making in the second half, but not the only one. I mean, there's going to be investments in marketing. There's going to be investments in better execution. That overall will drive the business -- the business growth to where we think it will be structurally in the coming years.
Operator: Thank you. One moment for our next question. Our next question comes from Peter Grom with UBS. Your line is open.
Peter Grom: Thanks, operator. Good morning, everyone. So I was hoping to get some color on Latin America. Organic revenue was the weakest we've seen in some time here, and I think in the prepared remarks Brazil and Mexico seems solid. So just curious, kind of what drove the weakness in the quarter? And then, Ramon, just as we look ahead, you mentioned you still expect strong growth from international in the back half of the year. How does Latin America fit into that equation? Would you anticipate improvement, or should we expect more muted performance to continue? Thanks.
Ramon Laguarta: No, I think -- again, I would look at LatAm and all the international business in like six months rather than a three months and three months. There's a lot of moving pieces between first quarter, second quarter, Chinese New Year. In particular, the LatAm situation in our case is related to Mexico. And Mexico because of the elections there have been some changes in disposable income given to the families by the government that created some, I would say some abnormalities in the way those funds were distributed, and that's impacted demand in Mexico in the last -- what we're seeing in the last three weeks in Mexico that as those funds have been given back to consumers again, that the demand has come back to our categories. So we don't foresee any issue in LatAm. LatAm, again, I mean, value continues to be a factor as it's always been in LatAm. We'll see plus and minuses between the different countries. But as a region, LatAm continues to be a high performing region for us, where we keep developing the categories and we keep expanding our margins and building scale businesses not only in Mexico and Brazil, but across multiple markets.
Operator: Thank you. One moment for our next question. Our next question comes from Filippo Falorni with Citi. Your line is open.
Filippo Falorni: Hey. Good morning, everyone. So just staying on the international business. Ramon, you sounded pretty confident on the growth in international. Maybe you can talk more about, like what regions do you see the greater growth potential in that business? And going back to the question on guidance on top line for the second half, is the improvement in organic sales mainly driven by an improvement in North America or an acceleration in international? If you can give some color there would be helpful.
Ramon Laguarta: Yes, Filippo. Hi. You should assume that most of the incremental acceleration of the business comes from mostly North America, right? And the two factors I mentioned, Quaker will get back to growth, the laps get better for North America, and then some of the interventions we're making both in value and in additional A&M should drive additional volume. Those are the three factors. Internationally, we're assuming that the rate of growth for the first half will continue in the second half. And again, we're seeing parts of the portfolio -- accelerating parts of the portfolio kind of stabilizing, some of them being a little bit softer. But overall the portfolio at this point is broad enough. We have enough scale across multiple markets that we're kind of hedged geographically. So that's what we're assuming and what we're seeing that per caps growth of the category will continue. We continue to invest meaningfully incremental funds to both execution and brand development, and we don't see any reason why not. Of course, it could be big geopolitical reasons why we change our mind later in the year. But with the information we have today about geopolitics and stability of countries, that's our best guess today.
Operator: Thank you. One moment for our next question. Our next question comes from Robert Moskow with TD Cowen. Your line is open.
Robert Moskow: Hi, thanks. A couple of questions. One is, I was hoping you'd give a little more color on the energy drinks category, growth has slowed dramatically in the U.S. And just wanted to get your perspective and ask like, do you think that the consumer there are making a value decision as well? There's a lot of premium price drinks there. Do you see any evidence of trading down to maybe higher caffeine carbonated drinks? Thanks.
Ramon Laguarta: Listen, I think fundamentally the energy category continues to provide long-term good prospects for our industry. I think it's a consumer need that will continue to be there and whether we are able to satisfy that through multiple options, that will continue to grow. There's always small ups and downs of subcategories within LRB that you could argue. Is it because of channel dynamics? Is it because it's very hard and people are moving to other parts of the portfolio? Like we're seeing, for example, in our case in the recent six weeks a massive growth in our hydration portfolio because, obviously, it's been very hot in the U.S. So I guess there is some cannibalization between energy and hydration for some consumers, and they prefer to do that. So, I wouldn't overread into the short-term of the category. I would try to think about this as a consumer needs energy, if we're able to provide energy in a consumer friendly way, including price, probably as you mentioned, but I would say functionality, clean labels, I mean like a lot of the things that I think the categories been working on, there should be a good runway for that segment of the category, and it's been value creating for a lot of us that participate in it, including the retailer partners and the brand owners.
Operator: Thank you. One moment for our next question. Our next question comes from Andrea Teixeira with J.P. Morgan. Your line is open.
Andrea Teixeira: Thank you. Good morning, everyone, Ramon, Jamie. My question is on the bridge to the mid-single digit organic sales growth in the second half. Assuming international, Ramon you just mentioned it grows the same kind of mid-single digits into the second half. And, of course, understanding the easy comps for Quaker. It still implies a good inflection into Frito and PBNA. How do you think, like we should be thinking about the progress? And perhaps related to that, from a channel perspective the away from home for you growing from what it seems to be like a distribution, what is the like-for-like in sales, basically by channel, if you would think about away from home and at home?
Jamie Caulfield: Andrea, it's Jamie. On the acceleration in the back half, as Ramon mentioned, that's going to come mostly from North America for the reasons we cited and we're making the investment, primarily focused North America, we've got the easier lapse. And Quaker, so that gives us a lot of confidence. On channels, look, away from home has been a focus area for us. We put investment behind that and it's outgrowing the balance of our portfolio, so we'd expect that to continue.
Operator: Thank you. One moment for our next question. Our next question comes from Chris Carey with Wells Fargo Securities. Your line is open.
Chris Carey: Hi. Good morning, everyone. Ramon, I know you mentioned international to be looked at on six-month cadence. I was wondering, however, if you could comment on some specific regions just in Europe. Why to your mind have trends been so resilient? I don't think it's just your portfolio, I think the region in general has been more resilient for longer than many expected. And then in Asia, I think you were clear last quarter that there were some timing benefit. Clearly we saw that normalize this quarter. What's the right run rate for this division? And do you have any comments on the progress in China? Thank you.
Ramon Laguarta: Yes. So listen, again, we're looking at international as a portfolio of geographies and markets, and we see the portfolio kind of when it's not growing so much here -- so at the end historically, we've learned that the portfolio is quite diversified and that gives us the opportunity to talk about an international business as a total. Obviously, we run the business locally. Now, when you go down to different parts of the world. Europe is resilient and is resilient in -- our business has been performing very well, both on top line and share and very importantly, in margin improvement, and that has been a focus of the management team for quite some time. We're getting a lot of traction. That's also giving the business the opportunity to reinvest, which also, obviously, drives the top line. And I think Europe in our case, is in a very positive cycle, which we expect to continue in the coming years. Now, I talked about Latin America, so I will not mention much. We continue to see a lot of growth in many parts of AMESA region, in particular, India is a big growth space for us, and is an investment area for sure. The opportunity is massive. If you think, it will take a decade perspective, and we're putting infrastructure on the ground and we're putting a lot of -- we are investing in the brands, make sure that we build the scale to capture what is going to be, I think a high demand market for many, many years. Then when it comes to Asia, we're seeing a very cautious consumer in China. The consumer is clearly saving more than spending, and that has an implication for many categories. Our categories is a low ticket item, so we continue to see good performance of our categories, and we're gaining share. It's quite an advantage business what we have in China, especially on the food sides. And we continue to invest in different regions of the country. We continue to get more penetration, additional distribution, that has been a big driver. So additional penetration, additional consumers coming to our brands, coming to the habit of snacking, and that has been very positive. So in spite of a cautious consumer, we have levers to continue to grow the business. Some of that physical availability, some of that is share of market and better penetration of our brands. I think we have advantage products there. We have a very strong R&D center in China that develops is for east products, and that is giving us an advantage versus other companies. So that's how we're seeing the different parts of the world. And again, we'll continue to invest. For us, this is a business that, if you think about our international business, it's almost $40 billion already, right? So it's been growing very fast over time. It's almost $40 billion, it's accretive to PepsiCo. It's higher margin than the average of PepsiCo, and it's clearly the largest growth opportunity for our company if you think about the next decade, and that's where we are putting so much focus, so much investment. We believe that we -- both on the beverage side and on the food side we have a many years of growth in that particular part of the business.
Operator: Thank you. One moment for our next question. Our next question comes from Robert Ottenstein with Evercore ISI. Your line is open.
Robert Ottenstein: Great. Thank you very much. I want to look at a more structural, strategic type question. And that is to get your thoughts around the Carlsberg Britvic transaction. And maybe talk a little bit why perhaps it made more sense for Carlsberg to buy Britvic rather than you, given the fact that you generally own your bottlers in the U.S., why not Britvic? Does that have any implications in terms of how you're thinking about the U.S. bottlers. And does the fact that maybe combining beer and CSDs makes more sense outside of the U.S., obviously for regulatory reasons. How should we think about that component? Thank you.
Ramon Laguarta: Yes. I wouldn't extrapolate too much. This is a decision by Carlsberg to make an investment in the UK business. It makes a lot of sense for Carlsberg for multiple reasons. And we partner with Carlsberg in other geographies. We are very happy with the partnership. We trust them as a partner to grow our business. And, of course, we supported the transaction. So I wouldn't over extrapolate it. Let's make it a UK decision by Carlsberg, and we decided to endorse the transaction because we have a great relationship with Carlsberg, and we trust them.
Operator: Thank you. One moment for our next question. Our next question comes from Carlos Laboy with HSBC. Your line is open.
Carlos Laboy: Yes. Good morning, everyone. Ramon, in keeping with the last two comments you've made in the Britvic deal, can you discuss the international franchise doctrine of PepsiCo? In other words, how are you thinking in terms of clarity of what each side is supposed to do and allowed to keep, right? I'm trying to get a sense of how you're compelling independent bottlers in these great growth territories that you see to step up investments for the purpose of accelerated system revenue growth and bottling returns?
Ramon Laguarta: Yes, Carlos. Listen, we're very pleased with the relationship we have with most of the bottlers and the strategic alignment. Actually, our international beverage business has been one of the growth engines of the company for the last few years. So we keep innovating and building great products that have consumer appeal, and specifically we've been very successful with our non-sugar business internationally. Our non-sugar Pepsi has been a great driver of growth for many years. Gatorade is also another great platform that we are moving around. So the last is growing 10% historically, and we will continue to invest. Now are there other opportunities to scale up some of our bottlers. Of course, there's always opportunities to improve the infrastructure, and we're working on that for the long-term, but I think this is a part of our business that is going well. It's a part of our business that we are prepared to invest even more. The bottlers know we obviously are very aligned statistically on which markets and which platforms we're going to put our focus and our investments. And I think, as I said, is part of our international story that I was referring to earlier. There's a food story and there's a beverage story, and there's a combination of the two story in some markets that we're playing long-term. So hopefully I'm answering your question. I don't know if you had some other kind of implications there.
Operator: Thank you. One moment for our next question. Our next question comes from Nik Modi with RBC. Your line is open.
Nik Modi: Yes. Thank you. Good morning, everyone. Ramon, I was hoping you can just kind of share some perspective around overall food volume, right? Because a lot of questions have been asked about where's the volume going? It's not just salty snacks that's been under pressure, it's pretty much across the board in terms of volumes. And so I was just curious on your thoughts. I don't think it's GLP-1, I know that's what some might suggest, but love your views on kind of where you think the volume is actually migrating?
Ramon Laguarta: Yes, listen. Nik, I don't know about all the categories. I know that for many categories the multiple year inflation that we had to take because our input cost went up, has created some perception and some reality in a lot of households that food is expensive and consumers are making choices. And they can make choices to cook versus buy finished goods or finished products, or they can make a lot of decisions around how they spend their money and how do they feed themselves every day with the lowest budget. And I think that's the fundamental question to address for the food companies. Now that our cost are kind of normalizing, our input cost, and we've all been going at productivity in our case, this has been a very, very strategic focus for us. Now, how do we deploy those resources against what are the best levers to reignite growth? And again, it will not be a blanket approach, it will be a segmented approach. In our case, it will be very rational, it will based on data. I think we have a lot of data, and we have great segmentation. And I think we can execute with again, with precision so that we don't destroy value where we create value for the category as we increase the net revenue of the category. So that's how we're thinking about it. I don't think GLP at this point, Nik, as material impact in our category for sure, and we have a lot of panels and we have a lot of conversation with consumers, it's not impacting us. At this point is an economic value relationship for our categories, and we will address them in the second half of the year.
Operator: Thank you. Our last question comes from -- one moment -- comes from Kevin Grundy with BNP Paribas. Your line is open.
Kevin Grundy: Great, thanks. Good morning, everyone. Covered a lot of ground, and not to beat a dead horse, but just to drill down a couple of areas, Ramon, if we could on the demand weakness in snack. So you mentioned some parts of the portfolio, but not all consumers. I apologize if I missed this. What are you seeing beyond the low income consumer? It's a lot of focus on where's the consumer and depends on which management call you're listening to or what industry frankly. What are you seeing specifically with the middle and high-end consumer? Is the weakness also being seen among that cohort as well? And then I think an important question as well, is there anything you're seeing in your market research? I know you're staying close to the consumer that gives you any pause with the longer term outlook for the Frito business, which has been so strong for so long. Is there anything there that kind of gives you pause or you do this to be entirely transitory? So thanks for that.
Ramon Laguarta: Yes, thanks Kevin. Listen, I think the -- this need for value or more value consciousness I think is impacting every household in the U.S. So it is different levels of income, I think it's impacting everybody. And we're seeing behaviors in different income levels. I would aggregate all that -- the consumer is much more price conscious, is looking for more value across. So maybe you see the higher income consumers that they're not going to expensive restaurants, they're adjusting their behavior to more affordable restaurants, or they stay at home and then they create their own entertainment moments or fun moments at home. So do you see different behaviors happening everywhere, I think the connecting line it would be, the consumer is more cautious, the consumer is more choiceful, but the consumer is willing to spend in areas where they see value and we see it in our category, right, the more -- the parts of the category there I was referring to. But also for other parts of the category, they're asking for more value and they're willing to compromise in some of their decisions. So that's the problem to address. So I would stay there and I think once we address that situation, we will be back in growth, and we feel pretty good about the tools and the resources we have and the actions that we're taking and we're quite encouraged by recent performance of the business. Okay. So I think we -- this is the last question. So thank you, everyone, for joining us today and your thoughtful questions. And also, obviously, for the confidence that you've placed in us with your investments, and we hope everybody has a great summer, and do buy a lot of PepsiCo products, so thank you.
Jamie Caulfield: Thank you.
Operator: Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day. |
ADBE | 2 | 2,024 | 2024-06-13 20:54:08 | Operator: Good day, and welcome to the Q2 FY 2024 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jonathan Vaas, VP of Investor Relations. Please go ahead.
Jonathan Vaas: Good afternoon and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's second quarter fiscal year 2024 financial results. You can find our press release, as well as PDFs of our prepared remarks and financial results, on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, June 13, and contains forward-looking statements that involve risk, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's Investor Relations website. I will now turn the call over to Shantanu.
Shantanu Narayen: Thanks, Jonathan. Good afternoon and thank you for joining us. Adobe had an outstanding quarter, achieving revenue of $5.31 billion, representing 11% year-over-year growth. GAAP earnings per share for the quarter was $3.49 and non-GAAP earnings per share was $4.48, representing 15% year-over-year growth. Our success is driven by growing customer value through an innovative product roadmap. The advances we are delivering across Creative Cloud, Document Cloud and Experience Cloud are enabling us to attract an expanding universe of users. Everyone from creators, communicators, students, entrepreneurs and businesses of all sizes are using our products to unleash their creativity, accelerate document productivity and power their digital businesses. Adobe's highly differentiated approach to AI is rooted in the belief that creativity is a uniquely human trait and that AI has the power to assist and amplify human ingenuity and enhance productivity. We're innovating across data, models and interfaces and natively integrating AI across all our offerings. In Creative Cloud, we have invested in training our Firefly family of creative generative AI models with a proprietary data set and delivering AI functionality within our flagship products including Photoshop, Illustrator, Lightroom and Premiere. We're reimagining creativity for a broader set of customers by delivering Adobe Express as an AI-first application across the web and mobile surfaces. Since its debut in March 2023, Firefly has been used to generate over 9 billion images across Adobe creative tools. In Document Cloud, we're revolutionizing document productivity with Acrobat AI Assistant, an AI powered conversational engine that can easily be deployed in minutes. This enhances the value of the trillions of PDFs which hold a significant portion of the world's information. Acrobat AI Assistant features are now available through an add-on subscription to all Reader and Acrobat enterprise and individual customers across desktop, web and mobile. At the end of May, we celebrated the five-year anniversary of Adobe Experience Platform, which we conceived and built from scratch and which is on track to be the next billion-dollar business in our Digital Experience portfolio. We released AEP AI Assistant to enhance the productivity of marketing practitioners through generative AI, while expanding access to native AEP applications. With Adobe GenStudio, we're bringing together products across our clouds including Creative Cloud, Adobe Experience Manager, Workfront, Adobe Journey Optimizer and Customer Journey Analytics as well as Adobe Express for Business to address the massive content supply chain opportunity. Our approach to empower marketers to quickly plan, create, manage, activate and measure on-brand content is resonating with customers and validating our leadership across data, content and journeys to deliver personalized experiences at scale. We're extending our applications to integrate third-party text, image and video models and partnering strategically to create multi-modal large language models offering customers greater choice in tools and further enhancing the value of our leading applications and solutions. We're driving strong usage, value and demand for our AI solutions across all customer segments and seeing early success monetizing new AI technologies across our Digital Media and Digital Experience businesses. Given this rich product roadmap, focus on execution and customer demand in the first half of the year, we are pleased to raise our annual Digital Media net new ARR, Digital Experience subscription revenue and EPS targets. I'll now turn it over to David to discuss the momentum in our Digital Media business.
David Wadhwani: Thanks, Shantanu. Hello everyone. In Q2, we achieved net new Digital Media ARR of $487 million and revenue of $3.91 billion, which grew 12% year-over-year. On the Document Cloud side, PDF has become a global standard for automating business and consumer workflows, and Acrobat is the platform of choice to view, edit, share and collaborate with these documents. We continue to see steady growth in monthly active users of our Document Cloud solutions, including Acrobat Reader, Acrobat Standard and Pro, and our signature, share and review workflows across mobile, web and desktop. The introduction of Acrobat AI Assistant, made generally available in April for English documents, marks the beginning of a new era of innovation and efficiency for the approximately 3 trillion PDFs in the world. Acrobat AI Assistant is empowering everyone to shift from reading documents to having conversations with them in order to summarize documents, extract insights, compose presentations and share learnings. AI Assistant is available as a standalone offer for use in Reader and as an add-on to Acrobat Standard and Pro. We're seeing early success driving adoption of AI Assistant as part of our commerce flows and remain optimistic about the long-term opportunities. In Q2, we achieved Document Cloud revenue of $782 million, growing 19% year-over-year. We added $165 million of net new Document Cloud ARR, which was a Q2 record, with year-over-year ending ARR growth of 24% in constant currency. Other business highlights include, general availability of Acrobat AI Assistant support for document types beyond PDF, meeting transcripts and enterprise requirements; Acrobat link sharing for PDF-based collaboration continues to grow rapidly, more than doubling year-over-year and driving viral new user adoption; free monthly active users of Acrobat Web grew over 60% year-over-year, as a result of link sharing and our Microsoft Edge and Google Chrome extensions; continued strength with free-to-paid digital conversion, as a result of product led growth optimizations; strong growth in the SMB segment for our Teams offering, driven by a combination of seat expansion and new account wins; Key enterprise customer wins with AstraZeneca, Chevron, State Government of Florida, State of Illinois, United Healthcare Services and Wells Fargo. Turning to Creative Cloud, creative professionals are leading the global charge to meet the everincreasing demand for engaging content across a variety of platforms and channels. Enterprises rely on creative professionals to produce differentiated content to drive increasingly personalized marketing campaigns. Solopreneurs and small businesses need to stand out in a crowded digital landscape with engaging videos and designs. Educators are passionate about providing students with the visual communication skills needed to thrive in the decades ahead. Consumers are increasingly looking for ways to share their stories digitally. Creative Cloud, Express and Firefly Services are uniquely positioned to catalyze this opportunity for everyone, by leveraging the promise of generative AI. Our Creative Cloud flagship applications continue to release new features that are significantly improving user onboarding while simultaneously delivering an unprecedented level of power and precision. Generative Fill and Generative Expand are already two of the top three features used by customers on the latest version of Photoshop. Text to vector support is off to a great start in Illustrator. Remove Object is the fastest growing feature in Lightroom mobile. Our preview of generative AI capabilities in Premiere won Production Hub Award of Excellence at NAB, the largest video show in North America. We are integrating our leading applications with Firefly and third-party generative AI models to deliver the richest, most engaging content. Our vision for Adobe Express is to provide a breakthrough application to make design easy for communicators worldwide, leveraging generative AI and decades of Adobe technology across web and mobile. Our launch of the all-new Express application on iOS and Android earlier this quarter is off to a strong start, with monthly active users doubling quarter over quarter. This week's Design Made Easy event, which focused on Express for Business, was another big step forward for us. Companies of all sizes are excited about the integrated power and commercial safety of Firefly, the seamless workflows with Photoshop, Illustrator and Adobe Experience Cloud and enterprise-grade brand controls that are now part of Express for Business, making it the optimal product for marketing, sales and HR teams to quickly and easily create visual content to share. We also announced the general availability of Firefly Services and Custom Models at Summit. The platform makes API calls and model customization available to developers, accessible through low-code, no-code tools and integrates with our Experience Cloud products. Firefly Services can power the creation of thousands of asset variations in minutes instead of months, and at a fraction of the cost. This allows us to monetize the volume of content being created through automation services. The increasing availability of Firefly in Creative Cloud, Express, Firefly Services and the web app is giving us opportunities to access more new users, provide more value to existing users and monetize content automation. These integrations are driving the acceleration of Firefly generations, with May seeing the most generations of any month to date. In Q2, we achieved $3.13 billion in revenue, which grew 11% year-over-year. Net new Creative Cloud ARR was $322 million. Other business highlights include, the launch of Express for Business, including support for brand controls and template locking, Firefly custom models, bulk creation and generation of variations, presentation and print capabilities, and workflows with Photoshop, Illustrator and Experience Cloud; the release of Firefly Image 3 Foundation Model with high quality image generation and more control with structure and style reference; the release of the Photoshop beta, with Reference Image and advances in Generative Fill; the debut of Generative Remove in Adobe Lightroom, enabling anyone to remove unwanted objects from any photograph non-destructively with stunning, high-quality, photo-realistic results; the release of the Premiere beta, with new audio workflows driving strong usage; the deep integration of Firefly in Substance 3D, which provides an easy way to create textures and materials from reference images; the introduction of an all new Frame.io, streamlining workflows across content types on a flexible and intuitive collaboration platform; key enterprise customer wins include Credit Agricole, FedEx, Infosys, Rakuten, Ralph Lauren, Samsung, Schneider Electric and Volvo. We're excited about the accelerating pace of innovation across the Digital Media business and pleased with the adoption of AI functionality as well as its early monetization across Document Cloud and Creative Cloud, including our flagship applications, Firefly Services and Express. We're pleased to raise our annual net new ARR target to $1.95 billion and excited to deliver on our rich product roadmap in the second half. I'll now pass it to Anil.
Anil Chakravarthy: Thanks, David. Hello, everyone. In Q2, we achieved Experience Cloud revenue of $1.33 billion. Subscription revenue was $1.2 billion, representing 13% year-over-year growth. We are the industry leader in helping enterprises deliver personalized experiences at scale to their customers by combining the right content, customer data and journeys in real time. When we introduced Adobe Experience Platform five years ago, it was a revolutionary approach to address customer data and journeys. Today, we're the number one digital experience platform, and AEP with native apps is well on its way to becoming a billion-dollar business. We're now transforming the content supply chain for enterprises with Adobe GenStudio, enabling them to produce content at scale, leveraging generative AI through native integrations with Firefly services and Adobe Express for Business. Enterprise customers, both B2C and B2B, view customer experience management and personalization at scale as key areas of differentiation, making it a priority investment for Chief Marketing Officers, Chief Information Officers and Chief Digital Officers. We are excited by the customer interest and adoption of our latest innovations, including AEP AI Assistant, a generative AI-powered conversational interface that empowers practitioners to automate tasks, simulate outcomes, and generate new audiences and journeys. For example, customers like General Motors and Hanes brands have been working with AEP AI Assistant to boost productivity and accelerate time to value, while democratizing access to AEP and apps across their organizations. Marriott International is a great example of a customer that's expanded its decade-long relationship with Adobe and turned to Adobe Experience Cloud to orchestrate highly personalized guest experiences across online reservations and the Marriott Bonvoy mobile app. Adobe Real-time CDP and Adobe Journey Optimizer enabled Marriott to connect data from disparate sources and activate relevant experiences in moments that matter, helping the company match individuals with the best options across its portfolio of more than 30 brands and nearly 9,000 properties. Other business highlights include: continued momentum with AEP and native applications, growing subscription revenue 60% year-over-year in Q2; AEP innovations announced at Summit include Adobe Journey Optimizer B2B addition, a new application for B2B customers built on AEP to orchestrate account-specific buying group journeys; federated audience composition, which enables enterprises to minimize data copy and generate audiences directly from their enterprise data warehouses; and real-time CDP collaboration, a new clean room application for brands and publishers to collaborate in a privacy safe way to discover, reach, and measure their high-value audiences in a world without third-party cookies. GenStudio innovations to address enterprise content supply chain needs across workflow and planning, creation and production, asset management, delivery and activation, and reporting and insights. Recent advancements include contextual search in Adobe Experience Manager assets, which enables users to find the right asset and variation in their growing digital libraries. Adobe Workfront Planning, which provides every user with a unified view of all activities across the marketing life cycle through highly visual marketing campaign calendars and dynamic briefs. And AEM Generate Variations, which accelerates the creation of audience-specific content variations to drive personalized web experiences. Strong industry analyst recognition including Gartner's Magic Quadrant for Content Marketing Platforms and leadership for both IDC's B2C and B2B MarketScapes for digital commerce applications. Key customer wins include Amazon, British Telecom, Comcast, Mercedes-Benz, Maruti Suzuki, Nationwide Building Society, Novo Nordisk, ServiceNow, Stellantis, Ulta Beauty, and U.S. Department of the Treasury. We have enabled our vibrant partner ecosystem of system integrators and agencies to deliver advisory and implementation services across our product portfolio. We look forward to engaging with customers and major agencies at the Cannes Lions Festival later this month. Our category-leading solutions, robust pipeline, and tremendous scale position us to drive strong growth in the second half, and we are raising our subscription revenue target for the year. I will now pass it to Dan.
Dan Durn: Thanks, Anil. Today, I'll start by summarizing Adobe's performance in Q2 fiscal 2024, highlighting growth drivers across our businesses, and I'll finish with financial targets. In Q2, Adobe delivered strong top line growth and industry-leading profitability while accelerating the pace of innovations we're delivering to market across Document Cloud, Creative Cloud, and Experience Cloud. In the quarter, Adobe achieved record revenue of $5.31 billion, which represents 10% year-over-year growth or 11% in constant currency, with strength across all three clouds. This performance stems from the diversification of Adobe's business across our market-leading products, business models, customer segments, and geographies. When combined with our talented employees, strong execution and world-class financial discipline, you have the ingredients that make this company incredibly resilient. Second quarter business and financial highlights included: GAAP diluted earnings per share of $3.49 and non-GAAP diluted earnings per share of $4.48; Digital Media revenue of $3.91 billion; net new Digital Media ARR of $487 million; Digital Experience revenue of $1.33 billion; cash flows from operations of $1.94 billion; and RPO of $17.86 billion exiting the quarter. In our Digital Media segment, we achieved Q2 revenue of $3.91 billion, which represents 11% year-over-year growth or 12% in constant currency. We exited the quarter with $16.25 billion of Digital Media ARR, up 13% year-over-year in constant currency. Adobe achieved Document Cloud revenue of $782 million, which represents 19% year-over-year growth as reported and in constant currency. We added $165 million of net new Document Cloud ARR, which was a record for Q2. Q2 Document Cloud growth drivers included: demand for Acrobat subscriptions across all customer segments and geographies; new user acquisition resulting from increasing Reader MAU; a great start monetizing AI Assistant through our digital channel; strong usage and engagement from Acrobat Web as well as through our Chrome and Edge partnerships, which are driving free-to-paid conversion; growing team subscription units sold to SMBs, both through adobe.com and our research channel; and strength in our enterprise solutions, demonstrating the importance of PDF as a source of unstructured data in business workflows. We achieved Creative revenue of $3.13 billion, which represents 10% year-over-year growth or 11% in constant currency. We added $322 million of net new Creative ARR in the quarter. Q2 Creative growth drivers included: new subscriptions for Creative Cloud All Apps with particular strength in digital acquisition on adobe.com, with multiple product releases during the quarter driving customer engagement and demand; strong growth of single apps, including in imaging, photography, design, and stock; accelerating customer interest and usage for our new Express Mobile and Express for Business offerings; strong renewals as customers migrate to higher-value, higher ARPU Creative Cloud plans that include Firefly entitlements; continued subscription unit growth, with particular strength in emerging markets; and strength from SMBs adopting our team offering as well as in the enterprise segment with ETLA adoption. We're pleased with the performance of the Creative business in the first half of the year, fueled by strong commercial subscriptions in both Q1 and Q2. As we look at the momentum we're carrying into the back half, we expect to deliver year-over-year growth of Creative net new ARR in Q3 and Q4 and are raising our Digital Media net new ARR target for the fiscal year. Turning to our Digital Experience segment. In Q2, we achieved revenue of $1.33 billion, which represents 9% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.20 billion, growing 13% year-over-year as reported and in constant currency. Q2 Digital Experience growth drivers included: subscription revenue strength from transformational accounts; market leadership with AEP and native applications, with subscription revenue growing 60% year-over-year; additional subscription revenue strength across the data insights and audiences and customer journey categories; and accelerated adoption of our AEM and Workfront solutions from businesses looking to solve their content supply chain challenges. Turning to the income statement and balance sheet. In Q2, Adobe delivered year-over-year EPS growth of 24% on a GAAP basis and 15% on a non-GAAP basis. This was driven by revenue growth and disciplined prioritization of our investments, which resulted in non-GAAP operating margin strength in Q2. The company continues to deliver world-class gross margins while investing in groundbreaking AI capabilities. Adobe's effective tax rate in Q2 was 18.5% on a GAAP and non-GAAP basis, in line with our expectations for the quarter. RPO exiting the quarter was $17.86 billion, growing 17% year-over-year as reported or 18% when factoring in a 1-point currency headwind. Current RPO grew 12% exiting the quarter. Our ending cash and short-term investment position at the end of Q2 was $8.07 billion, and cash flows from operations in the quarter were $1.94 billion. In Q2, we entered into a $2.5 billion share repurchase agreement, and we currently have $22.7 billion remaining of the $25 billion authorization granted in March 2024. We will now provide Q3 targets as well as updated fiscal 2024 annual targets, factoring in current macroeconomic conditions as well as strong momentum across our business, our current FX outlook into the back half of the year with the U.S. dollar remaining stronger as compared to our original expectations when we set our FY 2024 targets in December, and an expected strong seasonal finish to the year in Q4. For Q3, we're targeting: total Adobe revenue of $5.33 billion to $5.38 billion; Digital Media net new ARR of approximately $460 million; Digital Media segment revenue of $3.95 billion to $3.98 billion; Digital Experience segment revenue of $1.325 billion to $1.345 billion; Digital Experience subscription revenue of $1.20 billion to $1.22 billion; tax rate of approximately 18% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $3.45 to $3.50; and non-GAAP earnings per share of $4.50 to $4.55. For fiscal 2024, given our first half performance, we are now targeting: total Adobe revenue of $21.40 billion to $21.50 billion; Digital Media net new ARR of approximately $1.95 billion; Digital Media segment revenue of $15.80 billion to $15.85 billion; Digital Experience segment revenue of $5.325 billion to $5.375 billion; Digital Experience subscription revenue of $4.775 billion to $4.825 billion; tax rate of approximately 20.5% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $11.80 to $12; and non-GAAP earnings per share of $18 to $18.20. In summary, I'm extremely pleased with the company's performance in the first half of the year and the momentum we see in our business. Adobe's product leadership, velocity of innovation, diversity of our business, and financial discipline make us unique, enabling us to deliver strong top and bottom line results through dynamic market conditions. I'm confident in our ability to catalyze transformative long-term trends that will position us to win over the next decade. Shantanu, back to you.
Shantanu Narayen: Thanks, Dan. Adobe remains one of the greatest places to work in the industry, and I want to thank our employees for their relentless dedication to supporting our customers and communities. We continue to invest in hiring, including new college grads and interns to bring the best and brightest talent to Adobe. This quarter, Adobe was recognized among Fortune's 100 Best Companies to Work For, Glassdoor's Best-led Companies and the Civic 50 List of the Most Community-minded Companies in the U.S. Demand for our category-defining products and services continues to grow. Our business fundamentals and market tailwinds are strong, and we look forward to building on our momentum in the second half and beyond. Thank you, and we will now take questions.
Operator: Thank you. [Operator Instructions] Our first question will come from Mark Moerdler with Bernstein.
Mark Moerdler: Thank you very much and congratulations on the quarter and especially the strong net new ARR. I'd like to ask a little more color on specifically the net new ARR that we saw in Creative Cloud. Can you give us a sense of what the contribution near term, medium term to Digital ARR from seat growth versus upsell versus consumption, things like Adobe Stock and AI credits, even rank ordering or quantifying? Anything you can give us -- to give us a sense of what's driving that number? And that would be very helpful in really understanding what's going on in the drivers of that number. Thanks.
Shantanu Narayen: Sure, Mark, let me start and then certainly, David and Dan can add. To your point, we had a strong quarter. And I think what's really driving the quarter, big picture, continues to be the innovation that we're delivering. And the way AI is actually making our applications both more affordable, easy to onboard as well as, frankly, higher-value users. New users are still a big driver of the growth that we continue to see in the business. On the Document Cloud side, a lot of that has to do with the introduction of AI Assistant and the fact that people are migrating to the higher-value products. And on Creative Cloud, I would say the things that we're doing on imaging with Firefly and what we've seen both in Photoshop and Lightroom. I think in the prepared remarks Dan certainly talked about what's happening with also each of the different segments. So the SMB segment actually had a strong quarter. Enterprise continues to have a strong quarter. So across the board, Mark, we actually saw strength in the business.
Operator: And our next question will come from Alex Zukin with Wolfe Research.
Aleksandr Zukin: Hey, guys. Thanks for taking the question and congratulations on this incredible result. I wanted to ask kind of just similar to Mark's question, just how much gen AI demand did you see in the quarter in terms of -- for sort of both the Creative Cloud portfolio and Digital Media, in Creative Studio as well as in GenStudio? And how does it kind of help to pick up more on the enterprise side of the business, on the SMB side of the business? Help us understand that progression and maybe how you're planning for it in the back half of the [indiscernible].
Shantanu Narayen: Sure, Alex. Again, maybe I'll start with that. And just taking a step back, I think we've talked about the platform that we have for gen AI that constitutes data, as well as models and finally, interfaces. On the models, we released Firefly services. We've started to see some customer wins in Firefly services. So they're using it for variations, and these are the custom models that we're creating, as well as access to APIs. I would say that's early in terms of the adoption, but the interest as customers say how they can ingest their data into our models as well as custom models, that's really ahead of us, and we expect that to continue to grow in Q3 and Q4. I think the biggest opportunity for us and why we're really excited about gen AI is in the interfaces, because that's the way people derive value, whether it's in being able to complete their tasks faster, whether it's being able to do new workflows. And I would say in that particular space, Acrobat has really seen a significant amount of usage as it relates to AI Assistant. And Photoshop, I'll have David again add, but Generative Fill and what we are doing there, what we are doing in Illustrator. And that both for existing customers as well as for prospects who now come in and say, the products are becoming increasingly more productive for us, that's what's really driving the value there. And last but not least, the AI-first applications. When we think of an application like Express, Express is all about reimagining what we can do for creatives by sort of leapfrogging existing technologies and providing an AI-first application. And so that's also off to a good start.
David Wadhwani: Yes. And just to add to a little bit of what Shantanu said, Alex. We've talked a lot about how FY 2023 was the year that AI was in the playground, and this is the year we need to bring it into production. And a lot of that is industry-wide, but we're in a pretty special position as it relates to that. So to Shantanu's point, a lot of active releases this quarter, right? Acrobat AI Assistant, Firefly updates in Photoshop, Firefly was introduced for the first time into Lightroom, Express Mobile launched, Express for Business launched. We launched Firefly services for enterprises to produce content at scale. So, as you can see, there was a ton of innovation of our core -- in our core applications around generative AI. You put that together with some of the activations that we've done at Summit, and we did at Max London and we're getting our word out very broadly. It starts to create this ability to not just look at and play with AI, but actually use it as part of your workflow. So that's been deeply integrated into everything we do. And that's the key point, the interfaces that people work out if we bring AI there, everyone becomes more productive.
Shantanu Narayen: And maybe one last thing, Alex. Sequentially, if you look at it from a route to market, Digital had a very strong quarter as it relates to what we did on adobe.com. We had talked about enterprise doing well in Q1 as well, that continued. And SMB also, the interest in our teams product also continued to do really well. So I think sequentially, I would point to SMB and Digital's strength as driving the further growth.
Aleksandr Zukin: That's super helpful. And then maybe just one on the macro. Just given your guys' purview, like what is the story that you're seeing in terms of the macro on the demand environment? Clearly again, you're commenting on solid performance in the SMB and in the enterprise. Is there any areas that you're seeing pockets of weaknesses that's really vertical-dependent? Just maybe give a comment on kind of how we should think about it as we look to the rest of the year.
Shantanu Narayen: I think from a macro perspective, what I think differentiates Adobe more than any other company is how differentiated and how diverse the set of products that we have. And again, from individual consumers all the way to enterprises, our products are mission-critical. And so at this scale, it's all about execution. And the business cycles will come and go, Alex, but we're actually continuing to focus on execution and converting the pipeline and the interest and the awareness of AI into monetization. And so, we just will be ruthlessly focused on continuing to execute against that. So nothing really to report different on the macroeconomic environment from our perspective.
Aleksandr Zukin: Awesome. Keep doing what you're doing, guys.
Operator: And our next question will come from Saket Kalia with Barclays.
Saket Kalia: Okay, great. Hey, guys, thanks for taking my question here and echo the congrats on the quarter. Maybe for both, Shantanu and David. There are clearly just so many layers to the Firefly monetization story. But I think one theme that's coming out a little bit in this call and particularly interesting route to monetize is just the increased engagement that Firefly helps drive in your flagship products, right, or I think we call it sort of the interfaces, right? An example there would be like Generative Fill for Photoshop. And you've clearly started expanding that to other flagships like Premier and Illustrator. Maybe to go one level deeper, is there a way that you think about the potential opportunity from things like higher retention rates? Or any other way that -- I know it's really tough to size, but how have you sort of thought about it even qualitatively?
David Wadhwani: Yes, it's a great question. And yes, the core has been -- from the very beginning, we've talked to you guys about our primary focus for generative AI is about user adoption and proliferation, right? And that has continued to be the primary thing on our mind. And it's the primary thing on our mind for multiple reasons. And to your point, there are many different ways that we can monetize this. First is, as you think about the growth algorithms that we always have in our head, it always starts with, as Shantanu said, new users, right? And then it's about getting more value to existing users at higher ARPU, right? So in the context of new users, first and foremost, we want to make sure that everything we're doing generative AI is embedded in our tools, starting with Express, right? So we have Express in the market. We're seeing a lot of adoption and usage of Express in the market. As that's happening, we're infusing generative AI more and more into Express in a whole host of ways. And that's really helping, everything from our marketing message for the completeness of the AI offering in there, all the way through to user engagement and success in onboarding and retention. Similarly, though, this is having the same effect in our core Creative products as well, right? The introduction of Firefly combined with some of the product-led growth work we've been doing, in particular, something called the Context Bar makes it easy for new users coming in to just be more successful out of the gate which then, of course, helps with both conversion and retention. And then with AI Assistant, the ability to sort of embed that into the purchase flow for Acrobat and get a high attach rate, we always talk about that as a would you like fries with it moment at Adobe when someone's going through the checkout flow, it's just a great way for people to say, look, this is value I want, I want to add it and buy up to the higher plans. So there are a lot of different mechanisms that we see. But by far, the strongest is going to be the fact that we are seeing people like in Creative Cloud migrating to the higher-priced plans because they include Firefly. And so we just want to get more value to these users as well.
Shantanu Narayen: And in terms of the generation, Saket, I think we talked about it. We did a great job at MAX in London talking about some of the new functionality and releasing. Photoshop, I think we're up to 9 billion generations, and actually, I think the greatest amount of generations was in May. So the momentum clearly is the more we integrate this functionality into our interfaces, the more that usage is really driving adoption as well as retention.
Saket Kalia: Very helpful. Thanks, guys.
Operator: And our next question comes from Brent Thill with Jefferies.
Brent Thill: David, on Express, you mentioned the success you're seeing. Can you maybe drill into some of the other metrics and accomplishments that you're seeing out of Express this quarter?
David Wadhwani: Yes. For starters, there's a lot of buzz of Express here at Adobe coming off the event we just had earlier this week, but it's really based on the fact that the innovation in Express is on a tear, right? A few months ago, we introduced an all-new Express for the web. This quarter, we introduced an all-new Express for mobile. We introduced Express for Business. We also now have, as we've just talked about, been more deeply integrating AI features, whether it's for imaging generation or generative fill or text effects, character animation, design generations more deeply into the flow for Express. And that combination has led to an incredible set of metrics over the last quarter, in particular, but building throughout the year. Express MAU is growing very quickly. We talked about on the -- in the script earlier that MAU on mobile has more than doubled quarter-over-quarter, which is fantastic to see. And cumulative exports, if you look at year-over-year it has grown by over 80%. So really feeling good about sort of the momentum we're seeing. But if you take a step back, I think it is important to take a step back and understand our vision. Express that is now in market is built on a brand-new platform, right? And that brand-new platform lays the groundwork for the AI era. And this will be -- Express will be the place that anyone can come and create through a combination of conversational and standard inputs. That's the vision that we have. And I think it's an opportunity for us to really leap forward in terms of what we can do on the web and mobile at Adobe. And it's taken us a little time to get here. It hasn't happened overnight. But now that we are here, we are going to pour the gas on go-to-market, right? You know what we can do with our data-driven operating model. We've been ramping up what we're doing in Digital and Adobe.com journeys. We now can do the same thing and unleash all of that expertise in the mobile app store. You know what we're capable in terms of our product-led growth motions. We've now embedded Express Workflows into Acrobat Editor. We obviously have been embedding it into Creative Cloud workflows. And also, as we showed at Summit with Anil, we've embedded it into our Experience Cloud workflows as well. In addition to all of that, we're now unleashing our inside sales force to target the small/medium businesses. Our education teams are really gearing up for the back-to-school launch for K-12 and higher ed. And our field and enterprise sales now have Express for Business. So -- and we're doing all this globally, right? It's a massive market, and we're ramping up and we're ready to go.
Brent Thill: Thank you.
Operator: And the next question comes from Gregg Moskowitz with Mizuho.
Gregg Moskowitz: Hey, thank you very much. And I'll add my congratulations. For your Creative business, how are you thinking about the Q side of the P times Q equation over the balance of the year? Based on these numbers anyway, I would certainly assume that you had really healthy unit growth in Q2. And I'm wondering if you expect that to continue.
David Wadhwani: Yes. I mean, again, I think what -- it is this mix of product innovation that we've been putting out there and the steady drumbeat of that. A lot of it getting attention because of the quality and the hooks of AI and being able to sort of bring people, onboarding them quickly and successfully into the product. And then as we talked about, the more they use these AI features, the more they retain. And we feel really good about really that whole workflow. So yes, the new user growth continues to be our primary focus. And when you add in everything we're doing with Express, we're -- again, like I said, we're off to the races and we feel very good about the momentum on new user acquisition and existing member retention.
Shantanu Narayen: And Gregg, as you're aware, I mean, certainly with Express, we also have the model of customer acquisition as it relates to people coming in through trial and free and then conversion. So we are seeing the interest level as it relates to Express, in particular, significant interest.
Gregg Moskowitz: And Shantanu, since you also called out the strength in Digital earlier, including driving new Creative All Apps subscriptions from your website, are you doing anything different that's helping to drive that behavior? And if so, is that something you think can continue as well?
Shantanu Narayen: I would, Gregg, sort of modesty say, we've been world-class at sort of driving that for a long time now. But the team, I think, continues to do an amazing job. And I would say David referred to the DDOM. Adobe Home is now sort of increasingly the way that we're driving a lot of people to get aware of our new products. And so, I would say the mobile part as well and the mobile journeys, as we've got these mobile products, whether it's Lightroom or whether it's certainly, Express, that's an area of increasing focus for us. And the traditional sort of understanding where search terms are, I think we're getting better and better at that, which leads to way more digital traffic for us. So I think it's across the board. But I'd also highlight, I mean, the commerce team that we have at Adobe that understands what the segments are and how for those particular segments we can attract people, that's great. I mean, I think in the prepared remarks, Dan also talked about the strength in emerging markets. And I think the beautiful part about AI is that since they need access to the cloud to get all of the AI functionality, emerging market growth has been really strong for us.
Gregg Moskowitz: Very helpful. Thank you.
Operator: And moving on to Keith Weiss with Morgan Stanley.
Keith Weiss: Thank you guys for taking the question. And again, congratulations on a really solid set of results in an environment where not very many software companies have been able to beat and raise in this type of uneven environment. I wanted to maybe focus in a little bit on the question that Mark Moerdler asked, in particular on what gives you guys the confidence to see a return to year-on-year growth and Creative Cloud net new ARR. It declined in Q2, it declined in Q1. And if I'm not mistaken, the decline in Q2 was a little bit steeper than what we saw in Q1. So what are the particular drivers and maybe some detail on those drivers that give you guys the confidence that, that trend line that has been actually heading in the wrong direction is going to head in the right direction now? We're actually going to see growth in those metrics in Q3 and Q4?
David Wadhwani: Yes. Thanks, Keith. This is one of the areas that I think we've shared with you the complexity of the year-over-year comparisons in the first half based on prior pricing marks that we had. But more importantly, to your point, the year-over-year complexities are now behind us. And we're very excited about the momentum of the first half and how it sets us up for the second half, frankly, across both Document Cloud and Creative Cloud. Both are really momentum stories. The 478 -- the 487, sorry, just to be clear, the $487 million that we printed this time is obviously strong performance, and it implies that both CC and DC came in over what the growth -- the guide would have implied otherwise, right? So it's giving us a lot of good momentum going into the back half. Now the momentum is really driven by three things, and just I'll try to share a little bit more context here and hopefully gives you. First is new user acquisition, right? We're seeing Express starting to perform well in terms of bringing a lot of new users into the franchise across mobile and web. AI Assistant in Reader has been a really nice start for us, and we've been very pleased with how the uptake on that's going. And then Firefly itself, as I mentioned, has been increasingly more productive in terms of bringing in onboarding users and then retaining users because of the growth. We continue -- as we drive that more holistically throughout the product set, we start to see more people using it, including, as Shantanu mentioned earlier, in emerging markets. So we are seeing very good strength and usage in emerging markets, and that has certainly been a bright spot for us, which is something that obviously represents a lot of potential and upside for us. In terms of existing customers, the migration has been going very well for us as well. So, more people are moving to the higher-priced, higher-value plans because of the Firefly capabilities. We're even seeing this in enterprises where people are moving up to the highest versions of Creative Cloud, which is what we call it, Creative Cloud Enterprise 4, because they get more access to features beyond just generation. They have more collaborative capabilities beyond just kind of sharing via e-mail. And we're starting to see that create a nice momentum in upgrade cycles in the enterprise segment as well. And then certainly, let's not forget the new offerings, too. While still early, automation and content production is something that we're driving effectively in a lot of these accounts with Firefly services. So that mix of new users, existing user migration, and also the new offerings that we have in market are driving that growth formula that we talked about, which is now P times Q plus V for value with these automation systems.
Keith Weiss: That is a great answer. Thank you so much.
Operator: And we have a question from Brad Sills with Bank of America.
Bradley Sills: Oh, great. Thank you so much. I wanted to ask a question around the generative credit component to your pricing here. It seems like with all the progress you've made embedding Firefly across the key flagship products and the engagement levels that you're seeing, we should start to see perhaps some ramp in that generative credit component to your pricing. Is that a fair assessment? Would you expect to start to see that coming in? Or should we look to other services like the video capabilities that you're going to be launching shortly as a key catalyst there? Thank you.
Shantanu Narayen: I think you're right, Brad. When we think about what we've done with imaging and video, we've done the right thing by making sure the higher-value paid plans that people don't have to think about the amount of generative capability. And so there, the balance between for free and trialist users, they're going to run into the generative capability limits and, therefore, have to subscribe. But for the people who actually have imaging and vector needs, that they're not constantly thinking about generative, I think we actually got it right. To your point, as we move to video, expect to see different plans because those plans will, by necessity, take into account the amount of work that's required to do video generation. So you're absolutely right as a sort of framework for you to think about it. The two other things that I would say is, I mean, clearly, Express is really being driven by sort of the need for AI and how people are able to describe what they want and get the final output. When David talked about exports, just to clarify what that means is people who have successfully got what they want to get done, done. And that's a key measure of how we are doing it, and AI is certainly facilitating and accelerating that. And last thing I would say, Brad is, as you know, on the Acrobat side, it's a slightly different model which we like, which is anybody who has Reader and is looking at a document, they can have an upsell to their AI Assistant. If you have Acrobat Pro, you can upsell to the AI Assistant. And if you're a brand new acquisition of a user when you're coming in, the adoption of the highest-value products, so between Standard Pro and Pro Plus Assistant, we've been pleased to see how many people are migrating to the Pro Plus Assistant. So hopefully, that gives you some color of how we think about it differently by product.
Bradley Sills: Very helpful. Thank you, Shantanu.
Operator: And we'll take a question from Brad Zelnick with Deutsche Bank.
Brad Zelnick: Great. Thank you so much and congrats to all of you. I don't want Anil to feel left out, so I'm going to ask a DX question. Anil, it's good to hear AEP is on track to become the next billion-dollar business for Adobe. Can you expand on the journey and drivers that get you there? And in particular, how important are cloud migrations? And how do you see AEP AI Assistant perhaps accelerating the journey to $1 billion? Thanks.
Anil Chakravarthy: Thank you, Brad. Appreciate it. As you know, I mean, customer experience management and especially it's been a hugely important priority area for Chief Marketing Officers and with CIOs and Chief Digital Officers as well. And for us, we are focused on personalization scale, which is really built around the AEP platform. We're the largest provider in this space. We're growing faster than any of our peers, and we're the number one Digital Experience platform as a result. And that has really helped us keep the momentum. When you think about the AEP AI Assistant, it's doing a couple of things. One, it's really making it easier for customers to deploy use cases. When you think of use cases that they have around, for example, generating audiences and running campaigns around those audiences, these are things today that require some data engineering. They require the ability to put these audiences together. So they require marketing and IT teams to work together. The AEP AI Assistant is making it much easier for marketers to be able to do it themselves and be able to deploy a lot more use cases. So as there's more usage, it will help drive more consumption and help drive the growth in terms of number of profiles, number of users, and we help -- we see it helping us grow towards that billion-dollar business.
Brad Zelnick: Great to hear, and keep up the great work, guys. Thanks.
Jonathan Vaas: Hey, operator, we're almost at the top of the hour. We'll take two last questions and then wrap up. Thanks.
Operator: Thank you. We'll take a question from Kash Rangan with Goldman Sachs.
Kash Rangan : Hi, thank you very much. You guys could have three separate earnings calls because you have three different businesses that even the smallest one is very large. So yes, sorry, Anil, Dave, and Shantanu, I may not be able to ask all the questions that I want. I'm sure we have plenty. But I'll just keep it super high level, Shantanu. Generative AI, it seems to swing back and forth. Just so early in its evolution, the possibilities seem magical sometimes, endless sometimes, sometimes it feels very disappointing. But with every quarter that Adobe is executing on this path, where do you stand with the question that we do get from investors? Will generative AI be so good that it's the end of the creative process? So we don't need creative folks, that software will do everything? That sounds a little far-fetched, but I'm just throwing it out there to see how you would react that proposition. Same in Experience Cloud as well. Could generative AI create its own marketing campaign, put marketing people out of business? Or maybe it doesn't. I'm sure you have strong views. Maybe flipped on the other side, it does create category growth on the other hand, not category compression. So sorry for that super high-level question, but that seems to be a big debate on the stock here, at least from the long-term perspective. Thank you so much.
Shantanu Narayen: Yes, Kash. I think there are two things when we talk to investors that are perhaps on their mind. I mean, I think the first is it's fair to say that the interest that exists right now from investors as it relates to AI is all associated with the infrastructure and chips and perhaps rightly so because that's where everybody is creating these models. They're all trying to train them. And there's a lot of, I think, deserved excitement associated with that part of where we are in the evolution of generative AI. If the value of AI doesn't turn to inference and how people are going to use it, then I would say all of that investment would not really reap the benefit in terms of where people are spending the money. And so we're always convinced that when you have this kind of disruptive technology, the real benefits come when people use interfaces to do whatever task they want to do quicker, faster, and when it's embedded into the workflows that they're accustomed to because then there isn't an inertia associated with using it. So with that sort of as a broad segment, I am a big believer that generative AI is going to, for all the categories that we're in, it's actually going to dramatically expand the market because it's going to make our products more accessible, more affordable, more productive in terms of what you -- what we can do. I'm still acting CMO at the company, and I see the excitement around how we can, with agility, create way more content, create variations. When Anil talked about personalization at scale, I think there are two aspects to it, right? I mean, the first was always data, and Anil and the team have done a great job with sort of the real-time customer data platform to get that. And that's hydrated with users. But the real value is when you infuse that with the right content to make that personalized experience. So I think the demand is there for way more content than people can do, and generative AI is going to be an accelerant in that as well. And so net-net, I am absolutely betting on the fact that five years from now, there will be more people saying, I'm using creative tools to accomplish what I want, and there'll be more marketers saying, I can now, with the agility that I need, truly deliver a marketing campaign and an audience that's incredibly more specific than I could in the past. And that's Adobe's job to demonstrate how we are both leading in both those categories and to continue to innovate. But I recognize and I understand the question that exists in the industry associated with AI. If the value doesn't accrue to interfaces, I'll leave you with that. I think the investment would not be as beneficial as I believe it can be.
David Wadhwani: And maybe one thing to add to that, Kash, just to build on what Shantanu was talking about. I think the other thing we get asked a fair amount is about the comparison between different models, right? So Firefly might be better at something. Midjourney might be something at something else. DALL-E might do something else. And the key thing here is that around this table, we get excited when models innovate. We get excited when Firefly does something amazing. We get excited when third-party models do something because our view, to Shantanu's point, is that the more content that gets generated out of these models, the more content that needs to be edited, whether it's color correction, tone matching, transitions, assembling clips, or masking composite images. And the reason for this is that this is not a game where there's going to be one model. Each model is going to have its own personality, what it generates, what it looks like, how fast it generates, how much it costs when it generates that, and to have some interface layer to help synthesize all of this is important. And so just sort of to note, we've said this before but I'll say it again here, you will see us building our products and tools and services leveraging Firefly for sure, but you'll also see us leveraging best-of-breed personalities from different models and integrate them all together.
Kash Rangan : Awesome, the message here is that, gen AI is going to create more growth in the category. And Shantanu, you did that with the pivot to cloud. You grew the category, so here we go again. Thank you so much.
Shantanu Narayen: Thanks, Kash.
Operator: And next will be Jake Roberge with William Blair.
Jacob Roberge: Hey, thanks for taking the question and I'll echo my congrats on the great quarter. I know it's early, but what's been the feedback and customer behavior for those users that are on Firefly services and GenStudio? And then thinking more longer term, what type of price uplift could you see from those customers over time, just given what you said about the acceleration in Firefly generations being driven by those products? Thanks.
David Wadhwani: Maybe I'll start with customer zero. Right before this meeting, I was in a meeting with our CMO. And well, sometimes it's hard to tell, he's running the CMO or CEO head, but CMO this time. And we were reviewing a full-funnel campaign that we're planning on launching later this year. And exactly as Shantanu mentioned earlier, we saw benefits in terms of cost of the campaign, faster time to market for the campaign, and the amount of content that we can create to personalize that campaign. And that is one of those things that we've been doing more and more around our DDOM, which has actually been very productive for us, as you can see this quarter, and what we're pitching to other customers. So we've been working with -- we listed some of the customers earlier, but we've been working with a long list of customers on everything from accelerating the content creation for social, accelerating content creation for regional, and then increasing the number of amount of content that's created for increased personalization, which then, of course, flows through all of the Experience Cloud products that Anil is working on to get targeted better.
Shantanu Narayen: And Jake, maybe in terms of what I would say we're seeing usage of, I think the initial usage of Firefly services in most companies was all around ideation. How can they create multiple variations of them and in the ideation process really just accelerate that ideation process? Most companies are then starting with as they're putting it into production, how can they, with the brand assets and the brand guidelines that they have, do this in terms of the variations, whether they be geographic variations or they be just variations? I mean, if you take a step back also, every single ad company right now will tell you that the more variance that you provide, the better your chances are of appropriately getting an uplift for your media spend. So I would say that most companies are starting with creating these variations for geographies. The other one that we see a fair amount of is engaging with their communities. So when they want their communities to have assets that they have blessed for usage within community campaigns, that's the other place where Firefly services are being used. And a company has a community portal where the community can come in, take something and then post whether it's on whatever social media site that you want. So I think that's the initial one. All of the agency companies are companies that have actually even publicly said how GenStudio is something that they have embraced. But even the large media companies, because the media companies are certainly interested in understanding how all of this gen AI could be used to automate as well as accelerate the amount of content that they can produce. So hopefully, that gives you some color of it. If there's been sort of the questions that they ask along the way, which hopefully and actually, luckily, we have great answers, it's all around the indemnification and how they can use it. And I would say that continues to be a really key differentiator for us. But since that is the last question, let me just say I'm proud of how we executed in Q2, both across the product innovation, delivery as well as the go-to-market because clearly, a number of you asked how we were able to put together these numbers where others have perhaps talked about the macroeconomic environment. We certainly remain focused on leveraging technology to light a broader set of customers. And at the end of the day, to the questions that we were asked, we believe that the real value of AI will be in the interfaces that individuals, enterprises use to accomplish their tasks and workflows. And we think we're incredibly well positioned. So thank you for joining us.
Jonathan Vaas: Thanks, everyone. This concludes the call.
Operator: Thank you. This does conclude today's conference. We do thank you for your participation, and have an excellent day. |
AVGO | 2 | 2,024 | 2024-06-12 20:04:08 | Operator: Welcome to Broadcom Inc. Second Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Ji Yoo, Head of Investor Relations of Broadcom Inc.
Ji Yoo : Thank you, Operator, and good afternoon, everyone. Joining me on today's call are Hock Tan, President and CEO; Kirsten Spears, Chief Financial Officer and Charlie Kawwas, President, Semiconductor Solutions Group. Broadcom distributed a press release and financial tables after the market closed, describing our financial performance for the second quarter of fiscal year 2024. If you did not receive a copy, you may obtain the information from the Investor section of Broadcom's website at Broadcom.com. This conference call is being webcast live and an audio replay of the call can be accessed for 1 year through the Investor section of Broadcom's website. During the prepared comments, Hock and Kirsten will be providing details of our second quarter fiscal year 2024 results, guidance for our fiscal year 2024, as well as commentary regarding the business environment. We'll take questions after the end of our prepared comments. Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. In addition to US GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results. I'll now turn the call over to Hock.
Hock Tan : Thank you, Ji. And thank you everyone for joining today. In our fiscal Q2 2024 results -- consolidated net revenue was $12.5 billion, up 43% year-on-year as revenue included a full quarter of contribution from VMware. But if we exclude VMware, consolidated revenue was up 12% year-on-year. And this 12% organic growth in revenue was largely driven by AI revenue, which stepped up 280% year-on-year to $3.1 billion, more than offsetting continued cyclical weakness in semiconductor revenue from enterprises and telcos. Let me now give you more color on our two reporting segments. Beginning with software. In Q2 infrastructure software segment revenue of $5.3 billion was up 175% year-on-year and included $2.7 billion in revenue contribution from VMware, up from $2.1 billion in the prior quarter. The integration of VMware is going very well. Since we acquired VMware, we have modernized the product SKUs from over 8,000 disparate SKUs to four core product offerings and simplified the go-to-market flow, eliminating a huge amount of channel conflicts. We are making good progress in transitioning all VMware products to a subscription licensing model. And since closing the deal, we have actually signed up close to 3,000 of our largest 10,000 customers to enable them to build a self-service virtual private cloud on-prem. Each of these customers typically sign up to a multi-year contract, which we normalize into an annual measure known as Annualized Booking Value, or ABV. This metric, ABV for VMware products, accelerated from $1.2 billion in Q1 to $1.9 billion in Q2. By reference, for the consolidated Broadcom software portfolio, ABV grew from $1.9 billion in Q1 to $2.8 billion over the same period in Q2. Meanwhile, we have integrated SG&A across the entire platform and eliminated redundant functions. Year-to-date, we have incurred about $2 billion of restructuring and integration costs and drove our spending run rate at VMware to $1.6 billion this quarter, from what used to be $2.3 billion per quarter pre-acquisition. We expect spending will continue to decline towards a $1.3 billion run rate exiting Q4, better than our previous $1.4 billion plan, and will likely stabilize at $1.2 billion post-integration. VMware revenue in Q1 was $2.1 billion, grew to $2.7 billion in Q2, and will accelerate towards a $4 billion per quarter run rate. We therefore expect operating margins for VMware to begin to converge towards that of classic Broadcom software by fiscal 2025. Turning to semiconductors, Let me give you more color by end markets. Networking. Q2 revenue of $3.8 billion grew 44% year-on-year, representing 53% of semiconductor revenue. This was again driven by strong demand from hyperscalers for both AI networking and custom accelerators. It's interesting to note that as AI data center clusters continue to deploy, our revenue mix has been shifting towards an increasing proportion of networking. We doubled the number of switches we sold year-on-year, particularly the PAM-5 and Jericho3, which we deployed successfully in close collaboration with partners like Arista Networks, Dell, Juniper, and Supermicro. Additionally, we also double our shipments of PCI Express switches and NICs in the AI backend fabric. We're leading the rapid transition of optical interconnects in AI data centers to 800 gigabit bandwidth, which is driving accelerated growth for our DSPs, optical lasers, and PIN diodes. And we are not standing still. Together with these same partners, we are developing the next generation switches, DSP, and optics that will drive the ecosystem towards 1.6 terabit connectivity to scale out larger AI accelerated clusters.
,: Next year, we expect all mega-scale GPU deployments to be on Ethernet. We expect the strength in AI to continue, and because of that, we now expect networking revenue to grow 40% year-on-year compared to our prior guidance of over 35% growth. Moving to wireless. Q2 wireless revenue of $1.6 billion grew 2% year-on-year, was seasonally down 19% quarter-on-quarter and represents 22% of semiconductor revenue. And in fiscal '24, helped by content increases, we reiterate our previous guidance for wireless revenue to be essentially flat year-on-year. This trend is wholly consistent with our continued engagement with our North American customer, which is deep, strategic, and multiyear and represents all of our wireless business. Next, our Q2 server storage connectivity revenue was $824 million or 11% of semiconductor revenue, down 27% year-on-year. We believe though, Q2 was the bottom in server storage. And based on updated demand forecast and bookings, we expect a modest recovery in the second half of the year. And accordingly, we forecast fiscal '24 server storage revenue to decline around the 20% range year-on-year. Moving on to broadband. Q2 revenue declined 39% year-on-year to $730 million and represented 10% of semiconductor revenue. Broadband remains weak on the continued pause in telco and service provider spending. We expect Broadcom to bottom in the second half of the year with a recovery in 2025. Accordingly, we are revising our outlook for fiscal '24 broadband revenue to be down high 30s year-on-year from our prior guidance for a decline of just over 30% year-on-year. Finally, Q2 industrial rev -- resale of $234 million declined 10% year-on-year. And for fiscal '24, we now expect industrial resale to be down double-digit percentage year-on-year compared to our prior guidance for high single-digit decline. So to sum it all up, here's what we are seeing. For fiscal '24, we expect revenue from AI to be much stronger at over $11 billion. Non-AI semiconductor revenue has bottomed in Q2 and is likely to recover modestly for the second half of fiscal '24. On infrastructure software, we're making very strong progress in integrating VMware and accelerating its growth. Pulling all these three key factors together, we are raising our fiscal '24 revenue guidance to $51 billion. And with that, let me turn the call over to Kirsten.
Kirsten Spears : Thank you, Hock. Let me now provide additional detail on our Q2 financial performance, which included a full quarter of contribution from VMware. Consolidated revenue was $12.5 billion for the quarter, up 43% from a year ago. Excluding the contribution from VMware, Q2 revenue increased 12% year-on-year. Gross margins were 76.2% of revenue in the quarter. Operating expenses were $2.4 billion and R&D was $1.5 billion, both up year-on-year primarily due to the consolidation of VMware. Q2 operating income was $7.1 billion and was up 32% from a year ago with operating margin at 57% of revenue. Excluding transition costs, operating profit of $7.4 billion was up 36% from a year ago, with operating margin of 59% of revenue. Adjusted EBITDA was $7.4 billion or 60% of revenue. This figure excludes $149 million of depreciation. Now a review of the P&L for our two segments, starting with semiconductors. Revenue for our semiconductor solutions segment was $7.2 billion and represented 58% of total revenue in the quarter. This was up 6% year-on-year. Gross margins for our semiconductor solutions segment were approximately 67%, down 370 basis points year-on-year, driven primarily by a higher mix of custom AI accelerators. Operating expenses increased 4% year-on-year to $868 million on increased investment in R&D, resulting in semiconductor operating margins of 55%. Now moving on to infrastructure software. Revenue for infrastructure software was $5.3 billion, up 170% year-on-year, primarily due to the contribution of VMware and represented 42% of revenue. Gross margin for infrastructure software were 88% in the quarter, and operating expenses were $1.5 billion in the quarter, resulting in infrastructure software operating margin of 60%. Excluding transition costs, operating margin was 64%. Now moving on to cash flow. Free cash flow in the quarter was $4.4 billion and represented 36% of revenues. Excluding cash used for restructuring and integration of $830 million, free cash flows of $5.3 billion were up 18% year-on-year and represented 42% of revenue. Free cash flow as a percentage of revenue has declined from 2023 due to higher cash interest expense from debt related to the VMware acquisition and higher cash taxes due to a higher mix of US income and the delay in the reenactment of Section 174. We spent $132 million on capital expenditures. Days sales outstanding were 40 days in the second quarter, consistent with 41 days in the first quarter. We ended the second quarter with inventory of $1.8 billion down 4% sequentially. We continue to remain disciplined on how we manage inventory across our ecosystem. We ended the second quarter with $9.8 billion of cash and $74 billion of gross debt. The weighted average coupon rate and years to maturity of our $48 billion in fixed rate debt is 3.5% and 8.2 years respectively. The weighted average coupon rate and years to maturity of our $28 billion in floating rate debt is 6.6% and 2.8 years, respectively. During the quarter, we repaid $2 billion of our floating rate debt, and we intend to maintain this quarterly repayment of debt throughout fiscal 2024. Turning to capital allocation. In the quarter, we paid stockholders $2.4 billion of cash dividends based on a quarterly common stock cash dividend of $5.25 per share. In Q2, non-GAAP diluted share count was 492 million as the 54 million shares issued for the VMware acquisition were fully weighted in the second quarter. We paid $1.5 billion withholding taxes due on vesting of employee equity, resulting in the elimination of 1.2 million AVGO shares. Today, we are announcing a 10-for-1 forward stock split of Broadcom's common stock to make ownership of Broadcom stock more accessible to investors and to employees. Our stockholders of record after the close of market on July 11, 2024, will receive an additional nine shares of common stock after the close of market on July 12, with trading on a split-adjusted basis expected to commence at market open on July 15, 2024. In Q3, reflecting a post-split basis, we expect share count to be approximately 4.92 billion shares. Now on to guidance. We are raising our guidance for fiscal year 2024 consolidated revenue to $51 billion and adjusted EBITDA to 61%. For modeling purposes, please keep in mind that GAAP net income and cash flows in fiscal year 2024 are impacted by restructuring and integration-related cash costs due to the VMware acquisition. That concludes my prepared remarks. Operator, please open up the call for questions.
Operator: Thank you. [Operator Instructions] And our first question will come from the line of Vivek Arya with Bank of America. Your line is open.
Vivek Arya: Thanks for taking my question. Hock, I would appreciate your perspective on the emerging competition between Broadcom and NVIDIA across both Accelerators and Ethernet switching. So on the Accelerator side, they are going to launch their Blackwell product that many of the same customers that you have a very large position in the custom compute. So I'm curious how you think customers are going to do that allocation decision, just broadly what the visibility is. And then I think Part B of that is as they launch their Spectrum-X Ethernet switch, do you think that poses increasing competition for Broadcom and the Ethernet switching side in AI for next year? Thank you.
Hock Tan: Very interesting question, Vivek. On AI accelerators, I think we are operating on a different -- to start with scale, much as a different model. It is -- and on the GPUs, which are the AI accelerator of choice on merchant -- in a merchant environment is something that is extremely powerful as a model. It's something that NVIDIA operates in, in a very, very effective manner. We don't even think about competing against them in that space, not in the least. That's where they're very good at and we know where we stand with respect to that. Now what we do for very selected or selective hyperscalers is, if there's a scale and the skills to try to create silicon solutions, which are AI accelerators to do particular very complex AI workloads. We are happy to use our IP portfolio to create those custom ASIC AI accelerator. So I do not see them as truly competing against each other. And far for me to say I'm trying to position myself to be a competitor on basically GPUs in this market. We're not. We are not a competitor to them. We don't try to be, either. Now on networking, maybe that's different. But again people may be approaching and they may be approaching it from a different angle. We are as I indicated all along, very deep in Ethernet as we've been doing Ethernet for over 25 years, Ethernet networking. And we've gone through a lot of market transitions, and we have captured a lot of market transitions from cloud-scale networking to routing and now AI. So it is a natural extension for us to go into AI. We also recognize that being the AI compute engine of choice in merchants in the ecosystem, which is GPUs, that they are trying to create a platform that is probably end-to-end very integrated. We take the approach that we don't do those GPUs, but we enable the GPUs to work very well. So if anything else, we supplement and hopefully complement those GPUs with customers who are building bigger and bigger GPU clusters.
Vivek Arya: Thank you.
Operator: One moment for our next question, and that will come from the line of Ross Seymore with Deutsche Bank. Your line is open.
Ross Seymore: Hi guys. Thanks for taking my question. I want to stick on the AI theme, Hock. The strong growth that you had in the quarter, the 280% year-over-year, could you delineate a little bit between if that's the compute offload side versus the connectivity side? And then as you think about the growth for the full year, how are those split in that realm as well? Are they kind of going hand-in-hand? Or is one side growing significantly faster than the other, especially with the I guess, you said the next-generation accelerators are now going to be Broadcom as well?
Hock Tan: Well, to answer your question on the mix, you are right. It's something we don’t really predict very well, not understand completely except in hindsight. Because it's like, to some extent, to the cadence of deployment of when they put in the AI accelerators versus when they put in the infrastructure that puts it together, the networking. And we don't really quite understand it 100%. All we know, it used to be 80% accelerators, 20% networking. It's now running closer to two-thirds accelerators, one-thirds networking and we'll probably head towards 60%-40% by the close of the year.
Ross Seymore: Thank you.
Operator: Thank you. One moment for our next question. And that will come from the line of Stacy Rasgon with Bernstein. Your line is open.
Stacy Rasgon: Hi, guys. Thanks for taking my question. I wanted to ask about the $11 billion AI guide. You'd be at $11.6 billion even if you didn't grow AI from the current level in the second half. And it feels to me like you're not suggesting that. It feels to me like you think you could be [guided] (ph). So why wouldn't that AI number be a lot more than $11.6 billion? It feels like it ought to be. Or am I missing something?
Hock Tan: Because I guided just over $11 billion, Stacy could be what you think it is. It's -- quarterly shipments get sometimes very lumpy. And it depends on rate of deployment, depends on a lot of things. So you may be right. You may estimate it better than I do, but the general trajectory is getting better.
Stacy Rasgon: Okay. So I guess again, how do I -- are you just suggesting that, that more than $11 billion is sort of like the worst it could be because that would just be flat at the current levels, but you're also suggesting that things are getting better into the back half?
Hock Tan: Correct.
Stacy Rasgon: Okay. So I guess we just take that, that's a very -- if I'm reading it wrong, that's just a very conservative number?
Hock Tan: That's the best forecast I have at this point, Stacy.
Stacy Rasgon: All right. Okay, Hock, thank you. I appreciate it.
Hock Tan: Thank you.
Operator: One moment for our next question, and that will come from the line of Harlan Sur with JPMorgan. Your line is open.
Harlan Sur: Yeah, good afternoon. Thanks for taking my question. Hock, on cloud and AI networking silicon, good to see that the networking mix is steadily increasing. Like clockwork, the Broadcom team has been driving a consistent two year cadence, right of new product introductions, Trident, Tomahawk, Jericho family of switching and routing products for the past seven generations. You layer on top of that your GPU -- TPU customers are accelerating their cadence of new product introductions and deployments of their products. So is this also driving faster adoption curve for your latest Tomahawk and Jericho products? And then maybe just as importantly, like clockwork, it is been two years since you've introduced Tomahawk 5 product introduction, right which if I look back historically, means you have silicon and are getting ready to introduce your next-generation three-nanometer Tomahawk 6 products, which would, I think, puts you two years to three years ahead of your competitors. Can you just give us an update there?
Hock Tan: Harlan, you're pretty insightful there. Yes, we launched Tomahawk 5 in 2023. So you're right, by late 2025, the time we should be coming out with Tomahawk 6, which is the 100 terabit switch, yes.
Harlan Sur: And is the -- is this acceleration of cadence by your GPU and TPU partners, is that also what's kind of driving the strong growth in the networking products?
Hock Tan: Well, you know what, sometimes you have to let things take its time. But it's two-year cadence so we're right on. Late 2023, once when we shoot it out to a Tomahawk 5 and adoption. You're correct with AI has been tremendous because it ties in with the need for a very large bandwidth in the networking, in the fabric for AI clusters, AI data centers. But regardless, we have always targeted Tomahawk 6 to be out two years after that, which should put it into late '25.
Harlan Sur: Okay, thank you Hock.
Operator: Thank you. One moment for our next question, and that will come from the line of Ben Reitzes with Melius. Your line is open.
Ben Reitzes: Hi, thanks a lot. And congrats on the quarter and guide. Hock, I wanted to talk a little bit more about VMware. Just wanted to clarify if it is indeed going better than expectations. And how would you characterize the customer willingness to move to subscription? And also just a little more color on Cloud Foundation. You've cut the price there, and are you seeing that beat expectations? Thanks a lot.
Hock Tan: Thanks, and thanks for your kind regards on the quarter. But it's -- as far as VMware is concerned, we're making good progress. The journey is not over by any means, but it is pretty much very much to expectation. Moving to subscription, well, in VMware we are very slow compared to, I mean a lot of other guys, Microsoft, Salesforce, Oracle, who have already been pretty much in subscription. So VMware is late in that process. But we're trying to make up for it by offering it and offering it in a very, very compelling manner because subscription is the right things to do, right? It's a situation where you put out your product offering, and you update it, patch it, but update it feature-wise, everything as capabilities on a continual basis, almost like getting your news on an ongoing basis, subscription online versus getting it in a printed manner once a week. That's how I compare perpetual to subscription. So it is very interesting for a lot of people to want to can't get on. And so to no surprise, they are getting on very well. The big selling point we have as I indicated, is the fact that we are not just trying to keep customers kind of stuck on just server or compute virtualization. That's a great product, great technology, but it's been out for 20 years. Based on what we are offering now at a very compelling price point, compelling in a very attractive price point, the whole stack, software stack to use vSphere and its basic fundamental technology to virtualize networking, storage, operation and management, the entire data center and create this self-service private cloud. And thanks for saying it, you're right, and we have priced it down to the point where it is comparable with just compute virtualization. So yes, that is getting a lot of interest, a lot of attention from the customers. We have signed up who would like to deploy -- the ability to deploy private cloud, their own private cloud on-prem. As a nice complement, maybe even alternative or hybrid to public clouds, that's the selling point, and we are getting a lot of interest from our customers in doing that.
Ben Reitzes: Great. And it's on track for $4 billion by the fourth quarter still, which is reiterated?
Hock Tan: Well, I didn't give a specific time frame, did I? But it's on track as we see this process growing towards a $4 billion quarter.
Ben Reitzes : Okay, thanks a lot Hock.
Hock Tan : Thanks.
Operator: Thank you. One moment for our next question, and that will come from the line of Toshiya Hari with Goldman Sachs. Your line is open.
Toshiya Hari: Hi, thank you so much for taking my question. I guess kind of a follow-up to the previous question on your software business. Hock, you seem to have pretty good visibility into hitting that $4 billion run rate over the medium term, perhaps. You also talked about your operating margin in that business converging to classic Broadcom levels. I know the integration is not done and you're still kind of in debt paydown mode. But how should we think about your growth strategy beyond VMware? Do you think you have enough drivers, both on the semiconductor side and the software side to continue to drive growth or is M&A still an option beyond VMware? Thank you.
Hock Tan: Interesting question. And you're right. As I indicated in my remarks, even we found the contribution from VMware this past quarter where we have AI helping us, but we have non-AI semiconductor sort of bottoming out. We're able to show 12% organic growth year-on-year. So almost have to say, so do we need to rush to buy another company? Answer is no. But all options are always open because we are trying to create the best value for our shareholders who have entrusted us with the capital to do that. So I would not discount that alternative because our strategy, our long-term model has always been to grow through a combination of acquisition, but also on the assets we acquire to really improve, invest, and operate them better to show organic growth as well. But again, organic growth often enough is determined very much by how fast your market would grow. So we do look towards acquisitions now and then.
Toshiya Hari : All right. Thank you.
Operator: Thank you. One moment for our next question, and that will come from the line of Blayne Curtis with Jefferies. Your line is open.
Blayne Curtis: Hi, thanks for taking my question. I wanted to ask you Hock, on the networking business kind of ex AI. Obviously, I think there's an inventory correction the whole industry is seeing. But just kind of curious, I don't think you mentioned that it was at a bottom. So just the perspective, I think it's down about [60%] (ph) year-over-year. Is that business finding a bottom? I know you said overall whole semi business should -- non-AI should see a recovery. Are you expecting any there any perspective on just customer inventory levels in that segment?
Hock Tan: We see it behaving. I didn't particularly call it out, obviously because more than anything else, I kind of link it very much to server storage, non-AI that is. And we call server storage as at a bottom Q2, and we call it to recover modestly second half of the year. We see the same thing in networking, which is a combination of enterprise networking, as well as the hyperscalers who run their traditional workloads on those, though it's hard to figure out sometimes. But it is. So we see the same trajectory as we are calling out on server storage.
Blayne Curtis: Okay, thank you.
Operator: Thank you. One moment for our next question, and that will come from the line of Timothy Arcuri with UBS. Your line is open. Mr. Arcuri, your line is open.
Timothy Arcuri: Hi, sorry. Thanks. Hock, is there a way to sort of map GPU demand back to your AI networking opportunity? I think I've heard you say in the past that if you spent $10 billion on GPU compute, you need to spend another $10 billion on other [infrastructure] (ph), most of which is networking. So I'm just kind of wondering if when you see these big GPU numbers, is there sort of a rule of thumb that you use to map it back to what the opportunity will be for you? Thanks.
Hock Tan: There is, but it's so complex, I stopped creating such a model, Tim. I've said it. But there is because one would say that for every -- you almost say, for every $1 billion you spend on GPU, you probably would spend probably on networking, and if we include the optical interconnects as part of it, though we are not totally in that market, except for the components like DSPs, lasers, PIN diodes that go into those, high-bandwidth optical connect. But if you just take optical connects in totality, switching, all the networking components, it goes into -- attaches itself to clustering a bunch of GPUs, you probably would say that about 25% of the value of the GPU goes to networking, the rest on networking. Now not entirely all of it is my available market. I don't do the optical connects, but I do the few components I talked about in it. But roughly, the simple way to look at it is probably about 25%, maybe 30% of all these infrastructure components is kind of attached to the GPU value point itself. But having said that, it's never – we are never that precise that deployment is the same way. So you may see the deployment of GPU or purchase of GPU much earlier. And the networking comes later or sometimes less the other way around, which is why you're seeing the mix going on within my AI revenue mix. But typically, you run towards that range over time.
Timothy Arcuri: Perfect Hock, thank you so much.
Operator: Thank you. One moment for our next question, and that will come from the line of Thomas O'Malley with Barclays. Your line is open.
Thomas O’Malley: Hi, guys. Thanks for taking my question. And nice results. My question in regards to the custom ASIC AI. Hock, you had a long run here of a very successful business, particularly with one customer. If you look in the market today, you have a new entrant who's playing with different customers. And I know that you said historically, that's not really a direct customer to you. But could you talk about what differentiates you from the new entrant in the market as of late? And then there's been profitability questions around the sustainability of gross margins longer term. Can you talk about if you see any increased competition? And if there's really areas that you would deem more or less defensible in your profile today? And if you would see kind of that additional entrant maybe attack any of those in the future?
Hock Tan: Let me take the second part first, which is our AI -- custom AI accelerator business. It is a very profitable business, and let me put to scale -- look examine from a model point of view. I mean, each of these AI accelerators no different from a GPU. The way these large language models get run computing, get run on these accelerators, no one single accelerator, as you know, can run these big large language models. You need multiple of it no matter how powerful those accelerators are. But also, and the way the models are run, there is a lot of memory access to memory requirements. So each of this accelerator comes with a large amount of cache memory, as you call it, what you guys probably now know as HBM, high-bandwidth memory specialized for AI accelerators or GPUs. So we're supplying both in our custom business. And the logic side of it, where the compute function is on doing the chips, the margin there are no different than the margin in any -- in most of any of a semiconductor silicon chip business. But when you're attached to it, a huge amount of memory, memory comes from a third-party. There are a few memory makers who make this specialized thing. We don't do margin stacking on that part. So by almost buying basic math will dilute the margin of these AI accelerators when you sell them with memory, which we do. It does push up revenue somewhat higher but it has diluted the margin. But regardless, the spend, the R&D, the OpEx that goes to support this as a percent of the revenue, which is higher revenue, so much less. So on an operating margin level, this is easily as profitable, if not more profitable, given the scale that each of those custom AI accelerators can go up to. It's even better than our normal operating margin scale. So that's the return on investment that attracts and keeps us going at this game. And this is more than a game. It is a very difficult business. And to answer your first question, there is only one Broadcom, period.
Thomas O'Malley: Thanks Hock.
Operator: Thank you. One moment for our next question, and that will come from the line of Karl Ackerman with BNP. Your line is open.
Karl Ackerman: Hi, thank you. Good afternoon. Hock, your networking switch portfolio with Tomahawk and Jericho chipsets allows hyperscalers to build AI clusters using either a switch-scheduled or endpoint-scheduled network. And that, of course is unique among competitors. But as hyperscalers seek to deploy their own unique AI clusters, are you seeing a growing mix of white-box networking switch deployments? I ask because while your custom sales and business continues to broaden, it will be helpful to better understand the growing mix of your $11 billion AI networking portfolio combined this year. Thank you.
Hock Tan: Let me have Charlie address this question. He's the expert.
Charlie Kawwas: Yes. Thank you, Hock. So two quick things on this. One is the – you are exactly right that the portfolio we have is quite unique in providing that flexibility. And by the way, this is exactly why Hock, in his statements earlier on, mentioned that seven out of the top eight hyperscalers use our portfolio. And they use it specifically because it provides that flexibility. So whether you have an architecture that's based on an endpoint and you want to actually build your platform that way or you want that switching to happen in the fabric itself, that's why we have the full end-to-end portfolio. So that actually has been a proven differentiator for us. And then on top of that, we've been working, as you know, to provide a complete network operating system that's open on top of that using SONiC and Psi, which has been deployed in many of the hyperscalers. And so the combination of the portfolio plus the stack really differentiates the solution that we can offer to these hyperscalers. And if they decide to build their own NICs, their own accelerators are custom or use standard products, whether it is from Broadcom or other, that platform, that portfolio of infrastructure switching gives you that full flexibility.
Karl Ackerman: Thank you.
Operator: Thank you. One moment for our next question, and that will come from the line of C.J. Muse with Cantor Fitzgerald. Your line is open.
CJ Muse: Yeah. Good afternoon. Thank you for taking my question. I was hoping to ask two part software question. So excluding VMware, your Brocade, CA, and Symantec business now running $500 million higher for the last two quarters. So curious, is that the new sustainable run rate or were there onetime events in both January and April that we should be considering? And then the second question is as you think about VMware Cloud Foundation adoption, are you seeing any sort of crowding out of spending like other software guys are seeing as they repurpose their budgets to IT? Or is that business so less discretionary that it's just not an impact to you? Thanks so much.
Hock Tan: Well, on the second one, I don't know about any crowding out, to be honest. It's not. What we are offering, obviously, is not something that they would like to use themselves, to be able to do themselves, which is they're already spending on building their own on-prem data centers. And typical approach people take, a lot of enterprises take historically continue today than most people do a lot, people do is they have best of breed. What I mean is they create a data center that is compute as a separate category, best compute there is and they often enough use vSphere for compute virtualization due to improved productivity, but best of breed there. And best of breed on networking and best of breed on storage with a common management operations layer, which very often is also VMware we realize. And what we're trying to say is this mixed bag, and what they see -- is this mixed bag best of [big] (ph) data center, very heterogenous, is not driving that, is not a highly resilient data center. I mean, you have a mixed bag. So it goes down. Where do you find quickly root cause? Everybody is pointing fingers at the other. So you got a problem, not very resilient and not necessary secure between bare metal in one side and software on the other side. So it's a natural thinking on the part of many CIOs we talk to, to say, hey, I want to create one common platform as opposed to just [best-of-breed of age] (ph). So that gets us into that. So it is a greenfield that’s not bad, they started from scratch. If it's a brownfield, that means they have existing data centers trying to upgrade. It's -- that sometimes that's more challenging for us to get that adopted. So I'm not sure there's a crowding out here. There's some competition, obviously, on greenfield, where they can spend their budget on an entire platform versus best-of-breed. But on the existing data center where you're trying to upgrade, that's a trickier thing to do. And it cuts the other way as well for us. So that's how I see it. So in that sense, best answer is I don't think we're seeing a level of crowding out that is -- any and that very significant for me to mention. In terms of the revenue mix, no, Brocade is having a great, great field year so far and still chugging along. But will that sustain? Hell no, you know that. Brocade goes through cycles like most enterprise purchases. So we're enjoying it while it lasts.
CJ Muse: Thank you.
Hock Tan: Thanks.
Operator: Thank you. And we do have time for one final question, and that will come from the line of William Stein with Truist Securities. Your line is open.
William Stein: Great. Thanks for squeezing me in. Hock, congrats on the yet another great quarter and a strong outlook in AI. I also want to ask about something you mentioned with VMware. In your prepared remarks, you highlighted that you've eliminated a tremendous amount of channel conflict. I'm hoping you can linger on this a little bit and clarify maybe what you did. And specifically also what you did in the heritage Broadcom software business, where I think historically, you've shied away from the channel. And there was an idea that perhaps you'd reintroduce those products to the channel through a more unified approach using VMware's channel partners or resources. So any sort of clarification here, I think, would be helpful.
Hock Tan: Yes, thank you. That's a great question. Yes, VMware taught me a few things. They have 300,000 customers, 300,000. That's pretty amazing. And we look at it. I know under CA, we took a position that let's pick an A-list strategic guy and focus on it. I can't do that in VMware. I approached it differently. And I start to learn the value of a very strong bunch of partners they have, which are a network of distributors and something like 15,000 VARs, value-added resales supported with these distributors. So we have doubled down and invested in this resale network in a big way for VMware. It's a great move, I think but six months into the game. But we are seeing a lot more velocity out of it. Now these resellers, having said that, tend to be very focused on a very long tail of their 300,000 customers. The largest 10,000 customers of VMware are large enterprises who tend to -- they are very large enterprises, the largest banks, the largest health care companies. And their view is I want very bespoke service, support, engineering solutions from us. So we've created a direct approach, supplemented with the VAR of choice where they need to. But on the long tail of 300,000 customers, they get a lot of services from the resellers, value-added resellers, and so in their way. So we now strengthen that whole network of resellers so that they can go direct, manage, supported financially with distributors. And we don't try to challenge those guys unless the customers. On the end of the day, the customer chose where they like to be supported. So we kind of simplify this together with the number of SKUs they have. In the past, unlike what we're trying to do here, everybody is a partner. I mean, you're talking a full range of partners. And whoever makes the biggest deal gets the lowest. The partner that makes the biggest deal gets the lower -- biggest discount, lowest price. And they are out there basically kind of creating a lot of channel chaos and conflict in the marketplace. Here, we don't. The customers, I am aware. They can take it direct from VMware to their direct sales force or they can easily move to the resellers to get it that way. And as a third alternative which we offer, if they chose not -- they want to run their applications on VMware and they want to run it efficiently on a full stack. They have a choice now of going to a hosted environment managed by network of managed service providers, which we set up globally, that will run the infrastructure, invest and operate the infrastructure. And these enterprise customers just run their workloads in and get it as a service, basically VMware as a service. That's a third alternative, and we are clear to make it very distinct and differentiated for our end-use customers. They're available to all three is how they choose to consume our technology.
William Stein: Great. Thank you.
Operator: Thank you. I would now like to hand the call over to Ji Yoo, Head of Investor Relations, for any closing remarks.
Ji Yoo: Thank you, Cherie. Broadcom currently plans to report its earnings for the third quarter of fiscal '24 after close of market on Thursday, September 5, 2024. A public webcast of Broadcom's earnings conference call will follow at 2:00 p.m. Pacific Time. That will conclude our earnings call today. Thank you all for joining. Operator, you may end the call.
Operator: Thank you all for participating. This concludes today's program. You may now disconnect. |
COST | 3 | 2,024 | 2024-05-30 21:01:08 | Operator: Thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Costco Wholesale Corporation Third Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Gary Millerchip, Executive Vice President and Chief Financial Officer. Gary, you may begin your conference.
Gary Millerchip: Good afternoon, everyone, and thank you for joining the call today. I'd like to start by saying how excited I am to be part of the Costco team, and it's a pleasure to be hosting my first Costco quarterly conference call. The whole Costco team has been incredibly welcoming. And as you might imagine, my first three months working alongside Richard have been a lot of fun. It's also been great visiting warehouses and facilities to immerse myself in the Costco culture and experience firsthand how this is positioning the company for continued growth. Over recent months, I've spent time and met with many analysts and investors, several of whom I know through my prior role. And it's clear you value and appreciate the company's current approach to investor communications. While I can't promise to be able to match the humor that Richard Galanti has become famous for, I can promise the same level of open dialogue and transparency you've come to expect. Oh, and to clear up some recent media speculation, I also want to confirm the $1.50 hot dog price is safe. Before I talk about our results, I wanted to mention that Ron Vachris is also join today's call. Many of you have expressed interest in hearing from Ron, and so we thought it would be a good idea to have Ron join the discussion and he can also take a few questions. Ron, would you like to add anything before we talk about the quarter?
Ron Vachris: Thank you, Gary. And again, welcome to Costco. I'm very happy to report that the transition from Richard to Gary has gone very well and we're very excited to have Gary on board as part of Costco, and I look forward to working together on the growth opportunities ahead for our company. Before we jump into the quarter, I want to make a couple of comments on the leadership transition. As Richard has mentioned on previous calls, I've worked closely with Craig Jelinek for many years, including side-by-side for the last two years as President. And so the current CEO transition has been very seamless process. Since January, my time has been focused on working closely with the teams around the world to ensure we continue to deliver the best quality merchandise that are best value for our members. I'm incredibly proud of our employees and I believe our consistency of the results is a reflection of their commitment to our members and to each other. Consistent with how Craig and Richard manage investor communications, I intend to have Gary host the quarterly conference calls and I will join as business permits to answer a few questions. So Gary, let's go to the results and I'm happy to jump back in for the Q&A portion to field some questions today.
Gary Millerchip: Thanks, Ron. I'll start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time-to-time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made and the company does not undertake to update these statements except as required by law. Comparable sales and comparable sales excluding impacts from changes in gasoline prices and foreign exchange are intended as supplemental information and are not a substitute for net sales presented in accordance with GAAP. In today's press release, we reported operating results for the third quarter of fiscal 2024, the 12 weeks ended May 12. Before I walk through all the numbers, new for this quarter, we are making available a slide presentation on our investor site under Events and Presentations. These slides summarize much of the information I will share today, including Richard's famous matrices. We intend to make this information available every quarter. Reported net income for the third quarter came in at $1.68 billion or $3.78 per diluted share, up from $1.3 billion and $2.93 per diluted share in the third quarter last year. Last year's results included a non-recurring charge to merchandise costs of $298 million pre-tax or $0.50 per diluted share, primarily for the discontinuation of our charter shipping activities. Net sales for the third quarter were $57.39 billion, an increase of 9.1% from $52.6 billion in the third quarter last year. The following comparable sales reflect comparable locations year-over-year and comparable retail weeks. U.S. comp sales were 6.2% or 6% adjusted for gas inflation and FX. Canada was 7.7% or 7.4% adjusted. Other international was 7.7% or 8.5% adjusted, and this led to total company comp sales of 6.6% or 6.5% adjusted for gas inflation and FX. Finally, e-commerce comp sales were 20.7%, both on a reported basis and adjusted for foreign exchange. In terms of Q3 comp sales metrics, traffic or shopping frequency increased 6.1% worldwide and 5.5% in the U.S. Our average transaction or ticket was up 0.5% worldwide and up 0.7% in the U.S. Foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 20 basis points, while gasoline price inflation positively impacted sales by approximately 30 basis points. Moving down the income statement to membership fee income. We reported membership fee income of $1,123 million, an increase of $79 million or 7.6% year-over-year. Membership fee income growth was 8% excluding FX. In terms of renewal rates, at Q3 end, our U.S. and Canada renewal rate was 93%, up one tenth of a percent from Q2 end. The worldwide rate came in at 90.5%, the same as Q2 end. We ended Q3 with 74.5 million paid household members, up 7.8% versus last year, and 133.9 million card holders, up 7.4% year-over-year. At Q3 end, we had 34.5 million paid executive memberships, an increase of 661,000 since Q2 end. Executive members now represent over 46% of paid members and 73.1% of worldwide sales. Our reported gross margin rate in the third quarter was higher year-over-year by 52 basis points, coming in at 10.84% compared to 10.32% last year and up 54 basis points excluding gas inflation. Core was flat and higher by 2 basis points without gas inflation. In terms of core margin on their own sales, our core-on-core margins were higher by 10 basis points. Ancillary and other businesses gross margin was lower 6 basis points and lower 5 basis points excluding gas inflation. This decrease year-over-year was driven by gas, partially offset by e-commerce. 2% reward was lower by 1 basis point, both with and without gas inflation with higher sales penetration coming from our executive members. LIFO was a benefit of 2 basis points. We had an $11 million LIFO credit in Q3 this year compared to no LIFO charge or credit in Q3 last year. This is the third LIFO credit this year following a $15 million LIFO credit in Q1 and a $14 million credit in Q2. And finally, other was higher 57 basis points or 56 basis points excluding gas inflation. This was all related to lapping last year's negative impact from the $298 million pre-tax charge for charter shipping activities. Moving on to SG&A. Our reported SG&A rate in the third quarter was lower or better year-over-year by 15 basis points, coming in this year at 8.96% compared to last year's 9.11%. SG&A was lower year-over-year by 12 basis points adjusted for gas inflation. The operations components of SG&A was lower by 14 basis points and lower by 12 basis points, excluding the impact from gas inflation, despite an increase in warehouse wages this year. Higher labor productivity and great cost discipline by our operators drove the improved core SG&A results for the quarter. Central was better by 1 basis point and flat with our gas inflation. And stock compensation and pre-opening were both flat year-over-year. Below the operating income line, interest expense was $41 million this year versus $36 million last year and interest income and other for the quarter was flat year-over-year as lower interest income was offset by a foreign exchange gain in the quarter. In terms of income taxes, our tax rate in Q3 was 26.4% compared to 26.5% in Q3 last year. Overall, reported net income was up 29.1% year-over-year, and excluding last year's charge related to the discontinuation of charter shipping activities, it was up 10.3% year-over-year. A few other items of note. In terms of warehouse expansion, in the third quarter, we opened two new warehouses, both in the U.S. Additionally, since the end of Q3, we had two more openings. Last week, we opened in Loomis, California, and two days ago, we opened our seventh building in China in the Nanjing market. For the remainder of fiscal 2024, we plan to open another 12 new locations, nine in the U.S, two in Japan and one in Korea. This would bring the total for the full year to 30 openings, including one relocation for a net of 29 new warehouses. Regarding capital expenditures, Q3 spend was approximately $1.06 billion, and we estimate full year 2024 capital expenditure will be between $4.3 billion and $4.5 billion. Diving a bit deeper into some of the key themes we saw during the quarter. Non-foods have the highest comps of our core categories. This strength was aided by lapping some softness in sales a year ago, but was really driven by our merchandising teams doing a great job identifying high quality items with values that really resonated with our members and buying those items with conviction. As inflation has leveled off, our members are returning to purchasing more discretionary items. And growth in the category was led by toys, tires, lawn and garden and health and beauty aids. Bakery sales also showed great momentum in the quarter as our fresh foods team has reinvented that department with a number of new and exciting items, including the Kirkland Signature Lemon Blueberry loaf and Morning Buns. Within our ancillary businesses, the food court had the strongest quarterly sales with continued success of the chocolate chip cookie that was added to the food court this year. On the inflation front, it's more of the same from last quarter. Across all core merchandise, inflation was essentially flat in Q3, with fresh foods close to zero and slight inflation in food and sundries being offset by some deflation in non-foods. The deflation in non-foods was led by hardware, sporting goods and furniture, all still benefiting from lower freight costs year-over-year. Keep in mind that when we speak to inflation or in the case of non-food deflation, we're referring to our selling prices. We're intentionally creating incremental value for our members by delivering lower prices wherever possible. We believe our strategy of delivering value to drive unit volume and member satisfaction is the winning combination for us. In that vein, our buying teams are constantly aware of changing costs across all of their SKUs and are ensuring that we are capturing all cost decreases quickly so that we can pass on incremental value through price reductions. If we are unsuccessful in delivering ultimate value with branded goods, we evaluate the potential for new high quality Kirkland Signature items with a goal of providing at least 20% value versus what we would sell the national brand item at. This quarter, we released a new Kirkland Signature men's walking shoe and new Kirkland Signature facial wipes, both of which are doing very well. We also reduced prices on a number of existing items, including lowering Kirkland Signature pine nuts from $29.99 to $24.99 and reducing the price of our Kirkland Signature frozen shrimp SKUs by $1. These are just a couple of examples that came out of our recent monthly budget meetings where each country and region shares new and exciting items they have introduced to their warehouses and items where they've lowered prices. Turning now to digital. We continue to make enhancements to the app and website and are excited about the traction that these initiatives are getting with members. Total e-commerce sales growth in the quarter was led by Gold and Silver bullion, gift cards and appliances. In appliances, Costco logistics is playing a key role in providing both greater value and a better end-to-end experience for members. Deliveries through Costco logistics were up 28% in the quarter. Costco Next, our curated marketplace also continues to grow nicely and we added eight new vendors in Q3, bringing the total to 75. Our app downloads were up 32% versus a year ago with about 2.5 million new downloads in the quarter, bringing total downloads to more than 35 million. Site traffic was up 16% and average order value was up 8%. You may have also recently seen an announcement that we are expanding our relationship with Uber. Previously, Uber Eats delivered Costco orders in Texas and this new agreement allows consumers the ability to order from Costco through Uber Eats across all of Canada as well as 17 states in the U.S. We are also working to expand this partnership to several of our international countries in the coming months. In addition to the increased access to Uber Eats customers, the agreement will allow us to sell Uber gift cards globally and offer discounted Uber One annual membership to Costco members. Finally, in terms of our upcoming releases, we will announce our May sales results for the four weeks ending Sunday, June 2nd, on Wednesday, June 5th, after market close. Also, remember that our fiscal fourth quarter ending September 1, 2024, will have 16 weeks versus the 17 weeks in the fiscal fourth quarter last year. And with that, we will now open it up for Q&A.
Operator: Thank you. [Operator Instructions] Your first question comes from the line of Simeon Gutman with Morgan Stanley. Please go ahead.
Simeon Gutman: Good afternoon. Hey, Gary, how are you doing?
Gary Millerchip: Hi, Simeon.
Simeon Gutman: We're going to take a stab at this membership question. The way that we've thought about it is it's an inflation offset to the model. And it was described as if you have enough levers in the middle of the P&L to deliver whatever stated EBIT growth you're trying to do, you didn't need to touch the membership fee. Is that still the way that you look at it? And is that visibility on enough levers still intact?
Gary Millerchip: Yes. Thanks, Simeon. And you're talking about a membership fee increase now. Is that where your question is coming from?
Simeon Gutman: Right. Yeah. Yes.
Gary Millerchip: Yes. I would really kind of revert back to some of the comments that Richard shared previously. I don't think that we're thinking about it any differently than he's talked about in the last few calls. We've historically looked at increasing the membership fee every five years or so. And obviously, we're beyond that time period now in terms of what would be the typical cycle. There's nothing about anything that we see within how the business is performing that's changing our view on that. We feel really good about membership renewal rates. We feel really good about the test of are we delivering significantly more value to members than we were or have since we last increased the membership fee. But I think we are our own probably toughest competitor and that we look at what's happened in the marketplace over the last few years and when we were seeing high inflation and the risk and concern around recession. We -- as I know before I joined the company, it was talked about extensively and it continues to be talked about as it's something that is still a case of when we increase the fee rather than if we increase the fee. But we are still evaluating those considerations to determine what the right timing is. And when we reach that point where we feel it is the right time, of course, we'll be very open and direct in communicating that.
Simeon Gutman: Okay. Fair enough. Can I ask about your opinion on the U.S. expansion, it's been holding in a lot better. It's been more giving than we would have thought several years ago. Do you have any thoughts just your own perspective, you're probably looking at members per warehouse. Are you surprised at the runway you still have in the U.S.? You think it could be even more than what we're aware of today less? Just curious if there's anything surprising on that item.
Gary Millerchip: I think it's only surprising in as much as I know we've talked previously about we thought that we would potentially run out of runway for new warehouses in the U.S. and as you know, this year we're opening close to 29 net new warehouses and many of those will be continuing in the U.S. and we still see significant runway to continue to opening more warehouses in the U.S. in the future. I think that sort of 25 to 30 new warehouse count is a reasonable proxy for what we think the runway is for the foreseeable future for new warehouses. And I'd be surprised if at least half of those weren't in the -- continue to be in the U.S. because we still see significant growth when we open those new warehouses. And what it's doing for us in fill in markets is it's creating capacity for our members that are shopping very busy warehouses today to be able to shop more frequently and drive more engagement with us and also it increases membership renewal rates over time as well. So I think we still see plenty of runway in the U.S. to continue to open more warehouses, but we also see a lot of growth opportunity, of course, in the international markets as well.
Simeon Gutman: Okay. Thanks, Gary. Appreciate it.
Gary Millerchip: Thanks, Simeon.
Operator: Your next question comes from the line of Michael Lasser with UBS. Please go ahead.
Michael Lasser: Good morning. Good afternoon. Thank you so much for taking my question. There's been a lot of announcements from consumable retailers in recent times about making price investments. Do you think you need to make a sizable price investment in the next couple of quarters in order to remain competitive?
Ron Vachris: This is Ron Vachris. No, I think that this is part of our everyday DNA. I mean, we are competitive on a daily basis. Our buyers are on top of pricing daily, weekly and we all review them each month. And so we feel very good about where we are today and our runway to continue to be as competitive as we are moving forward.
Michael Lasser: My follow-up question is, given some of the changes in leadership over the last year or so, is there any thought given to being more aggressive with some of the evolution on the model, things like buy online pickup in-store, deploying more technology in the store or capitalizing on the ever so great amounts of data that Costco has in the form of trying to monetize it through retail media. Thank you very much.
Ron Vachris: That's no -- and I think the answer to that is yes, on all those fronts. We are working on all those aspects. Right now, we're rolling out an expanded buy online pickup in warehouse that is always going to be limited in scope based on the volume in our warehouses that we have. We can't expand to all categories, but we're expanding as we currently speak in televisions and other electronic items that are there as -- and so yeah, we see that as a real opportunity for us. Technology is going to be one of our key priorities moving forward. How do we improve that member engagement and the relationship we have with them in our brick-and-mortar warehouses as well as online and through other aspects such as travel and so forth. So technology we see is a great opportunity to enhance the member relationship with Costco and also drive a lot more business for us as well as we move forward. So we're going to continually innovate. I mean, with the management changes, I wouldn't expect major changes as we have a proven strategy now. But as we've done for the past 41 years, we continue to innovate to the needs of our members. Oh, and the last on data, absolutely. We see a great opportunity for data. We have expanded our group there. We have a significant program now with retail media and we see some great upside potential. We've expanded that team and we see some good potential and some good runway for us in that as well, things like personalization and so forth.
Michael Lasser: Thank you very much.
Gary Millerchip: Thanks, Michael.
Operator: Your next question comes from the line of Chuck Grom with Gordon Haskett. Please go ahead.
Chuck Grom: Hey, good afternoon and congrats again, Gary. And historically, Richard and team have been steadfast on the 14% to 15% margin ceiling, which has clearly paid dividends for the company over the years. I'm curious how you and Ron view this threshold you going to adhere to it? Do you think you can earn more? Just your thoughts on the margin front?
Ron Vachris: No, that 14%, 15% has been part of our life for many years. And so I think that's -- our objective, our buyer's goals is really how aggressive they can get on pricing and deliver the best value. So I don't see there's no plans to move that cap at all.
Gary Millerchip: And Chuck, maybe just one thing to build on that too. I think as you think about some of the opportunities that Ron mentioned on the earlier call, I completely echo Ron's comment about we have a really clear growth strategy that's obviously delivering momentum in the company today and these opportunities through technology and media, I think are great opportunities for us to find new ways to unlock value. But again, I think we see those very much in the mindset of how do we give 90%-ish of that back to the member, so that we're continuing to drive member engagement, member loyalty and member value.
Chuck Grom: Great. And then just to kind of build off Michael's question, just wanted to get your high level thoughts on digital e-com. What do you think Costco's strengths are? What do you think the weaknesses are today? And where do you think the biggest focus is going to be for the company in the coming years?
Ron Vachris: Our biggest strength on digital e-com is, of course, the merchandise and the value that we have. I mean that's what works for us in our brick-and-mortar. You know, the technology, the systems that we have, the teams have got a great roadmap of where they're going. A lot of the work that's being done right now is very foundational. So better fulfillment, quicker delivery times, the reliability of the site, those type of things. So those are the things. And then following that will come iterative changes of forward facing improvements that you'll see in the sites and move forward. So I think we've got a very good roadmap to do that. But I think that does -- it's -- I think personalization is a big deal for members that we could do a much better job on and also a better correlation of the warehouse and the online business. We're working towards warehouse inventory online. So members could use that in the app. But app functionality is one of our greatest opportunities.
Chuck Grom: Great. Thank you.
Gary Millerchip: Thanks, Chuck.
Operator: Your next question comes from the line of Scott Ciccarelli with Truist Securities. Please go ahead.
Scott Ciccarelli: Thanks, guys. Scott Ciccarelli. So given the strength of your discretionary sales following the well that we've seen with -- as the economy got a little funky, does that suggest your members are starting to feel better and more willing to spend on wants rather than needs?
Ron Vachris: Yes. It does indeed look that way. I've got to tell you that the discretionary spend we're seeing, I mean, we're definitely winning in consumables as we see the food business and dining away from home has softened up a bit and people are eating and we're seeing that in our fresh foods. But I have to tell you that categories such as the home division and toys are categories that have lagged quite a bit post-COVID that with great excitement, I mean, our buyers have come out and delivered some great items, have phenomenal values, have really rejuvenated those categories. And those are both leading categories for us in sporting goods, toys, furnishings, domestics, all those categories are really coming on very strong now and all of it discretionary in nature.
Scott Ciccarelli: Fascinating. And then today, we had a presentation. Obviously, Ron, you joined the call. Are there other changes we could potentially expect given some of the C-suite changes?
Ron Vachris: I mean, again, like I said, there's no major changes planned. The team is -- the team that's been running this company for some time. Gary has been a great addition to us and is contributing nicely. But our model is working. It's working around the world. Great value on quality merchandise seems to resonate in every region that we do business. So we'll continue to innovate. We'll continue to see new things and be relative to what our members needs are, but I can't sit here today and tell you to expect anything -- any great momentous changes in the near future. We just want to continue to actually execute well.
Gary Millerchip: And Scott, maybe just to add from my perspective of being new to the role and new to the company, early observations to me, obviously, the incredibly impressed with the culture and the strategy is clearly working very well. So my first priority is to really being new to the company is to really acclimatize and to support and enable a smooth transition with the culture to make sure the momentum that we have continues going forward. And I think the other point, as we talked about a little bit earlier on the call is we're on a journey with technology and data. And so hopefully, there's things that I can bring to work with the team and help us continuing on that journey and accelerate that journey. And really that's the priorities in my mind being new into the CFO role.
Scott Ciccarelli: Very helpful. Thanks, guys.
Ron Vachris: Thank you.
Operator: Your next question comes from the line of Kelly Bania with BMO Capital Markets. Please go ahead.
Kelly Bania: Thanks for taking our questions. And Ron and Gary, pleasure to have you both on the call and love the slides. Thank you. I wanted to just maybe go back a little bit to retail media strategy and personalization. I think, Ron, you noted a hire or maybe some key hires in that department. And Gary, I think you bring a unique perspective to this area or both of these areas. So I guess just can you help size up the opportunity for us on these two fronts in retail media and personalization? Is it at all different than a typical retailer because of Costco's unique model and SKU count or anything along those lines? And I guess, would that -- would your plans in these areas include any increase in technology spend in coming years?
Gary Millerchip: Sure. Thanks, Kelly. Yeah, I'll go first and then Ron may want to add some color as well. I think many of your comments are relevant to how we think about the opportunity. And from -- the first thing I guess I would say as being new and having joined the company is as you think about where a lot of companies talk about alternative profit streams, there are a lot of areas today where Costco is doing great things in that area today. So using the strength of the membership relationship in driving a very large co-brand payment program that delivers value to members and delivers values to the company. The travel services business that we have, which is pretty unique in retail, but I think in any other company would be viewed as a way of generating new revenue and alternative revenue streams from sort of expanding from that overall retail relationship. And then thirdly, I would say we have media revenue today in areas of the business. So it's not as though it isn't something that actually the business is delivering on today. But I think as Ron mentioned in an earlier comment that as technology and data are something that we're sort of building a path towards, I would still say there's significant opportunity for us to grow in that space because of the unique nature of the relationship we have with our members and the ways in which we can deliver value for them and tap into that data and tap into the growth that we're creating both in the warehouse and through digital channels. I think it's a little bit early to sort of size it in totality because you're right, there are also some unique elements about our model that would make our opportunity a little bit different. But from what we know today and from the team that's been brought in to help the company think through it, we certainly believe it's got significant runway to drive a lot of growth for the company. And as I mentioned earlier, though, I would definitely think of it as something that we'll look at to as we do with everything, reinvest in the member to really accelerate the growth of the company overall.
Ron Vachris: I would have to mirror what Gary says. We are -- we do have a unique model. We have a relationship with all of our members. Our responsibility is use that data wisely and respectfully. As far as IT spend, yeah, there will be some IT spend. We don't see as we look in the future, we don't see that to be anything that will really change our trajectory of our cap investments. But there will be some IT requirements, but we feel that will be in the normal course of business.
Kelly Bania: Thank you.
Ron Vachris: Thanks, Kelly.
Operator: Your next question comes from the line of John Heinbockel with Guggenheim Securities. Please go ahead.
John Heinbockel: So guys, I want to go back to personalization again. Where do you think just conceptually the biggest opportunities are, right? When you think about wallet share, every one of your members is going to be a little different, but you can probably do cohorts. Why are they not buying from you and why personalized promotions, outreach on new items coming into the warehouse. I mean, where do you think the biggest opportunities are to build further wallet share?
Ron Vachris: John, I'll go ahead and start out. I think the biggest opportunity is, just like you said, the awareness of the warehouse and keeping our members in tune on what's active, what's going on in the warehouse near them and how we can continue to enhance and drive those sales. I think that that's probably our greatest opportunity with digital as we see moving forward. Personalization is good. We talk here a lot about a fair reasonable amount of personalization. We never want to compromise the treasure hunt of Costco. And that's equally as important as people that go to costco.com, never knew that they needed a 16 foot shed and they see a phenomenal value as they do in the warehouse. And so we don't want to personalize to a detriment, that changes our DNA and who we are. But we do know that there's definitely some improvements we could have that would enhance the member experience. And that's everything that our team is focused on is that how does this move to the member and how does it improve their experience with us digitally.
John Heinbockel: Okay. Maybe -- and then as a follow-up, Gary, you talked a little bit about the core-on-core. But maybe you step back a little bit if you -- and I know the idea is not necessarily to maximize margin, but maybe some thoughts core-on-core this quarter and I know I think there had been pressure on fresh, right, as you kind of normalize post-COVID back to a regular level. Are we now through that process of fresh getting back down to a certain level?
Gary Millerchip: Yes. Thanks, John. Just maybe to give you a little bit more color on the core-on-core and how it kind of played out during the quarter. And so if you think about the three main categories in core between foods and sundries, fresh and non-foods, fresh would have continued to have been slightly lower year-over-year, and that's a very deliberate strategy for us to make sure we're delivering more value for the member, and we think that's a really important place for us to drive member engagement and support, especially as we're still seeing some commodities that are a little bit inflationary right now. So that would have been very much part of the plan from our perspective. But it was more than offset, as you mentioned by the improvement in non-foods during the quarter, which was what led to the 10-basis point improvement on core-on-core. Food and sundries actually was pretty flat overall. So we feel good about the way that we're managing the balance while staying true to that principle of delivering the best value for the member. And we were pleased with how it played out during the quarter based on the work all the merchandising teams did.
John Heinbockel: Thank you.
Gary Millerchip: Thanks, John.
Operator: Your next question comes from the line of Peter Benedict with Baird. Please go ahead. Peter, if you're on mute.
Peter Benedict: Sorry about that. Yeah. Sorry about that, guys. Thanks for taking the question. Ron, maybe one for you. Just kind of back to the member behavior, maybe back to Scott's question a little bit. Can you just talk about maybe just your observations around maybe income cohorts, any other ways you bucket or slice your membership base, just how the behaviors have evolved here over the last several months. Is there any change that you think is interesting to call out? You talked about the better general non-foods trends. Just curious if this environment reminds you of anything else historically? That's my first question.
Ron Vachris: Okay. It's a very healthy environment from what we see from our members right now. And as you take a category such as our meat department, which is growing very nicely. A lot of volume being driven in ground beef and our new everyday lower price on boneless skinless chicken breasts, really driving a lot of volume units there, while Wagu Beef and prime are growing at a great clip for us as well. So we're seeing that benefit from both sides of the consumer that great value in both areas are doing very well. The non-foods, I tell you that non-foods is strictly driven by newness and excitement and we see big and bulky going very well. It's been a year of our $1,200 swing set that we have on the floor. We can't get enough. They're just blowing out. But it's again that continuous innovation of merchandise that is exciting our members and really driving some sales force there. Executive membership continues to -- yeah, and that drives our executive base and because people are engaging at a much higher level.
Peter Benedict: Sounds good across the board. But we're expecting a dryer to get delivered from Costco logistics on in the next couple of days. So looking forward to that. And then the second question would be, yeah, Ron or Gary, either one of you, just your view on vertical sourcing. I mean, this has been something that has been evolved in for several years going across different categories as you guys continue to grow your business, you need more, I guess, definable sources of supply. Just curious your view of vertical sourcing, where you are today, and what areas you might focus on over the next several years? Thank you.
Ron Vachris: Sure. We have -- we've gotten into vertical integration and sourcing as the need arises. And if you think back in the infamous story about the hot dog and coke at $1.50 and how are you going to figure out how to keep that price there, while we're going to open our own meat plants. And as we looked at the prices of optical lenses going up and then we opened up our optical grinding plants. So we did that to continue to look at those things. The chicken plant came because we saw an inflection point where supply was not going to meet demand. So we had to get involved and because we didn't have a partner that was willing to expand into that area as well. There is a focus that I have a group focused on too is that let's not try and be everything though. Let's -- we've got a business to run here and we're not going to get vertically integrated just because it's something we can do. It really is going to be driven by where the needs are and when do you need to step in. It's equally -- we have great partners out there that supply our goods for us and they're long-term suppliers. And so it's strategically using that relationship is going to be the key in the future. So there's nothing that I could announce at this time that we're going to expand into, but we continue to keep that in our back pocket should we need to.
Peter Benedict: Terrific. Thanks so much.
Ron Vachris: You're welcome.
Operator: Your next question comes from the line of Paul Lejuez with Citigroup. Please go ahead.
Brandon Cheatham: Hey, everyone. This is Brandon Cheatham on for Paul. Thanks for taking our question. Recently, you were selling Instacart gift cards at a discount online and in warehouse and thought that was pretty interesting because it's potentially a gift card that could be used at a competitor as well. So I'm just curious, is there any strategy behind that? Are you trying to drive member engagement online and if there are any learnings from that initiative?
Ron Vachris: You know the strategy behind it was another avenue to bring value to our members is really what that was about is that there is an upcharge on having grocery delivered to home. We work closely with Instacart, now we will with Uber to try and keep those costs at a minimum, but they've got people to pay on their side as well. So the partnership was really to how do we continue to enhance that service for our members and drive more sales. And so that was truly the -- yes, somebody can go out and use that somewhere else. But again, our job is to save the members where we can and be it airline tickets or Uber Drive tickets or Instacart shopping, we look at all those opportunities to add value to the member.
Brandon Cheatham: Got it. Thanks. And my follow-up, how do warehouses react when you open an infill warehouse? Does it open differently than other new markets? Does the current market feel an impact? And how many warehouses that you opened over the past year would you quantify as infill versus new markets? Thanks.
Ron Vachris: I guess how they react. We normally have good data before we'll open up an infill building and we can judge based on our member information what cannibalization will realize in what building. So we're able to get in front of that and adjust labor and payroll and buying and all those type of things for the upcoming cannibalization that we plan. And our team does a very good job. They're normally within a percent or so of what reality is to the execution of where our plans are as well. So we've gotten pretty good at planning those things out. And with -- it's strategic and the number of cannibalized locations I'd have to tell you, I'd have to say that we probably opened eight this year that cannibalized other buildings. Some may have cannibalized one warehouse, others may be in the middle and we had one in Toronto that cannibalized four buildings around it, but they've built back their sales within six months. So those are the opportunities where you know to Gary's earlier point, frequency improves significantly because members can get back into a high volume club. And so it's strategic cannibalization, if you would, as we look around the world.
Brandon Cheatham: Very helpful. Thank you.
Operator: Your next question comes from the line of Greg Melich with Evercore ISI. Please go ahead.
Greg Melich: Hi, thanks. Ron, I wanted to follow up on the gross margin cap still very much in place at 14%, 15%. Is there any reason that SG&A now that it's back under 9% of sales couldn't fall to 8% if you keep having the growth that you have?
Ron Vachris: No, that's a very fair -- that's a very good point. No, we continue to see -- I mean, the company, we had a very healthy SG&A number this quarter. Inventory was flowing very well. We had fresh goods coming through the system. Our warehouses did a phenomenal job. SKU counts are in line. And so it's one of those things where all the stars aligned and this is the way we operate well. When you can deliver that kind of a top-line growth at our size now, our operators do a tremendous job leveraging that to the SG&A. So what could that -- could that get to? I'd hate to say 8%, but I do think that we can have continued runway of driving down that number.
Greg Melich: That's great to hear it. And on maybe some insight on gas gallons in the quarter. I know it was volatile and there's certainly a [indiscernible] pressure for a lot of members and consumers. Did that help the traffic acceleration in the quarter -- gas gallon growth?
Ron Vachris: Yes. We were 5% up in gallons, you know. And again, that's -- I think all those things when you can save people on gas, that's also going to lend to your traffic as well. But gallons were up 5% for the quarter.
Greg Melich: A great number. And I think a follow-up on gas. Is that still -- is the profitability in gas, Gary, kind of similar versus a year ago or last quarter or is that trending up or down?
Gary Millerchip: Yes, the gas profitability would have been down a little bit. I think you may have heard me mention in the prepared comments that when we looked at the overall gross margin rate for the quarter and the sort of headwind that we had was in the ancillary businesses, the other businesses, and it was essentially gas that created that headwind. So we did see a reduction in gas profitability during the quarter, but overall, the core-on-core margin improvement and e-commerce improvement essentially offset that to bring us pretty close to flat overall when you adjust for gas inflation in the results. So it was down. I would say general, we've seen on gas profitability, it's been relatively consistent to slightly improving if you look over the last few years, but obviously, there are points in time when you think about volatility in fuel prices where you can have those ups or downs in any given quarter and that was -- this last quarter was one where we did see a headwind in year-over-year gas profitability.
Greg Melich: That's fantastic. Well, welcome and I'll let somebody else ask about how much gold volume drove the comp. Take care, guys.
Ron Vachris: Thank you.
Gary Millerchip: Thanks.
Operator: Your next question comes from the line of Rupesh Parikh with Oppenheimer. Please go ahead.
Rupesh Parikh: Good afternoon. Thanks for taking my question. So just going back to unit growth. In recent years, it's been stuck in that, let's call that mid 20s, it looks like this year will be closer to 30. Just want to get a sense of the opportunities to potentially accelerate that unit growth, especially in the U.S. just given some of your competitors are planning to accelerate growth from here.
Gary Millerchip: You know it is a good risk. When you look at -- I talked before about managed cannibalization and when you do these infills and 29 locations is a solid number for us. As you start getting into infills, some of these projects take a little longer. It's a little tougher than there's not a whole lot of greenland out there for us to go in and open up a warehouse. So we have to do some creative things to find a way to infill in a very high market. International expansion continues to be strong. Some of the countries or regions that we do business in take quite a bit longer to get things done. So I think you'll see that ebb and flow. That number 25 to 29 or 25 to 30 is a good number for us. We feel good with our staffing and leadership and building out the infrastructure behind these warehouses. So we open with great solid support there.
Rupesh Parikh: Great. And maybe just one follow-up question. So in terms -- you guys added Uber to a number of locations. So as you guys think about the intermediate to longer-term, would you expect multiple providers at all Costco U.S. stores over time? So maybe just more the rationale in terms of adding Uber and their longer-term vision?
Gary Millerchip: You know we saw -- we were testing Uber for some time in Texas. We had the tests going on there and we did see a new cohort of members engagement that are on the Uber platform. Uber also allowed us to expand our international footprint too. So we're going to be out in Japan, Korea, Taiwan, UK and that we'll be expanding and where we don't have grocery delivery now. So there were some real benefits to that relationship, along with the long standing Instacart relationship that we had has been very good for many years. So we think that it does open up a window for us for some new member engagement and we also think that it's going to be very good for us internationally and expansion there as well.
Rupesh Parikh: Great. Thank you.
Operator: Your next question comes from the line of Christopher Horver with JP Morgan. Please go ahead.
Christian Carlino: Hi, good afternoon. It's Christian Carlino on for Chris. Could you speak to some of the innovation you're seeing in non-foods and anything else you think is driving some of the performance, particularly in discretionary categories. You called out toys, sporting goods and homes. So maybe any incremental color you can provide on those in particular? And while you're clearly gaining share, when you compare your own performance to some of the syndicated data out there, does the emerging newness suggest there's also somewhat of a rising tide in some of these categories that saw some pull-forward over the pandemic? Thanks.
Ron Vachris: Well, yeah, I think if you look at -- if you talk about the home category and definitely is furnishings, which is one that was quite soft post-pandemic that has come back strong in furniture, those type of things. Then home decor, it's been some very unique items. I mean we've got 7 foot artificial trees that have come in and just exploded out and just blowing out of the warehouses and those are going at a nice clip. Domestics, the most unique items, Swedish dish towels, import items we're finding from around the world are doing very well. But it really comes down to unique items at great values that are exciting to members in all those categories. The housewares categories have been great. You know, sporting goods and toys, inflatable outdoor toys have been a big, big category for us as well. We've added the Kirkland Signature driver into our golf lineup that has -- that sells out as quick as it goes online. So we're seeing wins in several different categories.
Christian Carlino: Got it. That's really helpful. And just broadly, are you seeing the competitive environment heat up in terms of peers investing in price, particularly in non-foods? You have some peers talking more and more about looking to drive units. Others are talking about a big step up in appliance promotions recently. So any color on what you're seeing competitively?
Ron Vachris: Yes. There'll be ebbs and flows with the competition, but I'm very confident that we are always in the right position and we're staying ahead of that to keep the value there for our members. So these are -- those things are cyclical, but we're going to be a value every day.
Gary Millerchip: And I think maybe just one thing to mention on that, Ron too, you mentioned it earlier, but with on the appliances, obviously, making sure we're always very competitive on price. But I do think the acquisition of Innoval Costco Logistics now and the value that we offer members there through both including the delivery and the insulation and the removal of the old appliance is proving to be a real differentiator for us on the member experience as well.
Ron Vachris: Absolutely.
Christian Carlino: Got it. Thank you very much.
Operator: Your next question comes from the line of Scott Mushkin with R5 Capital. Please go ahead.
Scott Mushkin: Hey, guys. Thanks for taking my questions. And Gary, welcome. It's nice to be talking to you at Costco. And Ron, thanks for [indiscernible].
Gary Millerchip: Thanks, Scott.
Scott Mushkin: I appreciate it. So my first question is kind of the opposite what everyone asks all the time around the fee. But given some of the stuff you've outlined around media and maybe driving the SG&A down, why do you need to increase the fee, right? Your sales are strong, your fee income growth is strong. So what -- just because you've always done it doesn't mean you should do it. So what would be the rationale behind driving a fee increase at this point?
Gary Millerchip: You know fee increases go back to the members in lower prices. I mean that's -- it creates -- I mean and that's one of the key parts that we use that money for is that it allows us to broaden that distance from the competition and bring greater values than improving our operation overall for the member. So that's the primary focus.
Scott Mushkin: Okay. And then my next question actually is kind of dovetails on the last one. But you guys talked about the consumer being a little bit better overall. And I guess what I was wondering is, is that really a Costco phenomenon? In other words, are you gaining share and that's what's really driving your improvements in some of these categories like electronics and appliances and big ticket rather than the consumer actually getting better. Is there any way to tease that out?
Ron Vachris: I would say that that's very fair. We -- our merchants report monthly on industry trends in the country and/or internationally as we're seeing. And we can see our sales performance compared to the rest of market. And I would think that you're spot on when you say that we're gaining market share.
Gary Millerchip: Scott, maybe one thing I would just add to is, I think we're all reading a lot about the consumer, of course and what they're going through right now. And I think what we see is that value and quality has never been more important. And so that plays to, as Ron described earlier, what we deliver, and we're making sure that the teams are laser focused on every day delivering that value and quality. And so I think we're drawing customers to what Costco has offer for many years and it's never more relevant than now based on what we're hearing from members and consumers.
Scott Mushkin: Yes, we definitely like our Costco here at the Mushkin residence. So thanks, guys. Appreciate it.
Ron Vachris: Thanks, Scott.
Operator: Your next question comes from the line of Edward Kelly with Wells Fargo. Please go ahead.
Edward Kelly: Hi, good afternoon, everyone.
Edward Kelly: I wanted to ask you about maybe membership fee increase, but in a different way. And you just touched upon it a little bit about membership fee increase, right, just gets reinvested to your members. But can you talk a little bit more about how you think about the areas of reinvestment? I'm sure you probably have already done a lot of work around like where you would like that to go. Is there anything that's unique about where you know reinvestment might come to this time -- this time around just thoughts around that?
Ron Vachris: It moves as time moves and you see pricing in categories and where we have the greatest opportunity to be more competitive for our members. And it may be in an area that if fresh foods is seeing some price inflation, we may invest more in the fresh foods departments for that period of time. The nice part about our model with 3,600 SKUs, 3,700 SKUs is we're still quite nimble as big as we are. So we can shift and based on the needs of our members and where we think the best investment in margin would take care of them. We're able to shift that thought process and then move it around. So I wouldn't say that there's any set, okay, if membership fee goes up, it's going to be spent in these areas. We work as a team and we continue to monitor it throughout the year and we act as needed.
Edward Kelly: Okay. And just a quick follow-up on club throughput. I mean, it's remarkable how you drive up to a Costco club and it's hard to find a place to park, but yet you guys can still comp the way that you do. How are you thinking about throughput and ways to improve that? And I don't know if both buy online and pickup is part of that. How do you think about things like scan and go or maybe it's club density? Just curious as to how you solve for that over time.
Ron Vachris: The part -- a good part of those is things like our e-commerce business and how we can -- how we can move out some of those goods out of the warehouse and move that business online. And as Gary spoke to, now that we have control over Costco logistics, we can bring great value to that experience as well. We continue to look at technology. We're testing some front door scanners that are going to -- they're speeding up our registers significantly when we get all the scanning and memberships are verified at the front door, it has shown a significant improvement in our register speed. And so that in turn turns over parking spaces much quicker. And so those kind of things along with strategic infills to help open up parking opportunities and gas expansions where those are needed as well. So there are several different levers that we'll continue to pull on how we can best serve the member in that building and where we need to make sure that we can look at throughput.
Edward Kelly: Great. Thank you, guys.
Ron Vachris: You're welcome.
Operator: Your next question comes from the line of Oliver Chen with TD Cowen. Please go ahead.
Oliver Chen: Hi, Ron and Gary. You've done some really creative merchandising around UPTs and units per transaction with pickup items and innovation on that treasure hunt. What are your thoughts there? And also, big ticket and electronics, previously, previously, it was a bit of a drag. Just would love your thoughts on what you're seeing there. And third part is marketplace, the marketplace model and the concession model, and alternative inventory models. Just what are your views of opportunities there because they're really big ones and your member is so loyal to you as well. Thank you.
Ron Vachris: On your UPT, you were asking about the transaction impact?
Oliver Chen: I'm thinking strategically about adding units to people's baskets going forward and merchandising in that way as well if it's something you see in terms of an opportunity.
Ron Vachris: Absolutely. We -- that's one of the big -- we were just in a session with our grocery divisions and talking there. And we've seen a great success in international foods that have been brought in to the U.S. and then of the like from the U.S. into the other regions of the world where we do business. But you want to take care of not only the consumables in the grocery side, but when we bring in an item that's a success in Taiwan or Korea or the UK and it creates that excitement for the member, that's when we really have done a good job of triggering that impulsive purchase where members are trusting the buyers and they will add that additional item to their cart. So that's been a big win for us. And again, it goes a lot of times with that treasure hunt. I mean, you've heard the plays, people come in to spend $100 and walk out with $300. That's because our buyers do and our operators do a great job in making the warehouses exciting and keeping those on the forefront of what they're -- when they come in and do their basic shopping, they pick up a few additional items that just compel them at the time.
Gary Millerchip: I think maybe just to add on that, Ron too. I mean, the nice thing about the opportunity there for us is with trips up by 5%, that's really why the average basket size has been more flat recently and that's because we've been growing member engagement in consumables, as Ron mentioned, with food and fresh. And so it does present a great opportunity. And I think it also speaks to the team doing a good job of driving more frequency of member visits. So it creates a great opportunity for us to drive more of that basket size as well.
Ron Vachris: And then your question on marketplace is a significant opportunity for us moving forward. I mean, we really do indeed see that. I think especially with our limited SKU count in the warehouse, how can we expand the offering to the members, bring value to their membership card beyond what's within our four walls or what's on costco.com and we see this as a great growth driver for us in the future and a way to bring expanded value to the members as we look forward. So I'm quite bullish on Costco Next and what that can become in the future.
Gary Millerchip: I think the difference for us on that would be, of course, as we are with Costco Next is just being very curated for the member. So we're unlike a traditional marketplace that is about maybe just sheer volume for us, it's about making sure the member is getting something that truly is unique and valuable and being consistent to who we are, but it's tremendous upside opportunity there in that regard.
Oliver Chen: Okay. And finally, on that big ticket question, would love any green shoots on electronics or TVs? And the last question on Asia, you have same day in China and you've done a lot of great things in the Asian region. Just would love any update there in terms of progress you made and the big opportunity for more end sales as well. Thank you.
Gary Millerchip: Yes, I think just briefly on electronics, so we believe -- I think Ron referenced earlier, we look at a lot of the market data and we believe that we're winning with the member there in terms of the value that we're delivering and when we look at our trends versus the market. So we feel good about our ability to continue to outpace the market there and we're seeing a good opportunity within digital in particular to really drive more connection with the member and take some of those big ticket items from the warehouse to online as well. And in Asia, I think it would be consistent with what we've talked about with warehouses in the past that we think all of the markets offer us a great opportunity for growth. Some of those markets in Asia are more mature, but there's still significant opportunities to open new warehouses and fill in those markets. And then obviously, we have markets like China where we're really just sort of starting that journey, but there's tremendous growth opportunity as we identify the right path forward in that market.
Ron Vachris: So the grocery delivery in China, we're up and going on six buildings we all just opened our seventh warehouse this week. That will start up this weekend. It's been a big win for our members. Its delivery within two hours is what is able to be done. And so we're seeing some good incremental shops initially out of that program, and we look forward to good things in the future on that.
Oliver Chen: Thank you. Best regards.
Ron Vachris: Thank you.
Gary Millerchip: Thanks.
Operator: Our final question comes from Joe Feldman with Telsey Advisory Group. Please go ahead.
Joe Feldman: Great. Hey, guys. Thanks for taking questions. A lot have been asked, but I do want to ask with Costco Logistics, what was driving that 28% increase, which is very strong? Was it new relationships with some of the other retailers or partnerships or just anything you could share on that would be helpful.
Ron Vachris: Yes, that is other -- that is only -- we only deliver Costco members' orders through Costco Logistics. There are no partnerships going through those numbers that you see. We do a trace amount of series numbers, but that's not in any of the numbers that we report the growth in. That is just part of the past relationship that's there as well. And it is appliances, furnishings and outdoor were the three big drivers. Appliances were almost 30% growth for us in the period. And again, to Gary's point, it's that member value of the all in, what you see is what you pay price for delivery, installation, haul-away, everything you need done at one time that has really resonated with our members and has been a great driver of sales force.
Gary Millerchip: Joe, I'll give you the practical example as a new entrant to the Seattle market. I just had Costco Logistics deliver two mattresses, three TVs and a couple of chairs as well for me. So that's the kind of stuff I think that we're seeing really resonate with members.
Joe Feldman: Got it. That's great. That's great. Thanks, guys. And then just one other question. I know it's still relatively small, I think, but the Costco Next, is that sort of -- it seems like it's ramping nicely. I guess how will that continue to ramp in the future? Like where do you see that going and how important is that a driver? Like is that sort of the basis for this marketplace that Oliver was just asking about?
Ron Vachris: As Gary mentioned earlier, Costco Next is a bit unique, but is it a fully curated marketplace. As there's many other marketplaces out there that are just for somebody to go on and sell goods on this marketplace. These are relationships that our buyers have with our suppliers and we're creating new suppliers as well. This has not only been a new way to sell goods, we've also found that we can find some really neat items that are selling through Costco Next that we in turn then bring into our warehouse. So it is a great testing ground for newness -- new items, a way to expand categories of accessories for certain categories that you have swing sets that we sell online, but you have additional swings and slides and other activities that you sell that we normally wouldn't be able to fit into a warehouse. So it really complements the core warehouse business, but gives us an opportunity to expand member value to these other partners as well. So we see a lot of upside there.
Joe Feldman: Got it. That's great. Thanks, guys. Good luck with the fourth quarter.
Gary Millerchip: Thank you.
Ron Vachris: Thank you.
Operator: We have no further questions in our queue. And with that, this does conclude today's conference call. Thank you for your participation and you may now disconnect. |
INTU | 3 | 2,024 | 2024-05-23 20:32:07 | Operator: Good afternoon. My name is David and I'll be your conference operator. At this time, I would like to welcome everyone to Intuit's Third Quarter Fiscal Year 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions] With that, I'll now turn the call over to Kim Watkins, Intuit’s Vice President of Investor Relations.
Kim Watkins: Thanks, David. Good afternoon and welcome to Intuit’s third quarter fiscal 2024 conference call. I’m here with Intuit's CEO, Sasan Goodarzi, and our CFO, Sandeep Aujla. Before we start, I’d like to remind everyone that our remarks will include forward-looking statements. There are a number of factors that could cause Intuit’s results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2023 and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit’s website at intuit.com. We assume no obligation to update any forward- looking statement. Some of the numbers in these remarks are presented on a non-GAAP basis. We’ve reconciled the comparable GAAP and non-GAAP numbers in today’s press release. Unless otherwise noted, all growth rates refer to the current period versus the comparable prior-year period, and the business metrics and associated growth rates refer to worldwide business metrics. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. With that, I’ll turn the call over to Sasan.
Sasan Goodarzi: Thanks, Kim, and thanks to all of you for joining us today. We had a strong quarter with solid momentum across the company as we executed our strategy to be the global AI-driven expert platform powering prosperity for consumers and small businesses. Third quarter revenue grew 12%. Small Business and Self-Employed Group revenue grew 18% despite an uncertain macro environment, demonstrating the importance of our platform in fueling success for small businesses and our momentum serving the mid-market. Consumer Group revenue grew 9%, and Credit Karma revenue grew 8%, driven by the impact of innovation for members and the benefits of TurboTax and Credit Karma product integration. I’m proud of our performance, and the momentum we are seeing across the company. Turning to tax. We continue to revolutionize how taxes get done for consumers and small businesses. Tax preparation represents a $35 billion TAM in the US. This includes $31 billion within the assisted consumer and business tax categories. We are well positioned to penetrate the assisted TAM by leveraging data, AI, and our Virtual Expert Platform. Let me share several proof points. This season we made good progress against our multi-year strategy to transform the assisted experience for customers. TurboTax Live, our assisted offering, including our do-it-with-me and full service tax offerings for both consumers and businesses is our largest durable growth opportunity. We expect TurboTax Live customers to grow 12% and revenue to grow 17% in fiscal 2024. TurboTax Live revenue is expected to be $1.4 billion, representing approximately 30% of total Consumer Group revenue growing at a significant scale. This gives us confidence that we can digitize a very manual, disaggregated, and high priced assisted category. Now let me spend a few minutes going deeper in several areas. First, TurboTax Live full service is resonating with consumers as we continue to innovate, making it simpler for customers to get their taxes done virtually. We expect TurboTax Live full service customers to double this fiscal year, with those new to TurboTax to triple. Our full service offering has a product recommendation score of 85, one of the highest at Intuit. Our learnings and insights from this season bolster our confidence in the continued opportunity we have to disrupt the assisted tax category. Second, we expect TurboTax to gain share with higher ARPR filers, as we strategically prioritized focusing on the assisted tax segment and higher value customers over the pay-nothing and lower ARPR segment. Third, Intuit Assist, our GenAI powered financial assistant, played a big role in our TurboTax experience this year. With Intuit Assist, we are creating a future of done for you, where the hard work is done automagically on behalf of our customers with a gateway to human expertise, fueling their financial success. More than 24 million customers used Intuit Assist to explain their refund, answer questions, and help deliver confidence that their return was completed accurately this year. This is data and GenAI working at scale, for both our customers and our AI powered experts helping customers virtually. I’m excited about what we are working on for next season to accelerate innovation and deliver even more customer benefits. And fourth, we delivered solid results with the product integration across Credit Karma and TurboTax. We grew the number of customers that filed with TurboTax from the embedded Credit Karma experience by 76%, and tax refunds deposited in a Credit Karma Money account by 28%. We also delivered strong growth in Credit Karma Money revenue this quarter. This product integration also drove new members to Credit Karma, consistent with our goal of driving higher engagement and monetization for Credit Karma over time. Given these results, we see big opportunities ahead to deliver on our vision to help consumers make ends meet, maximize their tax refund, save more, pay off debt, and take steps to improve their financial health. To significantly accelerate creating seamless, end-to-end consumer experiences that customers benefit from year-round, we are more closely aligning TurboTax and Credit Karma under Mark Notarainni, General Manager of the Consumer Group, who will oversee both segments. I’m excited to share that Joe Kauffman, currently President of Credit Karma and part of the leadership team for the last nine years, will be leading Credit Karma as of August 1, reporting to Mark. Additionally, Ken Lin will retire from Intuit around the end of this calendar year. I can’t thank Ken enough for his friendship, leadership, and impact across Intuit. In summary, we made strong progress this tax season that sets us up for continued success in the future. Now, let’s take a look ahead. The era of AI is one of the most significant technology shifts of our lifetime. It is reinventing customer experiences, creating new monetization possibilities, and structurally changing how we work within Intuit to deliver for customers. We are very well positioned to take advantage of this era with our AI-driven expert platform strategy and five Big Bets that pursue the largest customer problems and growth drivers for Intuit. As part of our financial planning process, we have identified key areas within our Big Bets where we plan to accelerate investments to deliver greater impact. These include: Big Bet 1 GenAI to deliver done- for-you experiences with Intuit Assist, Big Bet 2 go-to-market investments for TurboTax Live and QuickBooks Live, embedding AI powered experts across our small business offerings, Big Bet 4, our money solutions, to digitize the experience end-to-end for consumers and small businesses, from estimate, to invoicing, to getting paid and paying bills, Big Bet 5, doubling down on mid-market with additional investments in the platform and go-to-market motions; and finally, accelerating international growth with Mailchimp and QuickBooks. To increase our investments in the outlined focus areas given the green shoots we are observing, we are taking a hard look at what work we can stop doing and where we can reallocate investments, to accelerate top line growth while remaining committed to delivering operating margin expansion in fiscal 2025 and beyond. Wrapping up, we are excited about the opportunity ahead, and our ability to power prosperity for our customers. Now let me hand it over to Sandeep.
Sandeep Aujla: Thanks, Sasan. We delivered a solid third quarter of fiscal 2024 across the company. Our third quarter results include, revenue of $6.7 billion, up 12%. GAAP operating income of $3.1 billion, versus $2.8 billion last year, up 12%. Non-GAAP operating income of $3.7 billion, versus $3.4 billion last year, up 11%%. GAAP diluted earnings per share of $8.42, versus $7.38 a year ago, up 14%. And non-GAAP diluted earnings per share of $9.88, versus $8.92 last year, up 11%. Now turning to the business segments. Consumer group revenue of $3.7 billion grew 9% in Q3, reflecting the progress we made transforming the assisted experience for consumers and small businesses this season. Our strategy is working. We expect TurboTax Live revenue to grow 17% to $1.4 billion in fiscal 2024, representing approximately 30% of overall Consumer Group revenue, driving total average revenue per return up approximately 10%. I’m pleased with the sustained growth we’re seeing in our TurboTax Live business. Overall retention is expected to be up 3 points year-over-year in fiscal 2024, close to pre-COVID levels, demonstrating the strength of our offerings and highlighting the benefits we are delivering to our customers. As Sasan shared earlier, we expect TurboTax to gain share with higher ARPR filers, as we strategically prioritized focusing on the assisted tax and higher ARPR customers over the pay-nothing and lower ARPR segment. As a result, we expect TurboTax Live customers to grow 12% and total online paying units to grow approximately 2% in fiscal 2024, versus total IRS returns growth of 1%. Due to yielding share with pay-nothing and lower ARPR customers, we expect our share of total consumer returns to decline approximately 80 basis points this year, and total TurboTax units to decline 1%. We are raising our full year Consumer Group revenue growth guidance to $4.440 billion to $4.455 billion, which is at the top end of our previously provided guidance. I’m proud of the progress we made this season, and the learnings we had reinforce our confidence in the future. We continue to expect Consumer Group revenue growth of 8% to 12% long-term given the size and trajectory of TurboTax Live. Turning to the ProTax Group, revenue grew 3% in the third quarter. For the full year, we now expect ProTax Group revenue growth of 6% to 7%. Turning to the Small Business and Self-Employed Group. The revenue grew 18% during the quarter, driven by online ecosystem revenue which grew 19%. Our results continue to demonstrate the power of our small business platform and the mission-critical nature of our offerings, which resonate with customers as they look to grow their business and improve cash flow in any economic environment. With the goal of being the source of truth for small businesses, our strategic focus within the Small Business and Self-Employed Group is three-fold, grow the core, connect the ecosystem, and expand globally. First, we continue to focus on growing the core. QuickBooks Online accounting revenue grew 19% in Q3, driven by customer growth, higher effective prices, and mix-shift. As I shared last quarter, we continue to prioritize disrupting the small business mid-market, through continued focus on both go-to-market motions and product innovations. Mid-market customers drive a higher ARPC over time given their more complex needs and higher usage of services on our platform, although they are a smaller subset of the total customer TAM. This, coupled with our strategy to sell more of our ecosystem offerings to existing customers, shifts the emphasis in our growth formula towards ARPC over time. Second, we continue to focus on connecting the ecosystem. Online services revenue grew 20% in Q3, driven by payments, payroll, and Mailchimp. Within payments, revenue growth in the quarter reflects higher effective prices, ongoing customer growth as more customers adopt our payments offerings to manage their cash flow, and an increase in total payment volume per customer. Total online payment volume growth in Q3 was 22%. Within payroll, revenue growth in the quarter reflects an increase in customers adopting our payroll solutions, higher effective prices, and a mix-shift towards higher end offerings. Mailchimp revenue growth was driven by higher effective prices and paid customer growth. Revenue growth in Mailchimp decelerated this quarter, as we were lapping a larger benefit from price and line-up changes that we made last year. Third, we continue to make progress expanding globally, by executing our refreshed international strategy, which includes leading with both QuickBooks Online and Mailchimp in our established markets and leading with Mailchimp in all other markets as we continue to execute on localized product and line-up. On a constant currency basis, total international online ecosystem revenue grew 12% in Q3. Shifting to the Desktop Ecosystem. Desktop Ecosystem revenue grew 14% in the third quarter, and QuickBooks Desktop Enterprise revenue grew in the high-teens. At the end of this fiscal year, we will complete the three-year transition for customers that remain on our license-based desktop offering to a recurring subscription model. As I shared last quarter, starting next fiscal year, we expect our Desktop Enterprise offering, which accounts for over half of desktop accounting revenue, to grow in the high-single digit range. We also will continue to encourage remaining Desktop Plus subscription customers, who tend to be more complex and higher value, to migrate seamlessly to either QBO or our Desktop Enterprise offering when they are ready. Additionally, we see opportunities to continue to price the product for value. The online ecosystem remains our growth catalyst longer-term. As a result of the strong growth we are seeing in the Small Business and Self-Employed Group, we are raising our full year segment revenue growth guidance to 18%, up from the prior guidance of 16% to 17%. We continue to expect Small Business and Self-Employed Group revenue growth of 15% to 20% long-term. Moving to Credit Karma. Credit Karma delivered revenue of $443 million in Q3, up 8%. On a product basis, Credit Karma Money accounted for 3 points of growth, credit cards and auto insurance each accounted for 2 points, and personal loans accounted for 1 point. We saw strength in Credit Karma Money from TurboTax customers choosing to deposit their refund in a Credit Karma Money account, and we are seeing a return to growth in the insurance segment. However, the overall picture remains mixed, reflecting uncertain macro trends as we continued to see select partners taking a conservative approach to extending credit in both personal loans and credit cards in Q3. We are updating our full year Credit Karma revenue growth guidance to a growth of 2%, versus our prior guidance range of plus or minus 3% growth. In summary, I’m pleased with our continued momentum this fiscal year and our opportunities ahead. Shifting to our balance sheet and capital allocation. Our financial principles guide our decisions, they remain our long-term commitment, and are unchanged. We finished the quarter with approximately $4.7 billion in cash and investments and $6 billion in debt on our balance sheet. We repurchased $584 million of stock during the third quarter. Depending on market conditions and other factors, our aim is to be in the market each quarter. The Board approved a quarterly dividend of $0.90 per share, payable on July 18, 2024. This represents a 15% increase versus last year. Moving on to guidance, we are increasing our fiscal 2024 guidance. This includes, total company revenue growth of 13%, up from prior guidance of 11% to 12% growth; GAAP operating income growth of 21% to 22%, up from prior guidance of 15% to 18% growth; non-GAAP operating income growth of 16%, up from prior guidance of 12% to [16%] (ph) growth; GAAP diluted earnings per share growth of 28% to 29%, up from prior guidance of 11% to 15% growth; and non-GAAP diluted earnings per share growth of 17%, up from prior guidance of 12% to 14% growth. Our guidance for the fourth quarter of fiscal 2024 includes, revenue growth of 13% to 14%, GAAP earnings per share of $0.25 to $0.30, and non-GAAP earnings per share of $1.80 to $1.85. You can find our full fiscal 2024 and Q4 guidance details in our press release and on our fact sheet. Finally, as Sasan shared earlier, we have made strong progress on our five Big Bets and see opportunities to invest further in select focus areas to accelerate our pace of progress and deliver greater impact. Therefore, as part of our annual financial planning process, we are taking a hard look at reallocating investments. We remain committed to our financial principles, growing revenue double digits and growing operating income dollars faster -- slower than revenue, leading to expanding operating margin in fiscal 2025 and beyond. With that, I’ll turn it back over to Sasan.
Sasan Goodarzi: Great. Thank you, Sandeep. Let me close with three points. First, we're very well positioned to take advantage of the largest technological shifts of our era given Intuit strategy and five Big Bets with AI at the center as all we do. Second, given the green shoots we're observing, we are doubling down in key areas of our bets to accelerate growth. Third, we continue to recruit great technical and leadership talent across the company to accelerate our progress. In that context, I'd like to share that Greg Johnson recently returned as Executive Vice President, Intuit, Chief Commercial Officer and Global Small Business & Self-Employed Group Chief Revenue Officer. Greg is a world-class leader with nearly 10 years of experience at Intuit, leading TurboTax as the Head of Marketing and then as General Manager. I'm thrilled to have Greg back in Intuit. Now let's open it up to your questions.
Operator: [Operator Instructions] We'll take our first question from Keith Weiss with Morgan Stanley. Please go ahead. Your line is open.
Keith Weiss: Excellent. Thank you guys for taking the question. And a really nice quarter in that, you guys really flexed the ability to use the portfolio to outperform on the top line and outperform on the bottom line. And in what has been a pretty difficult earnings season actually taking earnings up we hear your full year EPS is coming off. So that's all great to see. I wanted to ask about the tax business overall. The shift towards kind of the high end, the higher ARPC customers seems more pronounced this year probably than what I was expecting, and I think most people were expecting. I think the underlying question most investors have is like, why can’t we do both right? Why can’t we price for the low end and get those customers on board as well as attracting those higher ARPC customers? Is that available to you? Or do you need to be shifting more upmarket?
Sasan Goodarzi: Hey, Keith, thank you very much for the complement and your question. Let me address your question in a couple of ways. First of all, I'll start with some of what we already shared, but it's important context in that we're really bullish in terms of what we saw with TurboTax Live going after the assisted segment because now you have a $1.4 billion business growing at 17%. And with that being 30% of the total TurboTax franchise, when we flip that over to, now it becomes 50%, 60% of the franchise, it really accelerates the growth of the entire TurboTax franchise. And what we demonstrated this year, I would almost say for the first time is, we moved the needle of taking share and assisted. When you look at the fact that -- although IRS grew 1%, most of that growth all happened in DIY, mainly with sort of three simple filer customers, assisted was flat, and that's where we took share. And I think that is a first sort of time of a sign that we're starting to build a flywheel effect that gives us a lot of confidence as we look into the future. I think the second thing that I would say is we -- because of our Credit Karma and TurboTax platform, we actually see the customers that are just really looking for a free tax software and are bouncing between platforms, and we are not interested in those customers. We're not interested in pursuing those customers, the cost of acquisition to get those customers when they simply are bouncing between platforms. We're really focused on quality of the customers, particularly because now we've just scratched the service in the assisted segment and what really matters is now accelerating the share take in the assisted segment. So that's really how we're thinking about it and what gives us confidence in not only what we delivered, but particularly in the future.
Keith Weiss: Got it. Makes sense. Thanks so much guys.
Sasan Goodarzi: Thank you.
Operator: We will take our next question from Daniel Jester with BMO Capital Markets. Please go ahead. Your line is open.
Daniel Jester: Great. Thanks for taking my question. I just actually want to expand on the comments you've made on. So on one hand, you talked about focusing more on sort of the higher end of the market, but you're also talking about deepening the integration between Credit Karma and TurboTax in the future. And so can you just maybe expand a little bit more, especially around the Credit Karma and TurboTax integration, what we should be expecting going forward? Thank you.
Sasan Goodarzi: Yeah, absolutely. This year, particularly, we're very excited about what we saw and actually what didn't work. And let me, if I could, hit on both. First and foremost, Credit Karma has over 40 million monthly active users and a larger chunk of those 40 million plus active users are actually doing their taxes using the assisted method. And so that's an enormous opportunity for us. This year, we embedded the TurboTax experience within Credit Karma, and we're very aggressive pursuing those customers. And in fact, we drove traffic north of $10 million within Credit Karma, those that were interested in doing their taxes with TurboTax. That's why it resulted in a 76% growth of the number of TurboTax customers that use the embedded experience within Credit Karma. At the same time, what we are constructively dissatisfied are two very basic things that did not work well this year. One with seamless log in, the second was performance of the app. And what I mean by seamless log in is, out of those 10 million-plus customers that were in the bucket of traffic, about 25% of them when they click to start doing their taxes with us or have us do it for them, they didn't have any instruction. They could just get started right away, where 75% of them could not. There was a lot of friction. And that was just an element of time. We were not able to get to all the work that was required to get everyone to experience, in essence, no log in. And that's a big deal, and we're all over it already. The second is performance of the app. We worked very hard to embed the TurboTax experience within Credit Karma, but the performance of the app was not where it needs to be. When I say performance of the app, some of the time that it took was like eight to seven seconds just for the app to be able to load. That's unacceptable, and we saw a lot of drop off. Both of those are in our control. Both of those, we are already working on. But I share that as an example of -- we saw a huge green shoot with our focus this year on every Credit Karma member becoming a TurboTax customer. And there's two very basic things that we're constructively dissatisfied with that gives us actually a lot of confidence as we look into the future. So hopefully, that answers your question.
Daniel Jester: That’s great. Thanks for the context.
Sasan Goodarzi: Very welcome.
Operator: We'll take our next question from Siti Panigrahi with Mizuho. Please go ahead. Your line is open.
Siti Panigrahi: Thank you. Thanks for taking my question. And Sasan, I want to ask about your vision and strategy for the Money platform. I have a multipart question there. We have seen you expanded invoice to bill pay. Would love to get your progress so far, any feedback there in the last couple of quarters. But also, we saw that you recently acquired Proper Finance and also made some hiring -- senior executive hiring in the money platform side. So I'd love to hear your strategy in which direction it's going in a money platform.
Sasan Goodarzi: Sure, Siti, thank you for the question. Let me actually talk about the focus around money on two dimensions that we're very, very excited about. And as you also heard in our prepared remarks, this is an area where we are accelerating our investments. We are seeing a lot of green shoots with all the work that we've been doing in the last several years, really digitizing the whole process of estimating invoicing to getting paid and having multiple paying options along with the bill pay capabilities that we've built that we are now rolling out to our customers. We're seeing a lot of green shoots in both of those areas. You saw in a pretty tough macro environment. Our payments overall total payments volume was up 22%, and that's an area where we're accelerating our investment. That's on the small business side. The thing that we're also excited about is money focused across the TurboTax Credit Karma platform. We saw a lot of green shoots this year with a 20% or 28% increase of the number of customers that put their refund on a Credit Karma Money account. We're excited about it, not because of the 28%. We actually believe that could be far bigger. But because of the areas of friction that we are going to remove and the fact that we have opportunities to give much earlier access to their tax refund and actually monetize it. So those are the two areas across our small business and consumer platform that we are focused on and we're accelerating our investments across both of those platforms in the coming year.
Sandeep Aujla: And Siti on the acquisition, you mentioned, as we've shared with you in the past, we are continually looking at by the partner, and that was a small technology tuck-in that we did to build some of the core money movement and risk management capabilities within our small business group.
Siti Panigrahi: Thank you.
Sasan Goodarzi: Very welcome.
Operator: We'll take our next question from Alex Markgraff with KeyBanc Capital Markets. Please go ahead, your line is open.
Alex Markgraff: Great. Thank you for taking my questions, Sasan. Just one for you on TurboTax. Just looking at recent Investor Day slides and sort of the long-term growth framework for the business. When we look at this total TurboTax share of IRS returns, I think implies sort of a positive share gain over the long term. And I'm just curious, I understand the focus in the assisted category. Should we be thinking about that input differently as it relates to total IRS returns going forward, just given what we're seeing at the lower end of the spectrum?
Sasan Goodarzi: Yeah, Alex, great question. Let me just -- one minute of context, and then I'll answer your question. Based on our estimates, we believe the IRS total returns will grow about 1%. And the majority of that, if not all of that will happen in the do-it-yourself category. The assisted category is generally flat, which is why we led with the fact that we are taking share. With that as context, it actually does not change our long-term goal post of we want to be able to increase share of total IRS returns. We also want to get there in the right way. So this year, I'm very comfortable with where we ended up because our entire focus was the assisted segment and high value, high average revenue per return filers. But over time, as TurboTax Live goes from being 30% of our franchise, growing at 17% to being 70% of our franchise. So that's when you're going to see us start moving the needle on increasing our share of the total IRS returns. And by the way, I would also liken this, although it's not directly at your question, I would liken this to the online desktop mix, if you think about the last five to 10 years in small business. We always said that once online becomes more than 50% of small business and then 60% and 70% over time because it's growing faster, it will actually accelerate the growth rate of the small business group. That is exactly what's happened. And we believe that same thing will happen in TurboTax as TurboTax Live goes from 30% to 70% one day, and that's what will result in our total share increasing of total IRS.
Alex Markgraff: Okay. Thank you.
Sandeep Aujla: One other point of context, if I may add, Alex, that's important to understand that even on the simple filers, there is a customer segmentation that is critical for us to keep in mind. We are -- we remain focused on the simple filers through both TurboTax and Credit Karma, but we are not focused on are the simple filers that have a higher propensity to change platforms year after year because we frankly don't think those -- that's a good return on our investment, and there's no opportunity for us to grow and earn revenue there. So I just want to make sure that customer segmentation was also pronounced in what you were hearing.
Alex Markgraff: Understood. Thank you.
Sasan Goodarzi: You’re welcome.
Operator: We'll take our next question from Kirk Materne with Evercore ISI. Please go ahead. Your line is open.
Kirk Materne: Yeah, thanks very much. Sasan, can you just touch upon Mailchimp a little bit? I was kind of curious what your thought is for the business into the back half of the year, given the fact that I think some people think on the small business side, cutting back on sort of go-to-market is often a place they might look to trim. Can you just talk about sort of what you're seeing there? And what gives you confidence that perhaps this is an opportunity for you guys to take share in that area? Thanks.
Sasan Goodarzi: Yeah. Great question. First of all, I'll reiterate what you heard from us earlier. The fact that the revenue decelerated was primarily because we're lapping a big price increase and some lineup changes from last year. The fundamental health of the business is consistent with what it was last quarter. So that's number one. Number two, our durable focus remains the same, which is -- we are integrating Mailchimp and QuickBooks. I'd be happy to talk about that more, if there are questions about it, two, mid-market, third, international. And we're being really very aggressive in international. In fact, I was just most recently in London, spent time with our new leader in Mailchimp that leads EMEA, that came from another company where he has built a really a large international business, and two, visited a number of customers and partners, and we're being very aggressive with our approach in what we've done with the platform, what we're doing with our pricing and then the marketing investments that we are making as we look ahead. And in fact, as I mentioned earlier, there are five areas where we are accelerating our investment. This is one of them. And so we're quite excited about the possibilities given the green shoots that we're seeing.
Kirk Materne: Thanks, Sasan.
Sasan Goodarzi: Yeah. Very welcome.
Operator: We'll take our next question from Kash Rangan with Goldman Sachs. Please go ahead. Your line is open.
Kash Rangan: Thank you very much. Sasan, you still remain the best predictor of small business. You've got the best read. And I'm curious what -- you said green shoots, I speak by that observation. And in a macro environment, which gets tougher, you guys have shown the ability to execute really well. So what are the other things in your toolkit that you have been able to unpack that if the macro environment continues to stay where it is? One of the things that could help them to continue to outperform these expectations for the small business segment. Thank you so much and congrats.
Sasan Goodarzi: Yeah. Thank you, and great to hear from you. The -- one of our fundamental execution philosophies that we have at the company is conviction on the long-term, ambitious testing and experimentation in the short term so that we can be nimble, we can learn and we can adjust. And really, the answer to your question is the five areas that you heard that we're accelerating our investments. I mean we are seeing green shoots with our learnings and insights with Intuit Assist, and we're accelerating our investments in GenAI. We -- as I talked about earlier, for the first time, we were increasing our share in the assisted segment. And so we're accelerating a number of areas with TurboTax Live. We are also embedding an expert within QuickBooks Live, within our entire small business platform where every offering will actually come with an embedded expert because we believe, based on green shoots that we've seen, that will improve conversion, it will also improve retention. And mid-market, I mean, we have been really assertive in building out capabilities in the platform. We have been asserted in building out our customer-facing capabilities from leadership all the way down to our frontline sales folks, and we're seeing great green shoots there to accelerate not only growing with our customers, but I'm hunting for new ones. And as you know, mid-market is not just about getting the customers, it's all the services that comes with the it, payments, payroll, live platform capability. So, Kash, those are the, I would say, key green shoots that we are seeing, all of which we are accelerating our investments currently, by the way, in the quarter and as we head into next year.
Kash Rangan: Fantastic. Thanks. Glad to hear that.
Sasan Goodarzi: Thank you.
Operator: We'll take our next question from Brad Reback with Stifel. Please go ahead. Your line is open.
Brad Reback: Great. Tanks very much. Sasan, as you sort of think about the overall economic environment, you did a great job there with Kash's question. But for the first time, I think, as long as you provided the data, payroll wasn't the number one growth driver on the online ecosystem. So maybe you can dig in there and give us a little sort of color on what's going on within the payroll business and if we should expect growth to continue to moderate there. Thanks.
Sasan Goodarzi: Sure. Well, let me start actually with the -- what we're seeing on our platform with respect to the health of small businesses, if I could just do that for a moment. One of the things that we are seeing, if we look back from today versus the last three to four months, we're actually seeing some improvement in profitability of small businesses on our platform. And that's a good sign compared to the last couple of years. Now within that, the -- depending on the sector that you're in, your performance is driven by the environment. And so for instance, manufacturing -- areas like manufacturing, professional services, auto repair, their profits are actually up nearly 20%, where real estate lending, their profits are actually down 15%. So the net of it is overall, we've seen improvement, depending on the sector you're in, your performance varies. But the net of all of that is that cash reserves are down 8% compared to this time last year, but up over 16% compared to pre-COVID. So what you should take away is small businesses are healthier but their cash reserves have been impacted. And for those that are on our platform, by the way, over four years, their cash reserves are over 60% higher than those that have only been with us for a year. Last thing I would just say is hours worked is actually up compared to the last quarter. Specific to your payroll question, let me ask Sandeep to answer specifically what you asked about payroll.
Sandeep Aujla: Brad, as I mentioned in my prepared remarks, we continue to see customers in our payroll business, adopting our solutions. They continue to take our higher-end offerings as well. The reason for the difference you called out is, I'll point to the payments business where the charge volume went to 22% growth in the quarter versus 20% the prior quarter. So that's the key item to call out in that sequencing.
Brad Reback: Perfect. Thank you very much.
Sasan Goodarzi: Very welcome.
Operator: We'll take our next question from Brad Zelnick with Deutsche Bank. Please go ahead. Your line is open.
Brad Zelnick: Excellent. Thank you so much for taking the question. Sasan, it's great to hear about the strong performance in full service this season. Can you double-click into which assisted filers, you feel you did a good job capturing, which might have been a little bit more resistant than your expectations? And how do you think about driving momentum in full service going forward?
Sasan Goodarzi: Yeah, Brad, great question. I was actually in San Diego all day yesterday with the TurboTax team doing deep dives on all of these durable priorities. One of them was full service. First of all, I would tell you that across all of the states, across different income levels, across all complexities, very consistent. And I would say that if you heard -- not if you heard, if you reflect back on what I said in the remarks, that our new customers in full service tripled, an outsized element of that was those that are sort of younger, the millennials, and they are actually embracing full service as a cohort more than others, not by an incredible amount, but it stands out for us. So I think what we learned -- and that's a big deal by the way. What we learned is, we were successful just in one area. But I'll tell you the biggest area we are constructively dissatisfied when you look at our overall assisted performance. We were very aggressive with our go-to-market and not just spend but the beginnings of being able to recommend an expert, the beginnings of when you search for a local expert us showing up. There's a lot of infrastructure that we built. We drive a lot of traffic to our front doors. Where we are constructively dissatisfied is, we have to work on our shopping experience. When you walk into somebody's firm, a store or somebody's home to have them do your taxes for you, you're not presented with a set of SKUs. You just go in there and you exchange documents and they do their taxes for you. Our shopping experience has to be improved. That's where we saw the biggest drop off. So what we have a lot of confidence in is the demand that we created. And by the way, the performance. But the demand that we created was exceptional. We need to get better at the shopping experience. It's one of the areas where -- by the way we saw this during the season, and there's a lot of work that's being done to actually leverage AI to personalize the experiences so that when we get a customer that comes in, that comes from an assisted method, they're actually greeted by an expert versus greeted with which SKU do you want to pick.
Brad Zelnick: Thank you so much for the color, Sasan.
Sasan Goodarzi: Yeah. Very welcome.
Operator: We'll take our next question from Steve Enders with Citi. Please go ahead. Your line is open.
Steve Enders: Okay, great. Thanks for taking the questions here. I guess maybe I just want to start on -- or want to ask about the AI and the assistant or the AI Intuit Assist solution that's now out of market. I guess -- what are kind of the proof points that you've seen? Or how is it kind of manifesting in kind of improving experience or driving monetizable outcomes for Intuit so far?
Sasan Goodarzi: Yeah, Steve, thank you for the question. I'm actually pleased with our progress, and I'll share some of the proof points, and I will also just remind us, we're still in the early days, but a lot has changed in the last three months. So let me share what those are. First of all, in TurboTax, 24 million customers used Intuit Assist to better understand the refund outcome and be able to get their questions answered. And not just the customer but Intuit Assist help our experts be much more efficient and effective in helping our customers. And as you can imagine, we would not have rolled that out to 24 million folks if that wasn't accretive to conversion. The second is Credit Karma. In Credit Karma, we have over 40 million monthly active users, and we have rolled out Intuit Assist capabilities, and I'll share what those are in a moment, to nearly half of our 40 million monthly active users. And what we have rolled out are the following things: one, to help you make a decision. And so by the way, if any of you on the call are Credit Karma users, and you happen to have iOS, unless you are in a holdout cell, you'll be able to see everything that I am articulating. So you will see things like Intuit Assist that we'll show you see why, see comparisons, let me help you. And when you engage, it helps you actually understand and have a conversation about which card is right for you. In the past, we always were able to use your data to deliver personalized experiences for you. In this case, personalized cards that are right for you, but now we can have a conversation with you and help you understand why one is better than the other. That's one huge element. The other is help you make financial decisions, help you understand how to build your credit, help you understand how to better save money, help you understand which cards are best to use and which cards you should reduce your utilization. That's what we've rolled out. And again, as you can imagine, we would not have rolled that out to almost 20 million Credit Karma members if it wasn't accretive to better monetization. And then the last couple of examples that I would use is on the small business side, where Mailchimp, nearly 300,000 customers have Intuit Assist available to them, particularly and specifically around personalized marketing campaigns, where you can -- where we help you put a campaign together, images, text, et cetera. And in -- across the QuickBooks platform, we have capabilities available to nearly 30,000-ish customers. And the capability is really about turning unstructured data into money and personalized feed. What that means is taking your e-mail as an example, and taking everything that's in your e-mail and turning it into an invoice that's paid and labeled so that you can get paid faster, and that's a monetizable event for us. And then business feeds that helps you orient to what's most important insight for the day, which ultimately depending on what you engage with is a monetizable event for us. So we've made a lot of progress in the last 90 days. And we're even more hopeful about what's possible in the future. I'll just end with -- it's early days, but it's amazing the progress that the team has made in the last 90 days.
Steve Enders: Great to hear. Thanks for the context there.
Sasan Goodarzi: Yeah, very welcome.
Operator: We'll take our next question from Brad Sills with Bank of America. Please go ahead. Your line is open.
Brad Sills: Great. Thank you so much. I wanted to ask a question around TurboTax Full Service. I know it's been a couple of seasons now under your belt here. What are some of the areas that you've learned from? What are some of the areas you've outperformed with full service. What are some of the learnings from a couple of tax seasons now under your belt? And what have you identified for the future in order to target that segment more aggressively? Thank you.
Sasan Goodarzi: Brad, thank you for your question. First of all, I would say, this actually was the first real season with full service. Last year, it was still -- although we rolled that out, it was still at the experiment level. With that said, to answer your question, a couple of things. One, because we were quite aggressive with our go-to-market, we learned that we can create a lot of demand. And we created a lot of demand not only by talking about the fact that we can do your taxes in less than a day, we can help extend your money and give you early access or immediate access to your money. But there is a lack of price transparency in the entire assisted segment, where you don't really know what you're going to pay until you walk into somebody's store or a firm. And we did a lot of testing to understand how important price is. We learned that it matters a lot. And so we created a lot of demand. That's number one. Number two, when you search locally for an expert or -- and/or if we showed you in when you engage with full services, there's an expert near you, the conversion rates were significantly higher than when we didn't so up in search. And that, by the way, is just an element of time. We'll be able to get all of what we were doing this year rolled out across all of our customers. But that's an enormous learning that local matters. People want to be able to search for pro-near-me, folks want to know that their expert is nearby, and we saw a significant expert or conversion lift. Last thing that we saw as a great proof point is, I think this was more towards the middle, towards the end of season, you could recommend your expert. That had a big conversion one. But we were not able to scale that for the entire season or to all of our customers, which we plan to do next year. So those are the big insights and the big learnings. And last, I'll just end with the following, which is what I mentioned a moment ago, we have a lot of work to do on our shopping experience. And to simply put it, when you walk into somebody's firm or a store, you're not presented with a SKU in a lineup. You just walk in and get -- have them get your taxes done. And that's what we are working on, which is, in essence, when you pick full service, you're greeted by the expert versus a pricing lineup to make a choice. And that with an enormous learning this year, all of which we're currently working on for next year that give us a lot of confidence.
Brad Sills: Very clear. Thanks, Sasan.
Sasan Goodarzi: Yeah. You’re very welcome.
Operator: We will take our next question from Scott Schneeberger with Oppenheimer. Please go ahead. Your line is open.
Scott Schneeberger: Thanks very much. Good afternoon. Sasan, this is primarily on TurboTax and on do-it-yourself in TurboTax. I think, I heard Sandeep say that overall consumer retention or TurboTax retention was 3 points yet there was some share loss, obviously, on the low end and seemingly in do-it-yourself. The full service metrics and overall TurboTax Live sound great. So I think you have good retention there, good new customer acquisition. But in the do-it-yourself in the paid customer, are you doing okay in share there? And what are you doing in that category specifically paid, do-it-yourself to build-share going forward. Because when you answered Alex's question earlier about growing share, it sounds like all like in the assisted category, and that's great. It's a great opportunity. Just curious, in the paid categories, what your opportunities are going forward? Thanks.
Sasan Goodarzi: Yeah. Thank you for the question. And Sandeep, please feel fear to build. I would say that overall, we feel good about our paid share because if you -- and we cut it multiple different ways internally. But if you look at what we've shared in our remarks, total IRS grew 1%. Our total paying customers grew 2%, and our retention grew 3 points. So we actually feel good about our paying share. I think what you heard us remark on is, where we lost share, which we're okay with because it was actually an intentional focus on the things that we've talked about today, was on customers that are, in essence, simple filers that are bouncing between platforms. And that's the area where we articulated earlier that we lost share. So that's the way I would have you think about our performance is when it comes to paying share, we actually feel good about our performance.
Sandeep Aujla: Scott, I would also add that you should have not take away that we are yielding any ground on the paying of DIY customers. Our marketing investments, we are focused on attracting both customers to our platform. Our experiences are helping those customers better understand their returns and gain better confidence leading to better conversion. And we remain relentlessly focused on improving our product experience for those customers. So in addition to the assisted category, which we are excited to disrupt the $31 billion market across consumer and small business, we also are focused on taking share. It was a paying DIY customer.
Scott Schneeberger: Great. Thank you both.
Sasan Goodarzi: You’re very welcome, Scott.
Operator: We will take our next question from Raimo Lenschow with Barclays. Please go ahead. Your line is open.
Raimo Lenschow: Thank you. Sasan, you talked earlier in the prepared remarks about desktop and the changes here in the coming year. Can you kind of link that up maybe a little bit is what we've seen in QuickBooks Advanced? And how -- if there's kind of more opportunity to bring desktop guys over and what you're seeing here on board?
Sasan Goodarzi: Sure. Let me -- thank you for the question. And let me answer your question, but if I'm not answering your question directly, please come at me again. I think what you heard us talk about earlier is, one, we've been in the middle of a business model shift moving all of our desktop customers to subscription. And at the same time, we've been building capabilities on our online platform. So eventually, all of our desktop customers have a destination, which is online. And we believe, over time, all of our desktop customers at one point will be on our online platform. With that said, the thing that I would say is that we've really built out a lot of our capabilities on QuickBooks Advanced. And in fact, we are aggressively building a number of capabilities that we'll be excited to talk to all of you about at Investor Day, really targeting even larger customers. And I think we'll be far better positioned to take on some of our larger enterprise customers that may choose to want to come to our online platform. And that's really the essence of what we were talking about earlier. As you think about our desktop franchise looking ahead, one, we have desktop enterprise that's growing high single digits. Number two, we view that we can get most of our customers over time to go to our online platform and price to value also plays an important role. And with all that said, I just think we're better positioned for some of our larger customers that come to our QB Advanced over time. And that's what really gives us confidence as we look into the future.
Sandeep Aujla: No, I was just going to add, the question was also about just the progress we are feeling about Advanced. What I would say across the mid-market and as I alluded in my prepared remarks, we continue to feel good about the progress we're making with the mid-market, including with QuickBooks Online Advanced and with the desktop enterprise product, which grew in the in the high teens. So that's an area we continue to feel good about, the add I would have.
Raimo Lenschow: Perfect. Thank you.
Sasan Goodarzi: Welcome.
Operator: And we'll take our next question from Taylor McGinnis with UBS. Please go ahead. Your line is open.
Unidentified Analyst: Hi, this is Daniela on for Taylor. Thanks for taking my question. So it looks like the Small Business & Self-Employed growth in the quarter was run by stable to our accounting growth and an acceleration in that stock. So as we look into 4Q, how much of the implied 17% for Small Business & Self-Employed growth is being driven by desktop versus stability in the online segment? And given that so many SMB software companies saw incremental pressure in 1Q, can you just comment on what you're seeing in terms of SMP Health and how that is influencing your guide? Thanks.
Sasan Goodarzi: Yeah, sure. Let me get us started. Sandeep, please jump in if you have any perspective to add. I'm not sure I understood the premise of your question, so let me just share what you should take away. What you should take away is the strength of our small business franchise is being driven by our online performance. Overall, it grew 18% or our online actually grew 19%, our services grew 20% and we actually feel very good about the trajectory of the business. And as we talked about, as we look ahead, we believe that desktop will continue to grow once the business model shift comes to an end, but that continued growth will come from the fact that half of desktop is enterprise, and it's growing high -- we anticipate it to grow high single digits. But the takeaway should be that in a macro environment, that is somewhat uncertain. Our online performance for small business has been quite strong, very resilient, and we're actually seeing a lot of engagement and usage by our customers just because it's really helping them manage their cash flow. It's helping them grow their business, and I think we're very well positioned in this environment.
Sandeep Aujla: And what I would add, in addition to Sasan's comments about the health of the SMB market is a reminder that 80% of our small business group's revenue is subscription-based. And when you look at those businesses, the part of that is not related to subscription, largely on our services side. Couple of factors just to underline, we saw our payments charge volume increased 22% in Q3, which was faster than what we saw in Q2. And we continue to see good adoption of our payroll offerings by customers as well as a mix shift towards the high end of payroll offerings. So heading into Q4, we feel good about our online ecosystem growth, which remains our growth catalyst going into the future.
Unidentified Analyst: Perfect. Thanks.
Sasan Goodarzi: You’re very welcome.
Operator: We'll take our next question from Michael Turrin with Wells Fargo. Please go ahead. Your line is open.
Michael Turrin: Hey, great. Thanks. Appreciate you fitting me on. The small business segment growth is holding in strong if we look at the international online ecosystem revenue growth, trailing at 12% in constant currency. Sasan, are there plays you see to potentially jump-start overseas growth? Is there anything you're experimenting with around Mailchimp that could help with tip of the spear there into broader international reach? Or what else do you see that yield potentially better growth down the line? Thanks.
Sasan Goodarzi: Yeah. Thank you for your question. First of all, I'll start with the fact that the Mailchimp lapping price increase from last year and some of the lineup changes that we talked about earlier impacts international growth, just since 50% of Mailchimp's revenue is international. So that was a big driver of why 12%. And two, yes, absolutely, given the green shoots that we are seeing with Mailchimp internationally and where we have product market fit with QuickBooks and Mailchimp, one of the five areas that we are accelerating our investments is, in fact, international. So we're excited about what's possible as we look at.
Michael Turrin: Thank you.
Sasan Goodarzi: Yeah, very welcome.
Operator: I'll now turn the program back to our speakers for any closing remarks. I do apologize. We will actually take our next question. I apologize again. We were going to take our question from Alex Zukin, but they have removed themselves from the queue. I will return the call to our speakers for any closing remarks.
Sasan Goodarzi: Well, listen, everybody, thank you so much for attending. Thank you for your wonderful questions, and we will see you at our next earnings. Be safe. Bye-bye.
Operator: This does conclude today's progress. Thank you for your participation. This concludes today's call. |
AAPL | 2 | 2,024 | 2024-05-02 20:30:10 | Suhasini Chandramouli: Good Afternoon, and welcome to the Apple Q2 Fiscal Year 2024 Earnings Conference Call. My name is Suhasini Chandramouli, Director of Investor Relations. Today's call is being recorded. Speaking first today is Apple's CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed Annual Report on Form 10-K and the Form 8-K filed with the SEC today, along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks.
Tim Cook: Thank you, Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $90.8 billion and an EPS record of $1.53 for the March quarter. We set revenue records in more than a dozen countries and regions. These include, among others, March quarter records in Latin-America and the Middle East, as well as Canada, India, Spain and Turkey. We also achieved an all-time revenue record in Indonesia, one of the many markets where we continue to see so much potential. In services, we set an all-time revenue record, up 14% over the past year. Keep in mind, as we described on the last call, in the March quarter a year-ago, we were able to replenish iPhone channel inventory and fulfill significant pent-up demand from the December quarter COVID-related supply disruptions on the iPhone 14 Pro and 14 Pro Max. We estimate this one-time impact added close to $5 billion to the March quarter revenue last year. If we remove this from last year's results, our March quarter total company revenue this year would have grown. Despite this impact, we were still able to deliver the records I described. Of course, this past quarter, we were thrilled to launch Apple Vision Pro and it has been so wonderful to hear from people who now get to experience the magic of spatial computing. They describe the impossible becoming possible right before their eyes and they share their amazement and their emotions about what they can do now, whether it's reliving their most treasured memories or having a movie theater experience right in their living room. It's also great to see the enthusiasm from the enterprise market. For example, more than half of the Fortune 100 companies have already bought Apple Vision Pro units and are exploring innovative ways to use it to do things that weren't possible before, and this is just the beginning. Looking ahead, we're getting ready for an exciting product announcement next week that we think our customers will love. And next month, we have our Worldwide Developers Conference, which has generated enormous enthusiasm from our developers. We can't wait to reveal what we have in-store. We continue to feel very bullish about our opportunity in Generative AI. We are making significant investments, and we're looking forward to sharing some very exciting things with our customers soon. We believe in the transformative power and promise of AI, and we believe we have advantages that will differentiate us in this new era, including Apple's unique combination of seamless hardware, software and services integration, groundbreaking Apple's silicon, with our industry-leading neural engines and our unwavering focus on privacy, which underpins everything we create. As we push innovation forward, we continue to manage thoughtfully and deliberately through an uneven macroeconomic environment and remain focused on putting our users at the center of everything we do. Now let's turn to our results for the March quarter across each product category, beginning with iPhone. iPhone revenue for the March quarter was $46 billion, down 10% year-over-year. We faced a difficult compare over the previous year due to the $5 billion impact that I mentioned earlier. However, we still saw growth on iPhone in some markets, including Mainland China, and according to Kantar during the quarter, the two best-selling smartphones in Urban China were the iPhone 15 and iPhone 15 Pro Max. I was in China recently where I had the chance to meet with developers and creators who are doing remarkable things with iPhone. And just a couple of weeks ago, I visited Vietnam, Indonesia and Singapore, where it was incredible to see all the ways customers and communities are using our products and services to do amazing things. Everywhere I travel, people have such a great affinity for Apple, and it's one of the many reasons I'm so optimistic about the future. Turning to Mac. March quarter revenue was $7.5 billion, up 4% from a year ago. We had an amazing launch in early March with the new 13-inch and 15-inch MacBook Air. The world's most popular laptop is the best consumer laptop for AI with breakthrough performance of the M3 chip and it’s even more powerful neural engine. Whether it's an entrepreneur starting a new business or a college student finishing their degree, users depend on the power and portability of MacBook Air to take them places they couldn't have gone without it. In iPad, revenue for the March quarter was $5.6 billion, 17% lower year-over-year, due to a difficult compare with the momentum following the launch of M2 iPad Pro and the 10th Generation iPad last fiscal year. iPad continues to stand apart for its versatility, power and performance. For video editors, music makers and creatives of all kinds, iPad is empowering users to do more than they ever could with a tablet. Across Wearables, Home and Accessories, March quarter revenue was $7.9 billion, down 10% from a year-ago due to a difficult launch compare on Watch and AirPods. Apple Watch is helping runners go the extra mile on their wellness journeys, keeping hikers on course with the latest navigation capabilities in watchOS 10, and enabling users of all fitness levels to live a healthier day. Across our watch lineup, we're harnessing AI and machine-learning to power lifesaving features like a regular rhythm notifications and fall detection. I often hear about how much these features mean to users and their loved ones and I'm thankful that so many people are able to get help in their time of greatest need. As I shared earlier, we set an all-time revenue record in services with $23.9 billion, up 14% year-over-year. We also achieved all-time revenue records across several categories and geographic segments. Audiences are tuning in on screens large, small and spatial and are enjoying Apple TV+ Originals like Palm Royale and Sugar. And we have some incredible theatrical releases coming this year, including Wolves, which reunites George Clooney and Brad Pitt. Apple TV+ productions continue to be celebrated as major awards contenders. Since launch, Apple TV+ productions have earned more than 2,100 award nominations and 480 wins. Meanwhile, we're enhancing the live sports experience with a new iPhone app, Apple Sports. This free app allows fans to follow their favorite teams and leagues with real-time scores, stats and more. Apple Sports is the perfect companion for MLS Season Pass subscribers. Turning to retail, our stores continued to be vital spaces for connection and innovation. I was delighted to be in Shanghai for the opening of our latest flagship store. The energy and enthusiasm from our customers was truly something to behold. And across the United States, our incredible retail teams have been sharing Vision Pro demos with customers, delighting them with a profound and emotional experience of using it for the very first time. Everywhere we operate and everything we do, we're guided by our mission to enrich users' lives and lead the world better than we found it, whether we're making Apple podcasts more accessible with a new transcripts feature or helping to safeguard iMessage users' privacy with new protections that can defend against advances in quantum computing. Our environmental work is another great example of how innovation and our values come together. As we work toward our goal of being carbon-neutral across all of our products by 2030, we are proud of how we've been able to innovate and do more for our customers while taking less from the planet. Since 2015, Apple has cut our overall emissions by more than half, while revenue grew nearly 65% during that same time period. And we're now using more recycled materials in our products than ever before. Earlier this spring, we launched our first-ever product to use 50% recycled materials with a new M3-powered MacBook Air. We're also investing in new solar and wind power in the U.S. and Europe, both to power our growing operations and our users' devices. And we're working with partners in India and the U.S. to replenish 100% of the water we use in places that need it most with the goal of delivering billions of gallons of water benefits over the next two decades. Through our Restore Fund, Apple has committed $200 million to nature-based carbon removal projects. And last month, we welcomed two supplier partners as new investors, who will together invest up to an additional $80 million in the fund. Whether we're enriching lives of users across the globe or doing our part to be a force for good in the world, we do everything with a deep sense of purpose at Apple. And I'm proud of the impact we've already made at the halfway point in a year of unprecedented innovation. I couldn't be more excited for the future we have ahead of us, driven by the imagination and innovation of our teams and the enduring importance of our products and services in people's lives. With that, I'll turn it over to Luca.
Luca Maestri: Thank you, Tim, and good afternoon, everyone. Revenue for the March quarter was $90.8 billion, down 4% from last year. Foreign exchange had a negative year-over-year impact of 140 basis points on our results. Products revenue was $66.9 billion, down 10% year-over-year due to the challenging compare on iPhone that Tim described earlier, which was partially offset by strength from Mac. And thanks to our unparalleled customer satisfaction and loyalty and a high number of customers who are new to our products, our installed base of active devices reached an all-time high across all products and all geographic segments. Services revenue set an all-time record of $23.9 billion, up 14% year-over-year with record performance in both developed and emerging markets. Company gross margin was 46.6%, up 70 basis points sequentially, driven by cost savings and favorable mix to services, partially offset by leverage. Products gross margin was 36.6%, down 280 basis points sequentially, primarily driven by seasonal loss of leverage and mix, partially offset by favorable costs. Services gross margin was 74.6%, up 180 basis points from last quarter due to a more favorable mix. Operating expenses of $14.4 billion were at the midpoint of the guidance range we provided and up 5% year-over-year. Net income was $23.6 billion, diluted EPS was $1.53 and a March quarter record, and operating cash flow was strong at $22.7 billion. Let me now provide more detail for each of our revenue categories. iPhone revenue was $46 billion, down 10% year-over-year, due to the almost $5 billion impact from a year ago that Tim described earlier. Adjusting for this one-time impact, iPhone revenue would be roughly flat to last year. Our iPhone active installed base grew to a new all-time high in total and in every geographic segment. And during the March quarter, we saw many iPhone models as the top-selling smartphones around the world. In fact, according to a survey from Kantar, an iPhone was the top-selling model in the U.S., Urban China, Australia, the U.K., France, Germany and Japan. And the iPhone 15 family continues to be very popular with customers. 451 Research recently measured customer satisfaction at 99% in the U.S. Mac revenue was $7.5 billion, up 4% year-over-year, driven by the strength of our new MacBook Air, powered by the M3 chip. Customers are loving the incredible AI performance of the latest MacBook Air and MacBook Pro models. And our Mac installed base reached an all-time high with half of our MacBook Air buyers during the quarter being new to Mac. Also customer satisfaction for Mac was recently reported at 96% in the U.S. iPad generated $5.6 billion in revenue, down 17% year-over-year. iPad continued to face a challenging compare against the launch of the M2 iPad Pro and iPad 10th Generation from last year. At the same time, the iPad installed base has continued to grow and is at an all-time high as over half of the customers who purchased iPads during the quarter were new to the product. In addition, the latest reports from 451 Research indicated customer satisfaction of 96% for iPad in the US. Wearables, Home and Accessories revenue was $7.9 billion, down 10% year-over-year due to a difficult launch compare. Last year, we had the continued benefit from the launches of the AirPods Pro second-generation, the Watch SE and the first Watch Ultra. Apple Watch continues to attract new customers, with almost two-thirds of customers purchasing an Apple Watch during the quarter being new to the product, sending the Apple Watch installed base to a new all-time high and customer satisfaction was recently measured at 95% in the U.S. In services, as I mentioned, total revenue reached an all-time record of $23.9 billion, growing 14% year-over-year with our installed-base of active devices continuing to grow at a nice pace. This provides a strong foundation for the future growth of the services business as we continued to see increased customer engagement with our ecosystem. Both transacting accounts and paid accounts reached a new all-time high with paid accounts growing double-digits year-over-year. And paid subscriptions showed strong double-digit growth. We have well over $1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. We continued to improve the breadth and quality of our current services from creating new games on Arcade and great new shows on TV+ to launching additional countries and partners for Apple Pay. Turning to enterprise, our customers continued to invest in Apple products to drive productivity and innovation. We see more and more enterprise customers embracing the Mac. In Healthcare, Epic Systems, the world's largest electronic medical record provider, recently launched its native app for the Mac, making it easier for healthcare organizations like Emory Health to transition thousands of PCs to the Mac for clinical use. And since the launch of Vision Pro last quarter, many leading enterprise customers have been investing in this amazing new product to bring spatial computing apps and experiences to life. We are seeing so many compelling use cases from aircraft engine maintenance training at KLM Airlines to real-time team collaboration for racing at Porsche to immersive kitchen design at Lowe's. We couldn't be more excited about the spatial computing opportunity in enterprise. Taking a quick step back, when we look at our performance during the first-half of our fiscal year, total company revenue was roughly flat to the prior year in spite of having one less week of sales during the period and some foreign exchange headwinds. We were particularly pleased with our strong momentum in emerging markets, as we set first-half revenue records in several countries and regions, including Latin-America, the Middle East, India, Indonesia, the Philippines and Turkey. These results, coupled with double-digit growth in services and strong levels of gross margin, drove a first half diluted EPS record of $3.71, up 9% from last year. Let me now turn to our cash position and capital return program. We ended the quarter with $162 billion in cash and marketable securities. We repaid $3.2 billion in maturing debt and commercial paper was unchanged sequentially, leaving us with total debt of $105 billion. As a result, net cash was $58 billion at the end of the quarter. During the quarter, we returned over $27 billion to shareholders, including $3.7 billion in dividends and equivalents and $23.5 billion through open-market repurchases of $130 million Apple's shares. Given the continued confidence we have in our business now and into the future, our Board has authorized today an additional $110 billion for share repurchases, as we maintain our goal of getting to net cash-neutral over time. We are also raising our dividend by 4% to $0.25 per share of common stock, and we continued to plan for annual increases in the dividend going forward as we've done for the last 12 years. This cash dividend will be payable on May 16, 2024 to shareholders of record as of May 13, 2024. As we move ahead into the June quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. We expect our June quarter total company revenue to grow low-single-digits year-over-year in spite of a foreign exchange headwind of about 2.5 percentage points. We expect our services business to grow double-digits at a rate similar to the growth we reported for the first-half of the fiscal year. And we expect iPad revenue to grow double-digits. We expect gross margin to be between 45.5% to -- and 46.5%. We expect OpEx to be between $14.3 billion and $14.5 billion. We expect OI&E to be around $50 million, excluding any potential impact from the mark-to-market of minority investments and our tax rate to be around 16%. With that, let's open the call to questions.
Suhasini Chandramouli: Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?
Operator: Certainly. We will go ahead and take our first question from Mike Ng with Goldman Sachs. Please go ahead.
Mike Ng: Hey, good afternoon. Thank you very much for the question. I have two, first, I'll ask about the June quarter guidance. The revenue outlook for low-single digits growth, I was wondering if you could run through some of the product assumptions, iPhone, like what kind of gives you confidence around that? And then on the service momentum, what was better than expected in the quarter? And then I just have a quick follow-up.
Luca Maestri: Hey, Mike. It's Luca. On the outlook, what we said is we expect to grow low-single-digits in total for the company. We expect services to grow double-digits at a rate that is similar to what we've done in the first-half of our fiscal year. And we've also mentioned that iPad should grow double-digits. This is the color that we're providing for the June quarter. In services, we've seen a very strong performance across the board. We've mentioned, we've had records in several categories, in several geographic segments. It's very broad based, our subscription business is going well. Transacting accounts and paid accounts are growing double-digits. And also we've seen a really strong performance both in developed and emerging markets. So very pleased with the way the services business is going.
Mike Ng: Great. Thank you. And I wanted to ask about, as Apple leans more into AI and Generative AI, should we expect any changes to the historical CapEx cadence that we've seen in the last few years of about $10 billion to $11 billion per year or any changes to, you know, how we may have historically thought about the split between tooling, data center and facilities? Thank you very much.
Luca Maestri: Yes. We are obviously very excited about the opportunity with Gen AI. We obviously are pushing very hard on innovation on every front and we've been doing that for many, many years. Just during the last five years, we spent more than a $100 billion in research and development. As you know, on the CapEx front, we have a bit of a hybrid model where we make some of the investments ourselves. In other cases, we share them with our suppliers and partners on the manufacturing side, we purchased some of the tools and manufacturing equipment. In some of the cases, our suppliers make the investment. On the -- and we do something similar on the data center side. We have our own data center capacity and then we use capacity from third parties. It's a model that has worked well for us historically and we plan to continue along the same lines going forward.
Mike Ng: Excellent. Thank you very much.
Suhasini Chandramouli: Awesome. Thank you, Mike. Operator, can we have the next question, please?
Operator: Our next question is from Wamsi Mohan with Bank of America. Please go ahead.
Wamsi Mohan: Yes, thank you so much. Tim, can you talk about the implications to Apple from the changes driven by EU DMA? You've had to open up third-party app stores, clearly disposes some security risks on the one-hand, which can dilute the experience, but also lower payments from developers to Apple. What are you seeing developers choose in these early days and consumers choose in terms of these third-party app stores? And I have a follow-up.
Tim Cook: It's really too early to answer the question. We just implemented in March, as you probably know, in the European Union, the alternate app stores and alternate billing, et cetera. So we're focused on complying while mitigating the impacts to user privacy and security that you mentioned. And so that's our focus.
Wamsi Mohan: Okay. Thank you, Tim. And Luca, I was wondering if you could comment a bit on the product gross margins, the sequential step down. You noted both mix and leverage. Any more color on the mix, if you could share if customers are at all starting to mix down across product lines or is this more a mix across product lines? Just trying to get some color on customer behavior given some of the broader inflationary pressures. Thank you so much.
Luca Maestri: On a sequential basis, yes, we were down. It's primarily the fact that we had a slightly different mix of products than the previous one. Obviously, leverage plays a big role as we move from the holiday quarter into the -- into, you know, a more typical quarter. So I would say primarily leverage in a different mix of products. I mean, we haven't seen anything different in terms within the product categories, we haven't seen anything particular.
Wamsi Mohan: Thank you so much.
Suhasini Chandramouli: Thanks, Wamsi. We'll take the next question, please.
Operator: Our next question is from Erik Woodring with Morgan Stanley. Please go ahead.
Erik Woodring: Great. Thanks so much for taking my questions. Maybe my first one, Tim, you've obviously mentioned your excitement around Generative AI multiple times. I'm just curious how Apple is thinking about the different ways in which you can monetize this technology because historically software upgrades haven't been a big factor in driving product cycles. And so could AI be potentially different? And how could that impact replacement cycles? Is there any services angle you'd be thinking? Any early color that you can share on that? And then I have a follow up, please. Thanks.
Tim Cook: I don't want to get in front of our announcements, obviously. I would just say that we see Generative AI as a very key opportunity across our products. And we believe that we have advantages that set us apart there. And we'll be talking more about it in as we go through the weeks ahead.
Erik Woodring: Okay. Very fair. Thank you. And then Luca, maybe to just follow up on Wamsi's comments or question. There's a broad concern about the headwind that rising commodity costs have on your product gross margins. Wondering if you could just clarify for us if we take a step back and look at all of the components and commodities that go into your products kind of collectively, are we -- are you seeing these costs rising? Are they falling? What tools do you have to try to help and mitigate some rising costs if at all, rising input costs if at all? Thank you so much.
Luca Maestri: Yes. I mean during the last quarter, commodity costs, and in general, component costs have behaved favorably to us. On the memory front, prices are starting to go up. They've gone up slightly during the March quarter. But in general, I think it's been a period not only this quarter, but the last several quarters where, you know, commodities have behaved well for us. Commodities going cycles and so there's obviously always that possibility. Keep in mind that we are starting from a very high level of gross margins. We reported 46.6%, which is something that we haven't seen in our company in decades. And so we're starting from a good point. As you know, we try to buy ahead when the cycles are favorable to us. And so we will try to mitigate if there are headwinds. But in general, we feel particularly for this cycle, we are in good shape.
Erik Woodring: Thank you so much.
Suhasini Chandramouli: Great. Thank you, Erik. Operator, we'll take the next question, please.
Operator: Our next question is from Ben Reitzes with Melius. Please go ahead.
Ben Reitzes: Hey, thanks for the question. And hey, Tim, I was wondering if I could ask the China question again. Is there any more color from your visit there that gives you confidence that you've reached a bottom there and that it's turning? And I know you've been -- you've continued to be confident there in the long-term. Just wondering if there was any color as to when you think that the tide turns there? Thanks a lot. And I have a follow-up.
Tim Cook: Yes, Ben, if you look at our results in Q2 for Greater China, we were down 8%. That's an acceleration from the previous quarter in Q1. And the primary driver of the acceleration was iPhone. And if you then look at iPhone within Mainland China, we grew on a reported basis. That's before any kind of normalization for the supply disruption that we mentioned earlier. And if you look at the top-selling smartphones, the Top 2 in Urban China are iPhones. And while I was there, it was a great visit and we opened a new store in Shanghai and the reception was very warm and highly energetic, and so I left there having a fantastic trip and enjoyed being there. And so I maintain a great view of China in the long-term. I don't know how each and every quarter goes and each and every week. But over the long haul, I have a very positive viewpoint.
Ben Reitzes: Okay. Hey, thanks, Tim. And then my follow-up, I want to ask this carefully though. It's a -- there's a fear out there that, you may lose some traffic acquisition revenue. And I was wondering if you thought AI from big picture and it doesn't have to be on a long-term basis, I mean from a big picture, if AI is an opportunity for you to continue to monetize your mobile real estate, just how you -- how maybe investors can think about that from a big picture, just given that's been one of the concerns that's potentially been an overhang, of course, due to, you know, a lot of the news and the media around some of the legal cases? And I was wondering if there's just a big-picture color you could give that makes us kind of think about it better and your ability to sort of continue to monetize that real estate? Thanks a lot.
Tim Cook: I think AI, Generative AI and AI, both are big opportunities for us across our products. And we'll talk more about it in the coming weeks. I think there are numerous ways there that are great for us. And we think that we're well-positioned.
Ben Reitzes: Thanks, Tim.
Tim Cook: Yes.
Suhasini Chandramouli: Thanks, Ben. Can we have the next question, please?
Operator: Thank you. Our next question is from Krish Sankar with TD Cowen. Please go ahead.
Krish Sankar: Yes, hi. Thanks for taking my question. Again, sorry to beat the AI haul. But Tim, I know you don't want to like reveal a lot. But I'm just kind of curious, because last quarter you spoke about how you're getting traction in enterprise. Is the AI strategy going to be both consumer and enterprise or is it going to be one after the other? Any color would be helpful? And then, I have a follow-up for Luca.
Tim Cook: Our focus on enterprise has been and you know through the quarter and the quarters that preceded it on selling iPhones and iPads and Macs and we recently added Vision Pro to that. And we're thrilled with what we see there in terms of interest from big companies buying some to explore ways they can use it. And so I see enormous opportunity in the enterprise. I wouldn't want to cabin that to AI only. I think there's a great opportunity for us around the world in the enterprise.
Krish Sankar: Got it. Very helpful. And then for Luca, you know, I'm kind of curious on -- given the macro-environment, on the hardware side, are you seeing a bias towards like standard iPhone versus the Pro model? The reason I'm asking the question is that there's a weaker consumer spending environment, yet your services business is still growing and has amazing gross margins. So I'm just trying to like square the circle over there. Thank you.
Luca Maestri: I'm not sure I fully understand the question, but in general, what we are seeing on the product side, we continued to see a lot of interest at the top of the range of our products. And I think it's a combination of consumers wanting to purchase the best product that we offer in the different categories and our ability to make those purchases more affordable over time. We've introduced several financing solutions from installment plans to trading programs that reduce the affordability threshold and therefore, customers tend to buy -- want to buy at the top of the range that is very valuable for us in developed markets, but particularly in emerging markets where the affordability issues are more pronounced. But in general, over the last several years and that is also reflected in our gross margins, over the last several years, we've seen this trend, which we think is pretty sustainable.
Krish Sankar: Got it. Thank you very much, Luca, and thanks, Tim.
Suhasini Chandramouli: Thank you, Krish. Operator, we'll have the next question, please.
Operator: Our next question is from Amit Daryanani with Evercore. Please go ahead.
Amit Daryanani: Thanks for taking my question. I have two as well. You know, I guess, first off on capital allocation, you folks have about $58 billion of net cash right now. As you think about eventually getting to this net cash-neutral target, do you think at some point, Apple would be open to taking on leverage on the balance sheet and continuing the buyback program? Or is it more like once you get to this neutral position, it's going to be about returning free cash flow back to shareholders? I'm just wondering, how do you think about leverage on your balance sheet over time and what sort of leverage do you think you'd be comfortable taking on?
Luca Maestri: Hey, Amit. This is Luca. I would say one step at a time, we have put out this target of getting to net cash-neutral several years ago and we're working very hard to get there. Our free cash flow generation has been very strong over the years, particularly in the last few years. And so as you've seen this year, we've increased the amount that we're allocating to the buyback. For the last couple of years, we were doing $90 billion, now we're doing $110 billion. So let's get there first. It's going to take a while still. And then when we are there, we're going to reassess and see what is the optimal capital structure for the company at that point in time. Obviously, there's going to be a number of considerations that we will need to look at when we get there.
Amit Daryanani: Fair enough. I figure it's worth trying anyway. If I go back to this China discussion a bit and, you know, Tim, I think your comments around growth in iPhones in Mainland China is really notable. Could you step back, I mean, these numbers are still declining at least Greater China on a year-over-year basis in aggregate. Maybe just talk about what are you seeing from a macro basis in China and then at least annual decline -- or year-over-year declines that we're seeing. Do you think it's more macro driven or more competitive driven over there? That would be helpful.
Tim Cook: Yes, I can only tell you what we're seeing. And so I don't want to present myself as a economist. So I'll steer clear of that. From what we saw was an acceleration from Q1, and it was driven by iPhone and iPhone in Mainland China before we adjust for this $5 billion impact that we talked about earlier did grow. That means the other products didn't fare as well. And so we clearly have work there to do. I think it has been and is through last quarter, the most competitive market in the world. And I -- so I, you know, wouldn't say anything other than that. I've said that before, and I believe that it was last quarter as well. And -- but if you step back from the 90-day cycle, what I see is a lot of people moving into the middle class, a -- we try to serve customers very well there and have a lot of happy customers and you can kind of see that in the latest store opening over there. And so I continue to feel very optimistic.
Amit Daryanani: Great. Thank you.
Suhasini Chandramouli: Thanks, Amit. Operator, we'll take the next question, please.
Operator: Our next question is from David Vogt with UBS. Please go ahead.
David Vogt: Great. Thanks guys for taking my question. I'm going to roll the two together, so you guys have them both. So Luca obviously, I'm trying to parse through the outlook for the June quarter. And just based on the quick math, it looks like all things being equal, given what you said, the iPhone business is going to be down mid-single-digits again in the June quarter. And if that's the case and maybe this is for Tim obviously, how are you thinking about the competitive landscape in the context of what you just said maybe outside of China and what changes sort of, the consumer demand or receptivity to new devices because we've been in this malaise for a while. Is it really this AI initiative that a lot of companies are pursuing? And do you think that changes sort of the demand drivers going forward? Or is it just really more of a timing issue in terms of the replacement cycle is a little bit long in the tooth, and we see a bit of an upgrade cycle at some point, maybe later this year into next year? Thanks.
Tim Cook: I do see a key opportunity, as I've mentioned before with Generative AI with all of our devices or the vast majority of our devices. And so I think that if you look out that that's not within the next quarter or so and we don't guide at the product level, but I'm extremely optimistic. And so that -- that's kind of how I view it. In terms of the -- I'll let Luca comment on the outlook portion of it. I think if you step back on iPhone though and you make this adjustment from the previous year, our Q2 results would be flattish on iPhone. And so that's how we performed in Q2.
Luca Maestri: Yes, David, on the outlook, I'll only repeat what we said before, and this is the color that we're providing for the quarter. We do expect to grow in total, low-single-digits. And we do expect services to grow double-digits, and we expect iPad to grow double-digits for the rest. I'll let you make assumptions and then we will report three months from now.
David Vogt: Great. Thanks guys. I'll get back in the queue.
Suhasini Chandramouli: Thanks, David. Operator, we'll take the next question, please.
Operator: Our next question is from Samik Chatterjee with JPMorgan. Please go ahead.
Samik Chatterjee: Hi, thanks for taking my question, and I have a couple as well. Maybe for the first one, your services growth accelerated from 11% growth to 14%. If you can sort of dig into the drivers of where or which parts of services did you really see that acceleration? And why it isn't a bit more sustainable as we think about the next quarter? Because I believe you're guiding more to sort of averaging out the first half of the year for the next quarter. So just curious what were the drivers and why not have it a bit more sustainably sort of improve as we go through the remainder of the year? And I have a quick follow-up. Thank you.
Luca Maestri: So a number of things on services. First of all, the overall performance was very strong. As I said earlier, all-time records in both developed and emerging markets. So we see our services do well across the world. Records in many of our services categories. There are some categories that are growing very fast also because they are relatively smaller in the scheme of our services business like cloud, video, payment services. You know, those all set all-time revenue records. And so we feel very good about the progress that we're making in services. As we go forward, I'll just point out that if you look at our growth rates a year ago, they improved during the course of the fiscal year last year. So the comps for the services business become a bit more challenging as we go through the year. But in general, as I mentioned, we still expect to grow double-digits in the June quarter at a rate that is very similar to what we've done in the first half.
Samik Chatterjee: Got it. Got it. And for my follow up, if I can ask you more specifically about the India market. Obviously, you continue to make new records in terms of revenue in that market. How much of the momentum you're seeing would you associate with your sort of retail strategy in that market, retail expansion relative to maybe some of the supply change or the sort of manufacturing changes or strategy you've undergone or taken in that market itself. Any thoughts around that would be helpful?
Tim Cook: Sure. We did grow strong double-digit. And so we were very, very pleased about it. It was a new March quarter revenue record for us. As you know, as I've said before, I see it as an incredibly exciting market and it's a major focus for us. In terms of the operational side or supply chain side, we are producing there, from a pragmatic point of view, you need to produce there to be competitive. And so yes, there the two things are linked from that point of view. But we have both operational things going on and we have go-to-market, and initiatives going on. We just opened a couple of stores as last year, as you know, and we see enormous opportunity there. We're continuing to expand our channels, and also working on the developer ecosystem as well. And we've been very pleased that there is a rapidly-growing base of developers there. And so, we're working all of the entire ecosystem from developer to the market to operations, the whole thing. And I just -- I could not be more excited and enthusiastic about it.
Samik Chatterjee: Got it. Thank you. Thanks for that.
Tim Cook: Yes.
Suhasini Chandramouli: Thank you, Samik. Operator, we'll have the next question, please.
Operator: Our next question is from. Please go ahead.
Aaron Rakers: Yes, thanks for taking the questions, and I think I have to have two as well like everybody else. I guess, I'm going to go back to the China question. I guess, at a high level, the simple question is, when we look at the data points that have been repeatedly reported throughout the course of this quarter, I'm curious, Tim, you know, what are we missing? Like where do you think people are missing, Apple's iPhone traction within the China market, just at a high level, you know, given the data points that were reported throughout this course of the last quarter?
Tim Cook: I can't address the data points. I can only address what our results are. And we did accelerate last quarter, and the iPhone grew in Mainland China. So that's what the results were. I can't bridge to numbers we didn't come up with.
Aaron Rakers: Okay. And then as a quick follow-up, I know you guys haven't talked about this, you know, quantified it in quite some time. But I'm curious how we would characterize the channel inventory dynamics for iPhone?
Tim Cook: Sure. The -- for the March quarter, we decreased channel inventory during the quarter. We usually decreased channel inventory during the Q2 timeframe. So that's not unusual. And we're very comfortable with the overall channel inventory.
Aaron Rakers: Thank you.
Tim Cook: Yes.
Suhasini Chandramouli: Thank you, Aaron. Operator, we'll take the next question, please.
Operator: Our next question is from Richard Kramer with Arete Research. Please go ahead.
Richard Kramer: Thanks very much. I'm not going to ask about China, but you regularly call out all the rapid growth in many other emerging markets. So is Apple approaching a point where all of those other emerging markets in aggregate might crossover to become larger than your current $70 billion Greater China segments, and maybe investors could look at that for driving growth for the wider business? And then I have a follow-up for Luca. Thanks.
Luca Maestri: I think, Richard, you're asking a really interesting question. We were looking at something similar recently. Obviously, China is by far the largest emerging market that we have. But when we started looking at places like India, like Saudi, like Mexico, Turkey, of course, Brazil and Mexico and Indonesia, the numbers are getting large, and we're very happy because these are markets where our market share is low, the populations are large and growing. And our products are really making a lot of progress with the -- in those markets. The level of excitement for the brand is very high. Tim was in Southeast Asia recently, and the level of excitement is incredibly high. So it is very good for us. And then -- and certainly, the numbers are getting larger all the time. And so the gap as you compare it to the numbers in China is reducing, and hopefully, that trajectory continues for a long time.
Richard Kramer: Okay. And then as a follow-up, maybe for either of you, I mean, you're coming up on four years from what was incredibly popular iPhone 12 cycle. And, you know, given you're struggling to reduce your net -- your -- reach your net neutral cash position and your margins are sort of near highs, do you see ways to deploy capital more to spur replacement demand in your installed base either with greater device financing, more investment in marketing, more promotions. I mean, do you feel like you needed to produce those sort of margins or is it a more important to spur growth with replacement? Thanks.
Tim Cook: I think innovation spurs the upgrade cycle, and as one thing, of course, there's economic factors as well that play in there. And what kind of offerings there are from our carrier partners and so forth. And so there's a number of variables in there. But we work all of those, and you know, we price our products for the value that we're delivering. And so that's how we look at it.
Luca Maestri: And if I can add to Tim's comments, Richard, one of the things that when you look over the long arc of time that maybe is not fully understood is that we've gone through a long period of very strong dollar. And what that means given that our company sells more than 60% of our revenue is outside the United States. The demand for our products in those markets is stronger than the results that we report just because of the translation of those local currencies into dollars, right? And so that is something to keep in mind as you look at our results, right? And so we are making all the investments that are needed and Tim has talked about innovation. Obviously, we made a lot of progress with financing solutions, with trading programs and so on, and we will continue to make all those investments.
Richard Kramer: Okay. Super. Thanks, guys.
Suhasini Chandramouli: Thank you, Richard. Operator, can we take our last question, please.
Operator: Our next question is from Atif Malik with Citi. Please go ahead.
Atif Malik: Hi. Thank you for taking my questions, and I have two questions as well. First for Tim, for enterprise, specifically, what are some of the top two or three use cases on Vision Pro you're hearing most excitement? And then I have a follow-up for Luca.
Tim Cook: Yes, the great thing is, I'm hearing about so many of them. I wouldn't say that one has emerged as the top, right now. The most impressive thing is that similar to the way people use a Mac, you use it for everything. People are using it for many different things in enterprise, and that varies from field service to training to healthcare related things like preparing a doctor for pre-op surgery or advanced imaging. And so the -- it commands control centers. And so it's an enormous number of different verticals. And you know our focus is on -- is growing that ecosystem and getting more apps and more and more enterprises engaged. And the event that we had recently, I can't overstate the enthusiasm in the room. It was extraordinary. And so we're off to a good start, I think, with the enterprise.
Atif Malik: Great. And then Luca, I believe you mentioned that for the March quarter, the commodity pricing environment was favorable. Can you talk about what you're assuming for commodity pricing on memory and et cetera for the June quarter and maybe for the full-year?
Luca Maestri: Yes, we provide guidance just for the current quarter. So I'll tell you about the, you know, the guidance. We're guiding to again to a very high level of gross margins, 45.5% to 46.5%. Within that guidance, we expect memory to be a slight headwind, not a very large one, but a slight headwind. And the same applies for foreign exchange. Foreign exchange will have a negative impact sequentially of about 30 basis points.
Atif Malik: Thank you.
Suhasini Chandramouli: Thank you, Atif. A replay of today's call will be available for two weeks on Apple podcasts as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0467138 followed by the pound sign. These replays will be available by approximately 5:00 P.M. Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142, and financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123. Thank you again for joining us. |
BKNG | 1 | 2,024 | 2024-05-02 00:00:00 | Operator: Welcome to the Booking Holdings First Quarter 2024 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied and forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical fact are intended to identify forward-looking statements.
For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the safe harbor statements at the end of the Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com.
And now I'd like to introduce Booking Holdings speakers for this afternoon, Glenn Fogel and Ewout Steenbergen. Go ahead, gentlemen.
Glenn Fogel: Thank you, and welcome to Booking Holdings' First Quarter Conference Call. I'm joined this afternoon by our CFO, Ewout Steenbergen. I am pleased to report a strong start to 2024. Our travelers booked nearly 300 million room nights across our platforms in the first quarter, which exceeded our expectations and grew 9% year-over-year. First quarter revenue of $4.4 billion grew 17% year-over-year, and adjusted EBITDA of about $900 million increased 53% year-over-year. Both revenue and adjusted EBITDA were ahead of our first quarter expectations. Finally, adjusted earnings per share in the first quarter grew 76% year-over-year, helped by improved profit levels as well as our strong capital return program, which reduced our average share count by 9% versus the first quarter last year.
We continue to see resiliency in global leisure travel demand, including healthy growth for travel on the books that's scheduled to take place during our peak summer travel season, although a high percentage of these bookings are cancelable, and what is on the books today represents a modest percentage of the expected total summer bookings.
As we look ahead to the second quarter, room night growth compared to last year will benefit from the shift in Easter timing. However, we expect that this will be offset by a less expansion of the booking window and an increased impact from the geopolitical situation in the Middle East. We believe this will result in some deceleration in room night growth versus Q1. Ewout will provide further details on our first quarter results and our thoughts about the second quarter.
Over the last few years, we have talked quite a bit about our key strategic priorities, which include building towards our connected trip vision, expanding our merchant offering at Booking.com, developing our AI capabilities and enhancing our genius loyalty program. These initiatives may seem to be distinct efforts, but I'd like to emphasize, they actually all fit together in our ongoing effort to deliver a much better planning, booking and traveling experience for our travelers while also benefiting our supplier partners.
By creating a much better experience for our travelers and solving more of the challenges they face when planning, booking and experiencing a trip, we believe travelers will choose to book directly and more frequently with us, resulting in increased loyalty over time. We see encouraging early proof points at Booking.com as we have grown the number of total active travelers while experiencing higher growth in repeat travelers, which speaks to the progress we are making in encouraging customers to book again with us. In addition, we are seeing increases in the average number of trips booked per traveler as well as an increasing mix of our room nights that are booked directly with us.
On direct mix, we are pleased to see the direct booking channel continues to grow faster than room nights acquired through paid marketing channels. While we see paid marketing channels becoming a gradually smaller proportion of our business over time, we think it's important for us to remain proactive in these channels in order to bring new travelers to our platforms, so long as we're able to do so at attractive ROIs.
We believe continuing to improve the experience for our travelers by advancing towards our connected trip vision will help to further drive these positive proof points around loyalty, frequency and direct booking behavior. I'm encouraged to see strong growth in transactions that are connected to another booking from a different travel vertical in a trip. These connected transactions increased by just over 50% year-over-year in the first quarter, though it's important to note that this growth is off of last year's small base.
Connected transactions represented a high single-digit percentage of Booking.com's total transactions in Q1. It's great to see more of our travelers choosing to book connected transactions. And we believe by providing more value and a better overall experience to those travelers, they may choose to book more trips with us and have a higher likelihood of booking directly with us in the future.
Flights is the most frequently booked vertical in a connected transaction outside of accommodations. And it is an important component of many of the trips our travelers are booking. In the first quarter, air tickets booked on our platforms increased 33% year-over-year, driven primarily by the growth of Booking.com's flight offering. We continue to see a healthy number of new customers to Booking.com through the flight vertical and are encouraged by the rate that these customers and returning customers see the value of the other services on our platform.
Winning a traveler's business is never easy because of the high level of competition in our industry. But we are pleased to see that by providing a better way to do it, less friction, better value, a broader selection and great customer service, we are building a customer base that is more likely to choose us.
Outside of flights and accommodations, we are seeing strong growth from rental cars and attraction bookings that are part of a connected transaction. We believe continuing to enhance and expand the attractions vertical has the ability to increase traveler engagement with the app while travelers are in destination and looking for something to do. And we believe that over time, travelers who experience the value we provide for in-destination services like attractions will choose to use us more in the future.
Bringing all of these elements of travel together in a seamless booking experience and unlocking the ability of merchandise across verticals is a capability we have been building at Booking.com over the last several years. In addition to being a foundational element to our connected trip vision, our merchant offering brings many other benefits to our travelers and partners. For travelers, we provide the ability to pay in many different methods. And we can offer discounts, incentives and other merchandising opportunities. For our supplier partners, our merchant offering enables us to take fraud liability from our partners as part of the services we provide, reduces cancellation rates versus the agency model. And over time, we believe we can help to lower payment costs for our partners.
In order to achieve the easier and more personalized experience with the connected trip, we have always envisioned AI technology playing a central role. We believe we are well positioned to leverage this technology given we have built strong teams of AI experts and gained valuable experience from using AI extensively for many years. In addition, we have proprietary data that can be used to train specific use case models or fine-tune large AI models and have the resources and scale required to help build AI-powered offerings.
As we have discussed before, our teams continue to work hard to integrate generative AI into our offerings in innovative ways, including Booking.com's AI Trip Planner, Priceline's generative AI travel assistant named Penny and Kayak's recent release of generative AI-powered features and tools. We will continue to learn from traveler interactions with these tools and enhance our offerings over time.
In addition, customer service, which is a critical function that we provide to both our travelers and partners, is an area we believe will be meaningfully enhanced by AI advancements. At each of our OTA brands, our teams are actively exploring ways to leverage generative AI technology to improve self-service tools, which we believe will reduce live agent contact rates and enable us to answer traveler questions faster. When customers still need to speak with a live agent, we believe that this technology will improve our live agent efficiency by making it easier to access information and document the conversations. In sum, we believe gen AI will lower our customer service cost per transaction over time and improve the customer experience.
Our Genius loyalty program at Booking.com also plays an increasingly important role in the multiple elements of travel that we offer as we expect our travelers will be able to experience the benefits of Genius in each of our travel verticals over time. In addition, bookings in travel verticals outside of accommodations will contribute to a traveler's Genius level tier. We have seen an encouraging number of our rental car supplier partners choosing to adopt the Genius program, and we have just begun to test the program in flights and attractions.
We are seeing success in moving more of our travelers into the higher Genius tiers of Level 2 and Level 3, which require 5 and 15 bookings in a 2-year period, respectively. We see encouraging behavior from our Genius Level 2 and 3 travelers, including higher frequency and a higher rate of direct booking than what we see for our overall business. We will continue to explore opportunities to enhance our Genius loyalty program and deliver more benefits to our travelers with more of our supplier partners electing to participate.
While we have mostly been discussing about our traveler customers, we operate a 2-sided marketplace, and our supplier partners are equally important to us. The success of our business is built on a mutually beneficial and balanced partnership with our millions of hotels, alternative accommodations and other supplier partners around the world.
We strive to be a trusted and valuable partner for all accommodation types on our platform, the majority of which are small independent businesses. We believe that improving the competitiveness and profitability of our smaller partners contributes to the long-term economic health of our sector. And we continue to onboard more small independent businesses through our alternative accommodation offering at Booking.com, and we are benefiting from having more listings available on our platform for travelers to choose from.
At the end of Q1, our global alternative accommodation listings were about 7.4 million, which is about 11% higher than Q1 last year. We are focused on continuing to build on this progress by further improving the product for our supply partners and travelers, particularly in the U.S.
In conclusion, I am encouraged by the strong first quarter results and the continued long-term resilience of leisure travel demand. We continue our work to deliver a better offering and experience for our supply partners and our travelers. We remain confident in our long-term outlook for the travel industry. We are positive about our future, and we believe we are well positioned to deliver attractive growth across our key metrics in the coming years.
I will now turn the call over to our CFO, Ewout Steenbergen.
Ewout Steenbergen: Thank you, Glenn, and good afternoon. I'm very excited to join the Booking Holdings team. I look forward to continuing to work with you and David in his new role and the rest of the leadership team to help drive continued future success for our investors, employees, traveler customers and supplier partners.
I will now review our results for the first quarter and provide our thoughts for the second quarter. All growth rates are on a year-over-year basis. Information regarding reconciliation of non-GAAP results to GAAP results can be found on our earnings release. We'll post our prepared remarks to the Booking Holdings Investor Relations website after the conclusion of the earnings call.
Now let's move to the first quarter results. Our room nights in the first quarter grew 9%, which exceeded the high end of our guidance by about 3 percentage points. The higher-than-expected room night growth was driven by a continued expansion of the booking window as well as healthy underlying demand with better-than-expected performance in Europe and less of a negative impact from the war in the Middle East than expected.
Looking at our room night growth by region. In the first quarter, Asia was up mid-teens. Europe and the rest of the world were up high single digits. And U.S. was up low single digits.
We are encouraged by the continued progress we are making in strengthening the direct relationships with our travelers. Over the last 4 quarters, the mix of our total room nights coming to us through the direct channel was in the mid-50% range, and when we exclude our B2B business, was in the low 60% range. We have seen both these mixes increase year-over-year in each of those 4 quarters.
We're focused on continuing to increase our direct mix going forward, which we believe will benefit from our efforts to improve the experience for our travelers, including building towards our connected trip vision. Increasing our direct mix benefits our P&L by driving higher efficiency of our marketing spend as a percentage of gross bookings while reducing the mix of bookings we source through paid marketing channels.
In our mobile apps, the significant majority of bookings we receive are direct. And we continue to see favorable repeat direct booking behavior from consumers in our mobile apps when compared to direct bookings on desktop or mobile web. The mobile apps also allow us more opportunities to engage directly with consumers. In the first quarter, mobile app mix of about 51% was 5 percentage points higher than the first quarter of 2023.
We continue to offer our travelers a broad selection of places to stay and are seeing an increasing mix of our room nights being booked in alternative accommodation properties. For our alternative accommodations at Booking.com, our first quarter room night growth was 13%. And the global mix of alternative accommodation room nights was 36%, which was up versus 33% in the first quarter of 2023.
Outside of accommodations, we saw airline tickets booked on our platforms in the first quarter increased 33%, driven by the continued growth of Booking.com's flight offering. First quarter gross bookings increased 10%, which exceeded our expectations. The 10% increase in gross bookings was approximately 2 percentage points higher than the 9% room night growth on an unrounded basis due to about a 1% higher accommodation ADRs plus about 1 point of positive impact from flight bookings. There was an immaterial impact from changes in FX on our gross bookings growth rate.
Our ADR growth was negatively impacted by regional mix due to a higher mix of room nights from Asia. Excluding regional mix, ADRs were up about 2 percentage points. Similar to comments we have made in the past, we have not seen a change in the mix of hotel star rating levels being booked or changes in the length of stay that could indicate that consumers are trading down. We continue to watch these dynamics closely.
Revenue for the first quarter of $4.4 billion also exceeded our expectations, increasing 17% year-over-year. Revenue as a percentage of gross bookings was 10.1% and improved versus the first quarter of 2023 due mostly to the Easter timing shift as well as the easier year-on-year take rate compare due to changes in the booking window last year, as mentioned on our first quarter 2023 earnings call.
Marketing expense, which is a highly variable expense line, increased 6% year-over-year. Marketing expense as a percentage of gross bookings was 3.7%, about 15 basis points lower than the first quarter of 2023 due to higher ROIs in our paid channels and a higher mix of direct business. Performance marketing ROIs increased year-over-year, helped by our ongoing efforts to improve the efficiency of our marketing spend.
First quarter sales and other expenses as a percentage of gross bookings was 1.6%, about 20 basis points higher than last year due in large part to a higher merchant mix. Our more fixed expenses on an adjusted basis were up 11%, which was below our expectation due primarily to lower G&A expense. We recognize that this fixed expense growth is elevated as we invest in the business but are fully focused on driving operating leverage from our more fixed expenses and targeting a much lower OpEx growth level in 2025.
Adjusted EBITDA of approximately $900 million was above our expectations, largely driven by stronger-than-expected bookings as well as better-than-expected marketing efficiency. Adjusted EBITDA was up 53%, including about 20 percentage points of benefit from the shift in Easter timing. Note that we expect the first quarter will be our seasonally lowest EBITDA quarter for the year.
Adjusted net income of over $700 million resulted in adjusted EPS of $20.39 per share, which was up 76%. Our average share count in the first quarter was 9% below the first quarter of 2023. On a GAAP basis, we had net income of $776 million in the quarter.
Now on to our cash and liquidity position. Our first quarter ending cash and investments balance of $16.4 billion was up versus our fourth quarter ending balance of $13.1 billion due to the $3 billion debt issuance in the first quarter and $2.6 billion in free cash flow generated in the first quarter. This was partially offset by the $1.9 billion in capital return, including share repurchases and the dividend we initiated in the quarter as well as $315 million in additional share repurchases to satisfy employee withholding tax obligations.
Now on to our thoughts for the second quarter. We expect second quarter room night growth to be between 4% and 6%, a deceleration from the first quarter as the first quarter benefited more from the year-over-year expansion of the booking window. We expect the booking window to be closer to the prior year in the second quarter. Additionally, the impact from the ongoing war in the Middle East was less negative than we expected in the first quarter. However, we expect a more negative impact in the second quarter given the geopolitical situation in April.
April room night growth rate was above the high end of that range and benefited by a couple of points from Easter being in March this year versus April last year. Adjusting for Easter, April room night growth was about in line with the high end of that range.
We expect second quarter gross bookings growth to be between 3% and 5%, slightly below room night growth due to about 3 points of negative impact from changes in FX, offset by about 1% higher constant currency accommodation ADRs plus about 1 point of positive impact from flight bookings.
We expect second quarter revenue growth to be between 4% and 6% and for revenue growth to be impacted by about 2 points of negative impact from changes in FX. Adjusted for the changes in FX, we expect second quarter revenue growth to be in line with second quarter gross bookings growth as the negative impact from the shift in Easter timing is offset by increasing revenues associated with payments.
We expect marketing to be a source of slight deleverage in the quarter. But if you adjust for Easter timing, we expect marketing as a percentage of revenue to be neutral year-over-year. We expect our sales and other expenses to grow faster than revenue in the second quarter, driven by a higher merchant mix. We expect our more fixed OpEx to grow faster than revenue in the second quarter due primarily to faster IT expense growth as we have been investing in new tech platforms and in line with the full year guidance we provided last quarter.
We expect second quarter adjusted EBITDA to be between about $1.7 billion and $1.75 billion, down low single digits year-over-year due to about 7 points of pressure from the shift in Easter timing and about 2 points of negative impact on growth from changes in FX. Normalizing for Easter timing and changes in FX, our expectation for second quarter adjusted EBITDA would be for mid- to high single-digit growth.
In closing, we are pleased with our first quarter results and the healthy leisure demand environment we are seeing. In terms of our outlook for the full year, we're not updating our previous full year commentary at this time. We want to see how the next few months develop before considering any updated commentary. We continue to expect 2024 to be a strong year for the company.
Lastly, I would like to thank all my new colleagues across the company for their hard work and dedication to make these strong first quarter results possible. And thank you for your continued commitment towards our shared vision of making it easier for everyone to experience the world.
We'll now move to Q&A. And Kathleen, will you please open the lines?
Operator: [Operator Instructions] Your first question comes from the line of Kevin Kopelman of TD Cowen.
Kevin Kopelman: So a quick one on the guidance. Can you talk about what changed in terms of the shape of the year that you're seeing versus what you expected on the February call? And walk us through this kind of changing booking window trends that you're seeing. And then if you could comment on whether it's giving you any concern about the back half or you see it as more of a neutral change.
Ewout Steenbergen: Kevin, this is Ewout. If you think about the second quarter guidance that we have provided to you, I think a couple of elements that you have to take in consideration. One is we are expecting a less expanded booking window in the second quarter than we have seen in the first quarter. So there has been a little bit of a pull forward of room nights from the second quarter into our first quarter results. We are expecting more of an impact from the Middle East from what we have seen so far. But in the opposite direction is that Easter is a slight benefit for the second quarter.
There is a little bit of noise, so to say, in the results quarter-by-quarter, particularly from Easter and the booking window. But if you look at the combined first half year results that we are expecting, so the actuals in the first quarter and the guidance for the second quarter, we believe that the results are really strong and very consistent to full year guidance that we have provided.
In terms of the comps that you are referring, actually, first quarter and second quarter comps are a bit tougher for us. And the second half of the year, the comps will become easier. So that is actually going to be a benefit during the course of 2024.
Operator: Your next question comes from the line of Mark Mahaney of Evercore.
Mark Stephen Mahaney: Can I try 2 questions, please? First, why do you think the ROI is higher in paid marketing channels? Is that just efficiencies you found or you find that overall performance marketing channels, platforms that are out there are just providing a better return on ad spend to their customers in general? And then secondly, could you quantify at all what percentage of total transactions now are connected?
Glenn Fogel: So why don't I say the first part, Mark, and I'll let Ewout talk a little bit about -- I think we gave away that -- a very generic term. I'll let him repeat it. So look, we are pleased with what we're doing with our marketing programs all around everything. And you know, Mark, we've talked about this for many, many years. We view this all holistically. And we're always looking for what is the best use of the money, what's the best way to put it to work. And when we find things that work, we put more into it. When we find things that actually are not incremental and are actually duplicative, we pull it out and say, well, let's not spend the money there.
And that's really what we've been doing. And I'm not going to get into specific things because, obviously, it's competitively -- a competitive advantage to have these things are better. But I definitely, definitely love the fact that we are producing some very nice ROIs on our marketing programs. It's really a lot of hard work by a lot of people. So I'm going to going to shout out to them because I know they've done some really good work. And Ewout, do you want to give a -- repeat what we've already said once? But go ahead.
Ewout Steenbergen: Sure. Mark, so the percentage of connected trip as a mix of total transactions at this moment is high single digits, and that is growing very rapidly. I think the way we look at it is really in combination with multiple other elements. We're seeing that we're delivering more value for our customers. Therefore, we see higher loyalty customers moving up to higher levels of Genius, more repeat customers coming to us. We can provide them more benefits over time. They're buying more from multiple verticals, and therefore, the connected trip is growing as well.
So this is really a flying wheel that we're having here. And we're seeing all of these metrics moving in the right direction, and they are all interrelated. So we're actually really encouraged by the total pattern of what we're seeing in terms of the added value we deliver to the customer and how it is being recognized by those travelers.
Operator: Your next question comes from the line of Justin Post from Bank of America.
Justin Post: I was wondering if you can give us the update of your regional mix. We get that question all the time and just how it's changed, any regions growing faster than others at this point and how it's changed maybe since pre-pandemic. And then second, the Digital Service Act in Europe has taken hold. And just wondering if you're seeing any changes in performance marketing channels around that or any disruptions or any opportunities.
Glenn Fogel: Thanks, Justin. I kind of missed the second part. Let me start with the first part, and then let Ewout pick it up on the other. So regional mix. And one of the things that we've been talking about for some years because of the pandemic. The issue has been depending on when the pandemic was in its worst parts and then people coming out of it, definitely impacted how we're doing different regional ways. So as we talked in the last year's calls -- calls last year, we talked about how Asia had been behind in coming out, but of course, we're getting a good comp because they were farther behind. And now we're still benefiting from some of that. The U.S., if you recall, came out first. So of course, we had a harder comp, so to speak, when we're looking last year.
But one of the things I've said, though, in terms of regional mix and one of the things, as you know, we are very strong in Europe. You also know that I have prioritized that we should be better in the U.S. And that is something we have been spending money, time, energy. And I'm really pleased, I've mentioned a couple of times in our previous calls, how well we have performed in the U.S. going back to pre-pandemic numbers. And it's just wonderful to see that the effort that we've put to work is actually producing results. We are going to continue to put priority in the U.S. I said that.
And one of the areas where I think we've done extremely well, in our alternative accommodations. As you know, we have a very strong alternative accommodation on a global basis, but I've also talked in the past about us being a little bit further behind in the U.S. in alternative accommodations, particularly in types of properties that I think will be helpful in the U.S. And we are making good progress, and we're improving the product. And it's giving you the reason that people have supply, the people who own the homes are willing to come now and put them onto our platform, too.
And you've seen some of our marketing, where we've been mentioning more about the alternative accommodations. All those things together are things the reason I believe we have a great opportunity to continue to increase our share in the U.S. and so I'm looking forward to. Ewout, I'll let you pick the rest because I didn't catch the second part.
Ewout Steenbergen: Yes. And quickly to give a couple of numbers around the regional mix. Europe, high single-digit growth in the first quarter, that was above our expectations. Very important that we see even Europe continue to do better than our own internal expectations. Asia, mid-teens growth, particularly very strong, China, Japan, Korea, India and Indonesia. And then U.S. at low single-digit growth, as Glenn already mentioned, but we believe that we have done better than the market in the first quarter with our U.S. growth and are on great trajectory and have many additional opportunities to grow faster in the future in the U.S.
With respect to your second question regarding the DMA changes, actually, if we look at the higher ROIs for our paid channels and the marketing leverage that we're seeing in the first quarter, that is all coming from our own actions, from the improvements we're making, the continuous optimization of our paid marketing approach as well as the growth of direct channels. We don't see really an impact from the Google DMA changes. And I would say that is more neutral for us as a total effect.
Operator: Your next question comes from the line of Doug Anmuth of JPMorgan.
Douglas Anmuth: Glenn, just hoping you could perhaps quantify anything on Genius frequency or bookings versus nonmembers? And maybe you can just help us understand what you see in the path of customers as they move into upper Genius loyalty tiers. And then Ewout, just a follow-up on your U.S. comments from a few minutes ago, the low single-digit room night growth above market. Is there anything to point to in that region in particular relative to the faster growth you've seen elsewhere?
Glenn Fogel: Doug, we don't give away numbers in our Genius membership. We don't talk about how many are in different tiers. I can say, though, how pleased I am and how the whole program continues to grow. And that's why we're continuing to expand, as I mentioned in my prepared remarks about we are now testing additional verticals, flights, attractions. The idea is that to give more value to the traveler, but it also provides a great opportunity for our supplier partners to get incremental demand when they need it. It's really a symbiotic relationship here. We're working together with our partners to both increase the value of our business but also increase the value of their business.
Genius is not something somebody has to do. A partner decides to participate and decides how they want to participate because they believe they are actually getting true value out of that. And we're going to continue to experiment with it in terms of different ways, and sometimes we'll even put value in ourselves to make sure that we are providing the best alternative for any traveler. They should come to us and then they start to come back.
And we talked about that in my prepared remarks about -- Ewout just mentioned it, too. As people get more value, as they get a benefit, they see the reason to come back. And then they come back not only again and again more frequently, but it's the coming back to rep. And that's the great thing. And I see this as another reason. I love Ewout using the term. I think he said flywheeling. I use flywheel. It's the same thing. It's the idea that giving more value will get people to come back more often, and that is something I see great opportunity for us. And I'll let Ewout talk a little bit about the low single digit for the U.S., any more comments he wanted to make on that.
Ewout Steenbergen: Yes, Doug, a couple of additional insights around the U.S. So what we like particularly is the sequential improvement from the fourth quarter in terms of our growth. Particularly within the growth, we saw the highest growth for alternative accommodations, which is really encouraging. If you look at U.S. bookers, more international growth than domestic growth. And then again, we really very much believe that U.S. is for us a growth market opportunity. It's fantastic with the scale that we have already today, with all the strategic expansions we're doing in multiple verticals and going more direct to connected trip, generative AI and many of the other strategic initiatives that we're having that we're actually having an opportunity to expand our position over the next few years in the U.S.
Operator: Your next question comes from the line of James Lee from Mizuho Securities. Sorry, your next question comes from the line of Brian Nowak from Morgan Stanley.
Brian Nowak: Maybe to come back to the last discussion you are having about the U.S. Over the last sort of 10 years or so, you've had a lot of strategies in the U.S. between branded spending, paid search spending, the merchant product and now AI. I guess maybe for either of you, as you sort of think about the next couple of years, what do you sort of think the largest unlock will be to differentiate yourself to drive continued outsized growth within the online travel category in the U.S.?
Glenn Fogel: Brian, a couple of interesting things about that question. And it's interesting when you said online, you kind of limited to online. I just had the benefit of looking at a research report by -- an industry report that talked about how much business there is that's not online yet and seeing that, saying, wow, this is still a tremendous opportunity for us. I'm speaking specifically about U.S.
But directly to your question, so you're right. We've been doing a lot of things, and I would say they all have worked out fairly well given the numbers, the share that we have increased over the time, again, going to pre-pandemic. And I love the way we're doing, the way it keeps going. And we're going to continue to grind it out. And I've talked about it. I've used that word a number of types in previous calls, about we're grinding it out, just doing incremental changes that are getting us a little bit more. And it continues to grow on itself.
But I think your question more is, is there going to be something down the road that is going to be transformational instead of just incremental? And I believe that is possible. I believe the things that we are doing with AI, the things that we can do with technology, the way we can do it, so it really is different. And I think I hear your question a little bit of is there enough differentiation between us and our competitors. And I believe over time, we will be doing that. And I believe the things that we can build will make it different. And I talk about how -- the frustration that travelers have nowadays.
So even though it's become so much better than it used to be, it's still not good enough. And I believe the use of AI, particularly gen AI, and what I'm seeing through, I'm seeing testing and things that are being done, I believe that over the next few years, it will become much better because of these technological advancements. Our job is to make sure we get it out fast, and we are able to provide it to both sides of the marketplace, to our supplier partners and our travelers, such that they see the value and they continue to come back. And then we begin. I love it. I'm going to be using flywheeling from now on.
Operator: Your next question comes from the line of James Lee of Mizuho Securities.
James Lee: Two over here. Can you guys comment about ADR by region and kind of what you're seeing among different markets that you're operating? And also, can you update us on ADR expectations for 2024? Maybe any changes from your prior expectation. I guess lastly, any trends that you see in terms of summer travel season, I guess, especially in Europe? How does that compare to last year?
Glenn Fogel: ADR by regions, James, in the first quarter, what we have seen is ADRs were up in Europe and were flat in North America and in Asia. So therefore, on a constant currency basis, 1% overall growth in ADRs as we have reported today.
Ewout Steenbergen: And in terms of summer, as I said earlier, I said that we have a healthy growth for travel on the books that's scheduled to take place during the peak summer. And that's where we're feeling that -- why I'm feeling pleased about the summer. I'm not going to quantify it though.
Operator: Your next question comes from the line of Stephen Ju of UBS.
Stephen Ju: So I was wondering if there is anything you can share about how the folks who have access to Trip Planner might be behaving. It seems like there's a lot of potential application here because if they're doing research, then there's top-of-funnel implications. And then you could theoretically recommend other pieces of the trip as well. So this could theoretically drive greater connected trip activity. So just wondering. This has been out for a little less than a year. So I'm just wondering what you guys are seeing so far.
Glenn Fogel: Yes. So it's low numbers of people who are using in such, and we're continuing to develop and learn all the time the interactions to see how people are using it. So it's a very small number of people compared to the number of people who use our services, but we are continuing to advance it.
And I agree with you. This has tremendous potential down the road. And I think a lot of people believe that, too. In fact, it's very hard to read any article about generative AI and not have in the first paragraph the use case of travel. It's always right there because we all see how complex the number of permutations, trying to understand what is the best way to do it. And using gen AI to simplify it, it's really something that I believe will make a huge difference, albeit it's going to take time. You're not going to see tremendous changes over the next couple of quarters.
But I do believe, over time, this will create a much better way for people to do their planning, their booking, executing and helping them when they are in destination, which is a really important thing because nobody goes on travel so they can sit it in the hotel. They want to do stuff. And we want to be able to provide that, too, and bring, as I said, about all the elements we've talked about, all the initiatives into one holistic system that enable it to be a better experience for our traveler customers. I believe that just has tremendous opportunity for us.
Operator: Your next question comes from the line of Lee Horowitz of Deutsche Bank.
Lee Horowitz: Great. Two if I could. Ewout, there remains sort of a robust debate on sort of what the structural growth algorithm is for online travel at this point. I guess in your early experience of booking, what strikes you as perhaps the most compelling area that you could put $1 of investment to work in order to drive faster revenue growth for longer that maybe comes in above the investor expectations? And then maybe one on fixed OpEx. Obviously, your fixed OpEx base is up materially relative to '19, particularly when you compare it to bookings growth relative to '19. So I guess maybe what has shifted in the business that is perhaps maybe a bit more capital intensive at this point or necessitating sort of greater headcount to sort of accomplish the goals that you guys want?
Ewout Steenbergen: Yes. Thanks, Lee. So first, your question about structural growth. So I am really super positive about the outlook for the company. Why? This is, of course, a phenomenal company, super high quality, very successful. And I very much believe that we will be able to grow in the future faster than GDP. Shift of offline to online bookings. I think overall, also consumers that will spend more on experiences than on material goods.
And then a number of areas that I believe actually, in my view, now being 6 weeks here in the position that are really underestimated for the company. So first, let me talk about direct. I think this is a company now that is -- completely has a complete game changer with respect to the share of direct. We're not only dependent on pay channels anymore. And that is now in the low 60% range for the B2C business. It's really important, and we are keeping those customers with us, and we have talked about it now before previous questions of really adding more value and more of those travelers coming back to the app, booking direct to us and the benefit we are having with that.
The other is the opportunity we have with respect to alternative accommodations. I think, again, this is completely not well understood and underestimated. We are actually, in terms of size, 2/3 of the largest player in this space, and we are growing faster in most of the last 8 quarters. And we still have a lot of opportunity to further develop our offering. But the fact that we are combining traditional accommodations and alternative accommodations on a platform and having travelers really being able to go from one to the other -- sometimes they go in and want to book one type of accommodation, and they end up booking a completely different type of accommodation.
And the last is gen AI. Glenn was just commenting on this. I have to say, I think the strategic benefit we have in terms of our capital investments we can make as well as the quality of the data because in generative AI, it's not so much about the language models. The data that go into the language models is strategically probably the biggest differentiator. And we have really advantage with respect to the data because of all the different ways that we touch travelers and partners and other stakeholders in the travel industry. So therefore, I'm really very positive and optimistic about the structural growth opportunities for the company over the next couple of years.
Quickly about fixed OpEx. I think that has to do with a couple of strategic expansions that the company has done, multiple verticals, moving in payments. But that is actually linked to your previous question. That will help drive future growth for the company. So that's actually a good thing. But as we have said, we are targeting to lower the growth of fixed OpEx from 2025 onwards. And you will see more operating leverage from that over the next few years. So this year, we'll still have some end finalization of some of the investments, for example, about some of the tech platforms. But then for next year, you will see more operating leverage coming in from all of those investments we have been making.
Operator: Your next question comes from the line of John Colantuoni from Jefferies.
John Colantuoni: Just wanted to ask about underlying room night trends. just talk about in the first quarter, the size of some of the transitory impacts that you called out like Easter shift, geopolitical disruption and the booking window and sort of how that shakes out to how you think about underlying trends in the business.
And second, on the attractions offering, can you talk about the investments that you've made so far and how your supply is today versus where you need it to be over time to sort of open up the full potential of that opportunity? And our understanding is that attractions are often booked closer to the trip date, which requires getting the traveler back to the app. Talk about how you're sort of looking to drive a solution to that dynamic and how the connected trip offering could help drive that behavior over time.
Ewout Steenbergen: With respect to your first question, room nights dynamics in the first quarter. So positives here compared to our original guidance for the first quarter were the fact that the booking window was expanding and that we're able to pull some room night bookings from the second quarter into the first quarter, healthy demand in Europe, and Europe was stronger than we anticipated, as we mentioned before, and less of an impact from the Middle East. And you saw excluding the Middle East impact, actually, the result was exactly the same. So there was no material impact from the Middle East. Easter was a negative, a small negative. But that was, of course, anticipated in the guidance that we provided before.
Glenn Fogel: So on attractions -- and it's a good question to ask because we haven't talked about it a lot in the past. Attractions is mostly supplied through third parties. So we have arrangements with companies like Viator, or a Klook or Musement. And we get the supply that way. In addition -- and we don't talk about this much at all either. We also have FareHarbor, which if you may recall, we acquired that. Think of it as the OpenTable for small- and medium-sized attractions because it's a good loop into those attractions.
We have priorities though. We can be anything, but we can't be everything, and we definitely can't be everything all at once. So the priorities have been to get the flight stuff up, get that one. It's the biggest thing, get that going well first. And then we have making sure that we have the ground transportation to make sure all that stuff is -- now our people have attraction. They also want to have a lot of emphasis, too, and they are doing a great job building that, and we've talked a little bit about that.
And that's going to come in as part of the overall connected trip because as you point out, people don't generally book their attractions far, far in advance. In fact, a lot of them want to book it when they're actually in destination, and that's why I love the fact of the increased amount of use of our app because that's like having your travel agent in your pocket and be able to -- we're able to send them great offers, great ideas where they go right to it, checks on the app and can they get something better.
And that's why we're bringing that into our Genius program for people to have an attraction business and want to get that incremental demand. We can push something to a customer who's in destination and give us on -- bring them to that particular supplier. All over, it's a tremendous opportunity down the road. We have yet to even really scratch the possibilities with that, and that's just another reason why I see just tremendous opportunity for us as we continue to roll on.
Operator: Your next question comes from the line of Ron Josey from Citi.
Ronald Josey: I want to ask maybe a follow-up on alternative accommodations here just given how much faster overall room nights are growing. And Ewout, you talked a little bit about this as well as Glenn, but I wanted to hear more about the supply side, the 7.4 million properties on the site. Are these higher quality than maybe what you've seen in the past? Are they differentiated from other platforms given -- that are available out there? And Ewout, you made a good mention earlier just that with Booking offering both alternative accommodations and traditional, that's an advantage. I'd love to hear your thoughts on what you're seeing from a consumer perspective, those that book both and then the mix between that going forward between those 2 bookings.
Ewout Steenbergen: So let me first take the second part of the question in terms of alternative and traditional accommodations. We're actually not so much separating in our thinking one versus the other because we believe that our unique proposition is that we're putting both in the same way on our platforms because it is an artificial separation as we are seeing many consumers are looking for both. They want to alternate -- look at different alternatives. They want to compare. And often, if they start to look for a traditional hotel, they maybe end up with an apartment they want to rent as an alternative accommodation or the other way around. So actually, the way we look at it is we think it's actually really strong to bring all of these propositions together and have a really a combined offering to our traveler customers.
Glenn Fogel: In terms of quality -- and I'd like to think that the inventory we have is high quality, obviously comes at different price points. It's a complete range. And you may not be surprised that lower-priced things may not be as luxurious the higher-priced things. And I think we cover the gamut, but we don't have enough of certain types in certain areas. And I've talked about this before. We're entering close to the summer, and I look at -- I live in the New York metropolitan area. And I'm looking, do we have enough of these high-end homes in the Hamptons? And I don't think we do. If I look at some of our competitors, I see more.
I look at that as opportunity for us, though, because we're doing so well. Yes, we don't have all the different types of accommodations and the quantity that I want to have in that. It's great that we are as big as we are, but I absolutely see no reason we shouldn't be significantly bigger throughout every geographical area. Look, our base was Europe. So we are very, very competitive. We have great inventory, all types there. But I've talked about the U.S., and that's an area we continue to do more work. And I mentioned earlier, I see us making great progress there.
Operator: Your next question comes from the line of Jed Kelly of Oppenheimer.
Jed Kelly: Great. Just following up on that last point, Glenn. How do you think about getting more of that single unit inventory? Is it connecting more with property managers, the PMS systems? And then my second question is, just how should we view the big events in Europe this year, this summer in travel, particularly around the Olympics impacting demand or how people would travel?
Glenn Fogel: Sure. So yes, and we definitely have -- you're not surprised of the fact that it's easier to get more inventory when you go to some of the managers who have significant number of the inventory you're looking for. And those multi-property managers are the place where we definitely assume more business. And we have not, until very recently, really spent a lot of time trying to do it in the low -- trying to go for individuals and trying to bring them in, too.
There's no doubt, though, over time, we have to make sure to make an effort to everybody. And that means being sure that we are providing a platform that a supplier really likes to use. And I saw something recent. Just to give you an example, turns out that until fairly recently, it was hard for some of our big managers to be able to reconcile the payments with individual properties. And we improved that significantly recently. And that's the reason, it was, okay, now I'll do that. And I can go through a whole bunch of different individual things that, well, by themselves may not be so big. As a whole, they end up saying, yes, I will now be more than happy to get incremental demand from Booking.com because I find it easy and helpful.
If somebody is going to make business to make money, you definitely never want to have your property empty. That's 0 revenue. You're never going to get back. That inventory expires. So that's why people are always looking to try and get more demand. As long as we provide them with demand and we provide them with a platform that they find easy and helpful, they will come to us.
In regards to the summer and things like Paris and the Olympics, stuff like that, it's always a mystery what's going to happen with the Olympics. So I've been here now 24 years. So I've been through a whole bunch of Olympics and thought it was going to be -- this is what's going to happen and then something else happens. Here's the big point. Let's not concentrate too much on one individual event to last for a couple of weeks.
I continue to say the important way to view value in this company in the long run. What have we done? What have we done over the last 24 years here? Continue to increase the value, bring in more customers and more suppliers and continue to produce more cash flow for our investors. That's the way we've done in the past and what we did in the past. And as far as how the Paris Olympics go, I really -- I can guess, but my guess is as good as yours. And I don't think that's something that I'd spend a lot of time worrying about.
Operator: Your next question comes from the line of Tom White from D.A. Davidson.
Thomas White: Just one. I wanted to follow up on some of the prior questions on the U.S. market. I was hoping you could kind of comment on maybe the relative unit economics of your U.S. accommodations business today versus in Europe. Obviously, the Booking.com brand here is well known but less well known than in Europe. And so maybe there's like a heavier kind of marketing load per room night here. But the ADRs here are nice and high. But then again, maybe the take rates are lower. So I'm just kind of curious directionally how accommodation kind of unit economics in the U.S. stack up versus Europe at the moment and maybe where you kind of see that going over the next few years.
Glenn Fogel: We don't disclose much more and giving you these regional growth rates. We don't go any further than that in terms of detail. And I don't think we'll be starting that right now. I understand your reason for asking, but for reason of competitiveness and such, we're not going to break this down any further than that.
Operator: That concludes our Q&A session. I will now turn the conference back over to Glenn Fogel for closing remarks.
Glenn Fogel: Thank you. I want to thank our partners, our customers, our dedicated employees, our shareholders, and I especially want to thank Ewout for joining the team. Ewout, thank you very much. We greatly appreciate everyone's support as we continue to build on the long-term vision for our company. Thank you, and good night.
Operator: Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect. Goodbye. |
MRNA | 1 | 2,024 | 2024-05-02 00:00:00 | Operator: Good day, and thank you for standing by. Welcome to Moderna's First Quarter 2024 Conference Call. [Operator Instructions] Please be advised, this conference being recorded.
I would now like to hand the conference over to the speaker today, Lavina Talukdar. Please go ahead.
Lavina Talukdar: Thank you, Kevin. Good morning, everyone, and thank you for joining us on today's call to discuss Moderna's First Quarter 2024 financial results and business updates. You can access the press release issued this morning as well as the slides that we'll be reviewing by going to the Investors section of our website.
On today's call are Stéphane Bancel, our Chief Executive Officer; Stephen Hoge, our President; and Jamey Mock, our Chief Financial Officer.
Before we begin, please note, this conference call will include forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Please see Slide 2 of the accompanying presentation and our SEC filings for important risk factors that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements.
I will now turn the call over to Stéphane.
Stéphane Bancel: Thanks, Lavina. Good morning or good afternoon, everyone. Thank you for joining us today. I will start with a review of our business. Jayme ill then present our financial results. Stephen will review our late-stage clinical programs, and I will close by sharing our 2024 commercial priorities and major upcoming milestones.
Our COVID vaccine has already impacted hundreds of millions of people. I'm excited by the progress we've made with our pipeline that has the potential to impact many more people.
During the first quarter, we presented substantial clinical progress during our Vaccine Day, with exciting data on EBV, VZV and Norovirus. In addition, along with our partner, Merck, we expanded studies for Individualized Neoantigen Therapy, INT into 3 new indications.
In addition, through ongoing Phase III studies in adjuvant melanoma and adjuvant non-small cell lung cancer, a Phase II/III study has started in neoadjuvant, adjuvant, cutaneous squamous cell carcinoma, another form of skin cancer.
Phase II clinical trials have started in adjuvant bladder and adjuvant kidney cancer. Together, our vaccines and therapeutic portfolio have a potential to impact hundreds of millions of people each year.
I am pleased with our Q1 performance. Since the beginning of the year, we announced 4 important business agreements and collaboration. We entered into a nonexclusive IP out licensing agreement with a leading pharmaceutical company in Japan. The agreement includes an upfront payment and low double-digit royalty to Moderna on net sales of our COVID key products marketed in Japan by this company. It is nice to see a company recognizing our IP and our figures for our license.
Second, we recently announced a contract to provide 4.5 million royalty of COVID-19 vaccine to the Ministry of Health in Brazil. I am very pleased with this partnership as it is the very first time that Moderna works with a broad environment, and we look forward to providing these doses to protect people in Brazil as they go into their winter season.
We announced the project financing program for up to $750 million in funding to Blackstone to further develop our flu program. We also made public our collaboration with OpenAI to use AI as a transformative tool to increase speed and efficiency and ultimately to improve patient outcomes across our business.
Finally, we agreed with Metagenomi to terminate our gene editing collaboration. All rights granted under the collaboration will be returned to Metagenomi. This is a good proof point of Moderna's continually aim to prioritize our investment for our best opportunities to drive returns.
Turning to Q1 financial results. In revenues, we were ahead of our plans at $167 million, reflecting a highly seasonal nature of our respiratory vaccine business. The net growth was $1.2 billion. We ended the quarter with $12.2 billion of cash and investments.
We communicated during our November call, our focus on financial discipline. I am pleased with what the team has achieved with our operating expenses, cost of manufacturing expenses plus cost of R&D expenses plus cost of SG&A expenses were down almost $800 million in Q1 2024 versus Q1 2023. Jamey will elaborate on this in his section.
With that, I will now hand over to Jamey.
James Mock: Thanks, Stéphane, and hello, everyone. Today, I will walk you through our financial performance for the first quarter and provide commentary on our 2024 financial framework.
Let me start with our commercial performance on Slide 8. Net product sales for Q1 were $167 million, down 91% year-over-year, mainly driven by lower sales volumes of our COVID-19 vaccine in regions outside the United States. This decline aligns with the anticipated transition of the COVID-19 vaccine market or it's a seasonal pattern, whereas in the first quarter of 2023, we primarily delivered doses that were deferred from 2022.
Q1 was driven by sales in the U.S. and the Rest of the World, largely Latin America markets. For Q2, we expect about $100 million in sales for a total of approximately $300 million in the first half of 2024. Q2 will include a portion of our recently announced contract with Brazil.
Moving to Slide 9. Net product sales were $167 million, as I just explained. For the first quarter of 2024, our cost of sales was $96 million, which included third-party royalties of $8 million, inventory write-downs of $30 million and $27 million related to unutilized manufacturing capacity and wind out costs.
This resulted in our cost of sales representing 58% of net product sales, up from 43% in the same quarter last year. The increase in cost of sales percentage was primarily due to the lowest level of sales in the quarter. We continue to expect the full year cost of sales to be approximately 35% of product sales. However, due to the strong seasonality of our business, we expect a higher percentage in the first half.
Moving to our R&D efforts. Q1 R&D expenses were $1.1 billion, reflecting a decrease of 6% year-over-year. This reduction was primarily due to the absence of upfront collaboration payments being made this quarter. The upfront payments made in the first quarter of 2023 were related to our strategic collaborations with Generation Bio and Life Edit Therapeutics.
With the Q1 spend of $1.1 billion, we are tracking towards the full year expected spend of approximately $4.5 billion. Q1 SG&A expenses were $274 million, marking a 10% decrease year-over-year. Importantly, this decrease was driven by all functions in SG&A, and it is a result of our strong focus on cost discipline and strategic investments, driving productivity. I will provide additional color on the next page.
We reported an income tax expense of $10 million for the first quarter of 2024 compared to an income tax benefit of $384 million in the same period last year. The shift is primarily due to the continued application of valuation allowance on the majority of our deferred tax assets, which we first established in the third quarter of 2023.
Net loss for the period was $1.2 billion compared to net income of $79 million last year. Diluted loss per share was $3.07 compared to diluted earnings per share of $0.19 in 2023. We ended the first quarter with cash and investments totaling $12.2 billion, down from $13.3 billion at year-end 2023, largely attributable to research and development expenses and operating activities.
Moving to Slide 10. I want to take a moment to elaborate on the efficiencies we are now seeing across the company. As a platform company, we have the opportunity to build a unique operating model. And over the last few years, we have invested purposefully into people, processes and technologies to build foundational capabilities that will allow us to scale efficiently.
First, we ended 2023 with nearly 6,000 employees, up from 1,300 at the end of 2020. Every function scaled capabilities to enable the increasing product launches we expect over the coming years. Additionally, as you know, Moderna has always led with a digital-first mindset. Over the past 3 years, we have nearly doubled our built-for-purpose software applications to digitally enable our teams.
As an example, we recently went live with the newly implemented rebuilt ERP system. SAP S4/Hana is our new digital backbone for all our operational activities. We have used SAP in the past, however, it was built for a research and development-focused company. And now we have implemented an entirely revised version, supporting our end-to-end business processes more effectively and efficiently.
Another example is our rapid adoption of artificial intelligence. Over the past year, we have built over 750 GPTs. One example in the legal space, our contract companion GPT streamlines the task of reviewing and summarizing contracts across the business. With the GPT providing step-by-step guidance to craft a tailored and insightful salary.
This enables any function to extract critical insights on contracts whenever needed, minimizing bottlenecks and freeing up Moderna's legal department to focus on work of higher strategic value, thus enhancing operational efficiency and decision making.
Another example in G&A is a big purchase of paid GPT for all questions around our procurement and payment processes. Instead of our employees having to find and read policies and procedures, they can easily query to GPT. It also saves time for our procurement and payables teams from answering numerous questions.
AI has already been a good chance for win in short period of time. In general, we see the areas helping incredible speed that allows for an unprecedented impact on productivity and many more. We have rolled out a comprehensive training program and are committed to driving this technology breakthrough.
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As a result of these strategic investments in the people, processes and technology, we were able to significantly reduce purchase services and our use of external consultants, which contributed heavily to the 10% year-over-year reduction in SG&A spend. We are also seeing similar benefits in R&D and manufacturing.
In general, we now have a solid foundation with our operating model. As we continue to grow our commercial activities, we will need to further invest, however we will be able to do that more efficiently.
Now let's turn to the 2024 financial framework on Slide 11, which is in line with what I shared on our last earnings call in February. We continue to expect net sales for 2024 of approximately $4 billion, which we think will be a low point as we expect to return to growth in 2025.
Sales in the first half of the year are now expected to be approximately $0.3 billion. We continue to expect cost of sales of approximately 35% of product sales for the full year. For R&D we continue to expect full year expenses to be approximately $4.5 billion, down from $4.8 billion in 2023.
For SG&A, we continue to expect full year expenses to be approximately $1.3 billion down from $1.5 billion in 2023, and we expect taxes to be negligible in 2024 and capital expenditures in 2024 to be approximately $0.9 billion.
Finally, we expect to end 2024 with approximately $9 billion in cash after touching a low point of approximately $8 billion at the end of Q3, due to the seasonality of collections.
Finally, let me also touch on our recently announced project financing deal with Blackstone, which we are excited about. In March, we entered into a development and commercialization funding arrangement, which commits Blackstone to providing us with up to $750 million of funding for our flu program, so that we can strengthen the product label and fulfill our remaining regulatory applications.
Subject to the regulatory approval in the United States, which depends on data from the funded activities, Blackstone will be entitled to receive up to $750 million in sales milestone payments. These milestone payments are contingent upon achieving specified cumulative net sales targets for our future influenza and combination vaccines.
Additionally, Blackstone will earn royalties on applicable net sales at a low single-digit percentage rate. This funding will offset our R&D expenses and is factored into our R&D framework for the year of approximately $4.5 billion. Overall, we are excited that this deal enables us to accelerate the advancement of our pipeline.
And with that, I will now hand the call over to Stephen.
Stephen Hoge: Thank you, Jamey. Today, I'll review updates from our clinical programs that were shared during our recent Vaccines Day, as well as new developments in our therapeutics portfolio.
Starting with respiratory vaccines. We shared updates to many of our respiratory programs at Vaccines Day in March. Our RSV vaccine in Canada is undergoing regulatory review in multiple countries. And pending approval, we expect to launch the product in the United States following the June ACIP meeting and recommendations this year.
At Vaccines Day, we shared updates from co-administration studies of RSV, confirming the ability to administer our vaccine and other vaccines given during the respiratory season.
With our flu program, we recently presented data from our Phase III P303 study at ECCMID and continued discussions with regulators globally towards the goal of filing this year. For our next-generation COVID vaccine, mRNA-1283, we have presented positive Phase III safety and immunogenicity data and are engaging with regulators on the path to approval for that product. Our combination flu and COVID vaccine, mRNA-1083 is in Phase III, and we look forward to sharing those clinical data in the current quarter.
Turning now to our leading and other vaccines. As shared at Vaccines Day, we've had -- we've made significant progress in this portfolio. Our CMV vaccine, mRNA-1647, has fully enrolled its Phase III trial, and we have the potential for an interim analysis of efficacy this year. We announced positive Phase I immunogenicity and safety data from our EBV vaccine candidate, mRNA-1189, and we are now advancing towards pivotal trials with that program.
A second therapeutic EBV candidate, mRNA-1195 is in a separate ongoing Phase I study. mRNA-1468, our vaccine against varicella-zoster virus showed strong immunogenicity, including strong T cell responses, and we are preparing to move that program forward towards a pivotal Phase III study as well.
And our HSV vaccine against Herpes simplex mRNA-1608, is now fully enrolled in its Phase I/II study, and we look forward to sharing clinical data updates when that's available. Now rounding out this portfolio, we presented the positive clinical data from our norovirus vaccine candidate, mRNA-1403 and shared that we are advancing that program towards its pivotal Phase III trial.
Turning now to Oncology Therapeutics. We are happy to report our ongoing Phase III studies are enrolling well. We were excited to announce 3 new INT trials, including a randomized Phase II/III study in neoadjuvant, adjuvant cutaneous squamous cell carcinoma; a randomized Phase II trial in adjuvant high-risk muscle invasive bladder cancer; and lastly, a randomized Phase II trial in an adjuvant renal cell carcinoma.
Now recently at AACR, we presented Phase I data from our INT program in advanced unresectable HPV-negative head and neck cancer in the metastatic setting. At AACR, we also presented Phase I translational data from another oncology therapeutic program, mRNA-2752 in various tumor types. Links to both of these presentations are provided on the slide.
Now as a final note, at ASCO, we'll be hosting another Moderna oncology event on the evening of June 3, and we look forward to seeing you there or having you join us virtually.
With that, I'll turn it back over to Stéphane.
Stéphane Bancel: Thank you, Stephen and Jamey. Slide 18 is an overview of our COVID-19 strategy for 2024, which is focused on the need of each 2 region.
In the U.S., our focus is working with public health officials, health care providers and pharmacies to increase vaccination coverage rates. In Europe, we are actively participating in the 2024 tender process. The tender allows for up to 36 million doses per year for up to 4 years. And in the Rest of the World, we have reoriented our commercial teams to prioritize markets for greater commercial focus and impact.
As mentioned earlier, the Brazil contract is an example of how this is working. In the fall of 2023, U.S. COVID vaccination rates lagged behind flu-vaccination rates. U.S. COVID vaccination rates were 11%, with flu vaccination rates at 4x that. And yes, COVID continues to show a higher [indiscernible] dieses.
U.S. operation for COVID began October 2023. And last week, we have 424,000 people, which is markedly higher demonstration from either flu or RSV infection. Actually, COVID operations were around the same level as [indiscernible] of flu plus RSV combined.
In addition, long COVID continues to be a serious risk to many healthy young adults in their 20s, their 30s, their 40s are losing lung capacity and the mental capacity due to long COVID. The data shows that COVID-19 vaccine reduced the risk of long COVID by 70%.
We believe education and awareness will be very important. We are working on educating consumers about the need for an annual COVID vaccine, just like flu. Too many people are getting hurt when we have safe and effective vaccines available. Our job will not stop until these vaccination numbers come down significantly.
As you know, strength selection by health authorities received approval and launch of COVID vaccine. Health authorities including the WHO and EMA in Europe, have recently selected the JN.1 strain for the 2024-25 formula. The FDA will launch the [ real fast ] meeting on May 16 to select the strength for the U.S. market.
Moderna has already manufactured JN.1 drug substance to support the potential August launch. We have also prepared for backups in case the FDA does not select JN.1. In 2023, COVID vaccines were available 5 weeks later after 2 vaccines. In the recent channel alone, more than 3 million flu vaccines were administered before the updated COVID vaccines were available.
As we look into the fall 2024 season, we see the potential to align the timing of flu and COVID vaccine approvals. We are encouraged by the earlier [indiscernible] meeting for this year's COVID trend selection versus last year. And we're working here and [indiscernible] for timely COVID approval. We expect higher vaccination uptake if COVID vaccines are available sooner.
Turning now to the anticipated launch of our second respiratory vaccine, or RSV vaccine, which is expected to launch into a large market. In its first year, the older adult RSV market was $2.5 billion in sales, and analysts expect the older adults' market to grow between $6 billion and $8 billion per year. With marketing application filed in markets globally, we are anticipating approval beginning in the first half of 2024. In the U.S., we're targeting a launch after the June ACIP meeting.
We are very excited to bring a product from a strong differentiated profile to market. Our vaccine has a strong efficacy and safety in clinical trials, and we'll be the only product available in the pre-lled syringe or PFS presentation.
Let me now double-click on what we believe are the benefit of PFS. We recently published a time and motion study that shows faster preparation time for PFS relative to vaccines that require constitution. We call that both RSV combination vaccines on the market require multiple steps to prepare their vaccines for administration.
One vaccine requires process and the overall next steps to prepare. Our PFS presentation is ready to use vaccine straight out of the box. The study from the PFS presentation to be 3x to 4x more efficient as measured by preparation time. Details from the study can be found through the link on the slide.
We believe our PFS presentation for RSV vaccine has the potential to ease the personal burden on pharmacies during the fall respiratory season. The pharmacy chains [indiscernible] independent pharmacies and we're looking forward to the launch.
Let me close with major upcoming pipeline milestones. While we're excited about the commercial prospects for the year, we're even more excited about the upcoming pipeline milestone and the effect they will have on our commercial outlook for the next several years serving patients.
In respiratory vaccines, we are eagerly awaiting the approval of RSV and the [indiscernible]. We are also waiting for data for RSV in the age group 18 and above. We are in discussion with regulators on our flu program and intend to file in 2024. We won next-gen COVID vaccine and on [indiscernible], we are pleased with a positive Phase III immunogenicity data and are engaging with regulators. Our flu plus COVID vaccine combo should get this Phase III data soon.
In latent with CMV fully enrolled and at current cases, we look forward to potential for Phase III data efficacy data in 2024. In our INT program, we're looking forward to completion of enrollment for Phase III adjuvant melanoma study. In addition, we are keen to discuss the possibility of accelerated approval with regulators based on Phase II study data.
As we shared before, there are 3 things we view as necessary before we could consider pursuing fed approval for INT. First, durability data from our Phase II study, which we announced in December last year; second, a substantially enrolled Phase III adjuvant melanoma study; and third, manufacturing readiness at the Marlborough site. And last but not the least, our revenue portfolio, we look forward to initiating pivotal study for PMMA.
This milestone will represent continued progress towards our mission to deliver the greatest possible impact to people for mRNA medicines. And asModerna, we are dedicated to achieving them all. Every data continues to confirm the power of our platform and its breadth in the service of patients. Two important save a date for your calendars. We will discuss our COVID program in Chicago on June 1, and our annual R&D Day will be held in New York the morning of September 1.
Thank you for listening, and we look forward to taking your questions. Operator?
Operator: [Operator Instructions] Our first question comes from Salveen Richter with Goldman Sachs.
Salveen Richter: Firstly, could you discuss your strategy for pursuing contracts for the RSV vaccine given 2 approved vaccine sort of have a head start, timing-wise? And help us understand, as you've communicated with large retail pharmacy, how significant the PFS formulation is to them?
And then secondly, with regard to moving into the 3 new indications for the INT program. Maybe help us understand signals or specific data points that support that?
Stéphane Bancel: On the RSV contract. So as you know, we are not allowed to contract until the product is approved by the regulators. But what we are doing, because we can do that, is our medical teams are actively engaged with retail pharmacies, but also IV and hospital networks in terms of making sure the data on the efficacy profile of the product, on safety, and of course, in the PFS and the benefit of PFS in terms of productivity. Those discussions are ongoing literally on a daily basis, including with leadership of those pharmacies. And the next step, of course, is to wait for the FDA approval. Stephen?
Stephen Hoge: Yes, sure. So thanks for the question. So on the 3 additional INT indications, I think the short version of it is they are all adjuvant settings. Similar to our melanoma Phase II results have been so encouraging, where KEYTRUDA has a known benefit and where we still believe that there's an opportunity to improve on that by driving a specific T cell response with INT.
And so as you know, in Phase I, we looked across a range of different indications. That was more in the metastatic setting. But as we've announced since we first saw that positive Phase II results from melanoma, we have been aggressively pursuing adjuvant indications where IO is approved and where we see an opportunity. And all 3 of these fits squarely in that space.
Operator: Our next question comes from Michael Yee with Jefferies.
Michael Yee: Two questions as well. On RSV, I guess, the competitor GSK as well this week was commenting about how they're expecting you to be in the mix and contracting is ongoing. I know you have some RSV in your guidance. I think the math implies maybe hundreds of millions of dollars. Can you just perhaps comment on how you adjusted, or probability adjusted or thought about how much is there in your guidance and your confidence on that for this year?
And then secondly, on INT as well. I know you had some data at ASCO. I know you have breakthrough therapy and prime designation. How important is the Phase III enrollment progress, the confirmatory study? I feel like that's always an important discussion with FDA. So how important is that progress before you can really engage with FDA?
James Mock: Yes. Maybe I'll take the first one. Thanks, Mike, for the question.
So as you may know, we haven't guided any specific guidance or number for RSV. In the past, we did break down the $4 billion into 3 different segments around the U.S. market, the APAs we walked into the year with and then another category of other COVID sales that didn't have any APAs across the rest of the world, a good example is Brazil that we just signed, as well as RSV. So no specific guidance for RSV from a financial perspective.
Stephen Hoge: And your question on INT. I think you nailed it, it's a really important topic, and in particular right now, as we think about accelerated approval that we demonstrate the diligence and substantially enroll the confirmatory study. So really all you're waiting for is for that study to mature, it could be several years.
We think it's really important. To be fair, we have not consulted with the agency on that yet. As we've said, we're waiting until we crossed our own threshold. And also at this point, until we've established the manufacturing facility with that line of sight to that.
But we do feel that, as we've said, substantial enrollment demonstrating that essentially all you're waiting for is the readout on that confirmatory study is our obligation before we even want to go forward with that question.
We are making great progress this year, and we're optimistic that both that and the facility will be available in short order. And then, of course, we'll want to start engaging with our data, including the FDA on the question of accelerated approval.
Operator: Our next question comes from Terence Flynn with Morgan Stanley.
Terence Flynn: Great. Maybe two parts for me. Just on the RSV vaccine. Can you provide your latest perspective on what the most likely ACIP recommendation will be? Will you get a parity recommendation to the competitors? Or do you think there's a potential for a differential recommendation here?
And then just wondering any update on your ongoing conversations regarding filing your seasonal flu vaccine? I know you mentioned in your prepared remarks, but just any more insight in terms of what the gating steps are here.
Unknown Executive: Thanks for both questions. So first on RSV, caveat by saying we have to complete the approval process with FDA. And then at the end of the day, the recommendation really falls to ACIP and the committee members, so I defer to them.
Our expectation, our hope is that when they review the data package that we already have as well as additional data that we expect to be able to share at the ACIP meeting on durability through a second season, on immunogenicity across other populations, we expect a parity recommendation. We certainly think the data supports that. But again, I'll defer to the committee members on the ultimate decision.
Stephen Hoge: On the question of flu, we are actively engaged right now on the -- with regulators on the process for submission of the flu vaccine. As I mentioned a moment ago, we are also closing in on clinical data from our combination flu COVID vaccine, mRNA-1083. And that obviously has an important role in our engagement with regulators, generally on flu versus flu COVID combination.
And so those discussions are ongoing. I won't provide any other update on it except to say, as we've said today, and we will continue to say we expect to file the flu product this year, but it will be dependent upon a number of considerations plus we also including the [indiscernible] data that we expect to see soon.
Operator: Our next question comes from Eli Merle with UBS.
Eliana Merle: On CMV, how are you thinking about the need or benefits of potentially boosting both from a clinical as well as a commercial perspective? And if you would study those? And then second, just on CMV, if you don't meet the interim, the analysis there, would you disclose that?
Stephen Hoge: So first, on the question of boosting. So far, what we have -- we obviously don't have the efficacy readout. That's the Phase III study is ongoing. But we do expect to have quite substantial durability data on immunogenicity. And it's quite possible that the efficacy data will give us a signal what the core of production could be.
And so we don't, right now, have any evidence they're not good, durable, multiyear, possibly as long as 5 years, we continue to track the immunogenicity protection. It's possible that will extend out to 10 years and then some boosting is necessary. It's also possible that we decide that a booster might be necessary shorter term in that, let's say, 5 years or 10 years.
We just don't know at this time. And so at present, the data we do have on the durability of the immunogenicity, it looks quite strong. And so we do think our 3-dose series will likely be protective for a very long period of time, all subject to the efficacy data that you just referenced.
So on the interim analysis for efficacy, as we've said before, we're making great progress in that study in accruing cases, and we do expect to be able to provide an update on -- or conduct at least an initial interim efficacy analysis this year.
Because of the rate of case accrual and also because the protocol calls for us to cross a median of 1-year follow-up, the timing may be sets -- by the time we get to that first interim analysis, we are also have enough cases for a final analysis or that a final analysis is imminent. Let's say, it's a very short period of time away.
And so because of that uncertainty, until we see that data and understand how close we are to that final analysis, I don't think we can commit, one way or the other, whether we're going to be updating, it will really depend upon the data we see and then how quickly we expect to get that final analysis.
At the end of the day, if we have news to share both on interim and the final, we, of course, will, but I don't think we can commit at this stage because we haven't seen the data yet.
Operator: Our next question comes from Hartaj Singh with Oppenheimer.
Hartaj Singh: Great. I just have a question on -- you're developing a refrigerator stable vaccine and flu vaccine, I believe. And I'd just like to kind of understand how you think about that. When could that get approved? And then will the combo vaccine also be refrigerator stable?
Stephen Hoge: Great. [indiscernible]
Operator: [Technical Difficulty] Ladies and gentlemen, please stand by, your conference will resume momentarily. Once again, ladies and gentlemen, please stay on the line.
And pardon me, can you all hear me now? Could you try speaking again? Your line was muted.
Unknown Executive: Yes, I'm here. Can you hear me?
Operator: Yes, we can hear you now. So your line got muted, but you can go ahead and continue.
Stephen Hoge: Right. Sorry for that brief interruption. So Hartaj, thank you for the question. Just to quickly restate what I was saying. The -- all of our respiratory portfolio, RSV, flu, COVID and the flu COVID combo are being developed towards refrigerator stable PFS. And so our mRNA-1083 program, the flu COVID program as well as the flu program are intended to be a refrigerator stable prefilled syringes. As Stéphane mentioned a moment ago, we really view that as the ideal presentation, the helpful presentation for health care providers really around the world to facilitate their delivery of the vaccine to patients.
Operator: Our next question comes from Gena Wang with Barclays.
Huidong Wang: I have two. One is regarding COVID. So for the EU, you said up to 36 million doses every year in EU. What could be the scenario you can get 36 million doses in EU? And also the price in Brazil and the EU, should we use pandemic price of $25 to $30 per doses at the benchmark?
Quickly on R&D, accelerated approval path. Based on, say, today's comments and the prior discussion, our impression is you could achieve all the 3 key components by the end of this year. Is Merck is also fully on board to submit for the accelerated approval in melanoma?
Stéphane Bancel: Gena. It's Stéphane. I'll take the COVID question and then Stephen will talk about INT. So the tender is up to 36 million doses, will depend on a number of countries that apply to the tender through the EU. So this, we'll know at the end of the process. And as it's a tender process so there is no dialogue, we're just entering all the files and all the data, and that's really ongoing. The team is obviously very active on it.
And on price, for obvious competitive reasons, we're not going to share price in any market to -- because competitors will know the price right away. Stephen, INT?
Stephen Hoge: Yes. So we haven't specifically guided to when we expect to complete, obviously, the second and third parts of our 3-part criteria. That being manufacturing readiness, as you can imagine, work is going on around the clock as well as the enrollment we've made great progress, but we have to sustain that progress.
On your question of where is Merck on this. I think you'll have to direct it to them. Our view is that if we're able to get to the point where ancillary approval is appropriate and regulators are supportive of that, we can't imagine why ourselves and Merck wouldn't want to make the product available to help people suffering from cancer right now.
But the contingencies, there are, obviously, we have to do our work and our doses this year. And then ultimately, we have to speak to regulators, and they get to decide whether that pathway is available to us. And so I think for both ourselves and our partner Merck, we want to defer to regulators ultimately on that choice.
Operator: Our next question comes from Luca Issi with RBC Capital.
Luca Issi: Maybe a very quick one on RSV. I think the last press release actually cited May 12 as the PDUFA date. While today, you're simply saying the initial regulatory approvals in the first half of '24. So is there anything to read to it? Can you just confirm that the PDUFA date is still May 12, which is actually the end of next week?
And then maybe second, on IP, can you just comment on the recent decision by Judge Goldberg to rule out, obviously, [indiscernible] or you're looking on a particle. Our understanding, this can have pretty material impact on both prior and future sales of COVID. So again, any thoughts there, much appreciated.
And then super quickly on INT. Stephen, what's holding you back on starting the randomized trial intended to cancer into metastatic static? I thought the data they see that was pretty impressive. So any thoughts there, much appreciated.
Stephen Hoge: Great. Perfect question. I'll take this first from the third very quickly. So on the function of RSV, we continue working towards the same PDUFA date, and there's no change to that. As you know, there's a lot of work and around the clock work by ourselves, obviously, and folks at the agency.
And so we're hopeful that, that happens as planned, but if it takes a little bit longer, at the end of the day, what really matters is the duty for [indiscernible] meeting, but there's been no change to report. So don't read anything into that.
As far as the INT question, on head and neck, I appreciate the question because we are also obviously enthusiastic about that data. However, our partner, Merck and ourselves, we have not yet decided where that fits in the priority of other indications, pathologies and opportunities we're pursuing.
As you've already seen in the past year, we've stood up a very large number of study. And we're just trying to pace ourselves. And so it will take us a little bit of time with our partner, Merck, to determine what the next steps are in head and neck. And at this point, we do not have an update on.
Stéphane Bancel: And I'll take the IP questions. I mean as you know, our COVID-19 vaccine technology, including our lipid nanoparticle delivery system is the result of independent research and development. We have a strong belief that our technology does not impact on the patent asserted by [indiscernible]. We are confident in our position, and we look forward to presenting our case after next year.
Operator: Our next question comes from Jessica Fye with JPMorgan.
Jessica Fye: I had a few here. So for INT, I know you mentioned you can't comment on when you expect to complete the manufacturing scale up. But can you provide a status update on where you stand with that today, and the number of patients you can support right now as well as where you want to take that capacity once you get to the end of this 3-phase scale-up process, even if you don't put a timeline on when you'll get there?
Next one is coming back to flu. Can you just refine a little bit when the 1083 immunogenicity data will be available? And maybe elaborate on how the combo data play a role in the regulatory talks on 1010. I thought you previously said these products could stand on their own. And that you might not need 1010 approved to get 1083 approval. So now wondering kind of why 1083 might factor in for 1010.
And then lastly, on CMV, can you remind me how the risk of CMV and pregnancy compares in seropositive versus seronegative individuals. I'm thinking from a commercial standpoint, how you weigh the strategy of pursuing vaccinating everyone versus just seronegative people.
Stéphane Bancel: Great. I'll start with the INT question on manufacturing, then Stephen can add around [indiscernible]. So we have not provided some capacity numbers of the factory in Marlborough. But of course, as you can assume, we now the size of melanoma market. And we know our stronger data. We [indiscernible] people benefiting from the Phase II data.
So we've sized the plant accordingly, as you can imagine. But also, we are building the plant for care because, as you know, Stephen and his team and his colleagues are running a lot of studies. So this is not a platform in [indiscernible] a plant for INT. Again, from a manufacturing standpoint, we don't care which cancer is in terms of organ because we use genetic information to design an individual product for every human being.
So basically, we bought a plant last year that was kind of -- is a big building finished, saves us time to market. Obviously, we don't have to get the permitting and build the building. And so the team since then, that is now more than a year ago, has been working actively to get the plant ready.
And the plant is on the building in modules inside the building. So basically, we're going to launch with the first module of manufacturing capacity. And then -- and one day maybe we do an opening of a facility like we did for [indiscernible]. You will see that there's another empty space left behind, which has also a very quick ramp-up because the HVAC system and all utility system has been set up for the entire plant. And so then you just add modules as you go. So we'll be able to scale very quickly as we get more indication available.
But again, we're aware of the melanoma number of cases. And so the plant will be sized so we make sure we can provide products to patients. Stephen?
Stephen Hoge: Thank you for the clarifying question on flu. So let me just start by saying that independently, we are looking to submit both the flu program and the flu COVID combo program. So that's 1010 and 1083. Obviously, we need to see the 1083 data, and we'll announce that when we have it.
The question on the timing of that data, it's imminent. And so in the coming quarter, we expect to be able to share that update. The point about interdependency, I suppose, is just more about sequencing of those submissions and in some places and some regulatory geographies, obviously, you can't stack them on the same day if you will. There's a logical sequence.
And what we want to assess once we see the 1083 data is our regulatory strategy as well as our preparation and delivery of data for the submissions to determine which one will go first or second. But at this point, we're trying hard to make sure that we can do both products across all of our major markets, if the data is filed in this year.
And so we'll go more on that as we move forward. But for now, we are proceeding without independently. Sorry for the confusion model.
On the question of CMV and seropositivity. So it's a really important point. Thank you for raising it. But while the majority -- well, the risk of vertical transmission of CMV to pregnancy to the fetus is highest in seronegative. It does happen in seropositives as well. So congenital CMV is a disease that's seen in -- particularly in reactivation or sometimes reinfection, even in the seropositive context. And so we do believe that there's a potential for benefit for a vaccine even in seropositive population.
We are evaluating the study right now in seronegative because the rate of that transmission and obviously, the potential to prevent against infection is more enriched and therefore the study size, primary are focused on seronegatives.
But we are looking. We have studied the vaccine from a safety perspective in seropositives. And we are looking at things like [ Sheng ]. If you draw a little bit of an analogy to correlate to the EVB data that we've already put out there in a different virus, but we've been able to show that we can really control the rate setting even in seropositives [indiscernible] qualifiers.
And so we have some reasons for optimism and believe that when we pull together the totality of the data, there will both be the obvious potential benefit, which is that there is still vertical transmission in seropositives and some -- potentially some data on the rate of [indiscernible] that would be supportive to that.
Ultimately, though, we're studying all the way down to 16-year-olds. And our goal will be a label that 16 plus, with the goal going into a population that is not as highly seropositive as it is later in life and therefore, we see a very large opportunity, improvement, and then primary infection CMV with the vaccine and the potential for [indiscernible] seropositives [indiscernible].
Operator: Our next question comes from Geoff Meacham with BofA.
Alexandria Hammond: This is Alex Hammond for Geoff Meacham. So on your [ zoster ] vaccine candidate, when should we receive updates on your pivotal strategy? And is there any color you can provide today in terms of your current thinking on the Phase III design?
And then our second question is on the PA and MMA programs that are advancing into pivotal trials, can you provide any thoughts on the nature of editorial and the comments on safety?
Stephen Hoge: Yes. Could you describe about the first part of the question was on which program? The zoster?
Alexandria Hammond: The zoster, the shingle.
Stephen Hoge: Shingle zoster. So on the [indiscernible] program, we have -- we're obviously very excited by the Phase I data, which was compared against a licensed product, and we saw really strong T cell response in immunogenicity. And generally, we've been in that across our programs. But in that one, it was very encouraging.
We're in the process right now of trying to find the pivotal strategy. That will include, obviously, dose selection, the number of doses in that study and then how we're going to expect that study.
We do not have an update till today on what that will look like in addition to our own thoughts on it, we obviously want to consult with regulators before we finalize that [indiscernible]. But we are moving for forward -- towards a pivotal study in PCV. We do not have a [indiscernible] on that update yet.
As it relates to MMA and PA, the clinical data that we have continues to show a compelling benefit risk profile, good safety profile. In fact, in the PA studies, we have many folks who've been in those -- in the study on drug for well over a year. And over 30 years, I think, from our last update in overall patient dosing experience.
So we are starting to get a very clear perspective on the safety profile. The editorial question, I don't have a view on editorials or opinions based on the preclinical data. I think we stand behind the clinical data that we have and are quite encouraged by that profile, and we'll continue to watch it closely in our ongoing Phase I studies, but we do not have any specific or new concerns based on the clinical data today.
Operator: Our next question comes from Evan Wang with Guggenheim Securities.
Boran Wang: Two for me. First, on the combo 1083 program, so data, it sounds like this quarter, I believe enrollment was completed a few months ago. So I guess how comprehensive will the top line update be in terms of follow-up? And then with submission, is longer-term vault needed there? And are there parallels from 1010 that we can take in terms of regulatory filing speed for 1083? Or is that more impacted by the decision for buying one or the other first?
And then second, on RSV, it's kind of early ahead of approval, but with some international markets, it seems that's more nascent in terms of established some reimbursement there. So I guess how are you thinking about positioning internationally?
Stephen Hoge: Great. So for the 1083 data, yes, on this quarter, and I would say that we're -- we enrolled the majority of the 1083 studies you know last fall. And the 1010 second-generation study. So we talked about the P303 study. The first part of that enrolled over last summer, just a few months before the combo study.
And the second part of it, there was a part B and C, as you know, looking head-to-head against [indiscernible], that actually enrolled the same time as the 1083 study last fall. And so they've been actually kind of tracking right on top of each other.
I think we're going to wait to see the data before we can provide growth guidance on timing. But obviously, we're -- we've been working towards that flu COVID combination product for a while, and we will want to make sure that we get that filed, if it is positive as fast as possible.
I wouldn't draw too many, because of the difference in the structures of the study between the P303 study, which has a part A and the B and a C, and the 1083 study, which was done very quickly. I wouldn't draw too many correlations between [indiscernible] reading out and the timing for submission on [indiscernible].
Stéphane, do you want to take the RSV question?
Stéphane Bancel: Sure. So with internal markets, obviously, very important, the U.S. is very important, the U.S. and Russia also super important. As we shared before, we found in all the major geographies already. Of course, EU, U.K., Canada, Australia, some countries in Asia, some countries in the Middle East.
RSV is well known by public health leaders like it is in the U.S. So I think that there's a very strong desire, again, to protect the elderly or what we are doing here in terms of true COVID RSV, that's becoming very kind of a standard that probably [indiscernible] across at least the developed world. But even in developing countries, there's more and more interest as you see aging population everywhere.
So it's not only the U.S. approval that we expect coming soon is we have several geographies that would start being approved so.
Operator: Our next question comes from Simon Baker with Redburn Atlantic.
Simon Baker: Two quick ones, if I may. Just in terms of the timing on the CMV interim data. You said this quarter, it could be as early as the end of '24. That sounds slightly later than you previously said. I just wondered if that's me over-interpreting the semantics or whether there is a slight delay there?
And then the second question is on the HSV vaccine. Previous quarters, we talked about the EBV vaccine and the potential utility in multiple sclerosis. So I just wondered what your thoughts were about HSV and it's the hypothesis that implicates it's role in Alzheimer's disease?
Stephen Hoge: So first on the clarification. There's no change to our expectations on when the CMV readout will happen. I think we previously tried to be careful in saying that we expect it to happen this year. And so obviously, by the end of this year, it is meant to say the same thing, but there's no change in our expectations at this point.
On the HSV Alzheimer's hypothesis, it's a very interesting -- there's a lot of neuroinflammatory questions that go with the herpes simplex virus infection across a range of different mutations, Alzheimer's one of them.
At this point, the studies that we expect to move forward with HSV will be for seropositive to improve outcomes. So shedding days, for instance, or lesion based, and then eventually, we will want to consider whether we want to go at prevention of infection, which is obviously a different standard of different indication. That might be more relevant for them, how you think about some of the neuroinflammatory or long-term supply.
I think you asked my opinion on the -- I think it's incredibly interesting and exciting. I do think it's early for us to start drawing connection from a vaccine perspective in terms of our potential impact for it. I hope over time, there is an opportunity to intervene and things like that.
Obviously, in the EBV vaccine with multiple sclerosis, that science has firmed up to the point where there's reasonably high conviction that there's a potential for benefit there. We have to go prove that. But at this point, it's still earlier days, I think, with HSV and Alzheimer's.
Operator: Our next question comes from Edward Tenthoff with Piper Sandler.
Edward Tenthoff: Congrats on everything. Actually, most of my questions have been answered. But I wanted to ask with respect to the cancer efforts, are you able to break out what the actual R&D cost is for that program and that's still a cause some profit share with Merck? And how many indications do you guys ultimately plan on pursuing?
Stephen Hoge: Maybe I'll take the first one, Ed. So we obviously know what we're spending, [indiscernible] but at this point, that we are not prepared to disclose. So maybe someday, but not at this time.
Edward Tenthoff: Understood. And then -- with the expansion...
Stephen Hoge: Yes. On the expansion indication. Look, at the joint decision, our partnership with Merck has been really strong. We've been building this out. We do like to review those strategically and then bring them forward once we've started them. And so I don't want to get ahead of that because those are our private strategic competition with Merck. But we are not done yet. We will keep adding in the years ahead.
Edward Tenthoff: Very exciting. Look forward to seeing you in Chicago.
Operator: Ladies and gentlemen, this does conclude the Q&A portion of today's conference. I'd like to turn the call back over to Stéphane for any closing remarks.
Stéphane Bancel: Well, thank you, everybody, for joining in today for a great session. We look forward to seeing you at latest ASCO. Have a great day.
Operator: Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day. |
AMGN | 1 | 2,024 | 2024-05-02 00:00:00 | Operator: My name is Julianne, and I will be your conference facilitator today for Amgen's First Quarter 2024 Financial Results Conference Call. [Operator Instructions]
I would now like to introduce Justin Claeys, Vice President of Investor Relations. Mr. Claeys, you may now begin.
Justin Claeys: Thank you, Julianne. Good afternoon, and welcome to our first quarter 2024 earnings call. Bob Bradway will lead the call and be followed by a broader review of our performance by Jay Bradner, Murdo Gordon, Vikram Karnani and Peter Griffith.
Through the course of our discussion today, we will use non-GAAP financial measures to describe our performance and have provided appropriate reconciliations within the materials that accompany this call. We will also make some forward-looking statements, which are qualified by our safe harbor statement. And please note that actual results can vary materially. Over to you, Bob.
Robert Bradway: Okay. Thank you, Justin, and thank you to our callers for joining us today. This is a busy and exciting time here at Amgen. And as you can see from our results, we're reaching many more patients around the world with our existing medicines, advancing a broad range of potential first-in-class medicines in our mid- and late-stage pipeline, and redefining what's possible in research as we integrate wet and dry lab capabilities and harness transformative technologies.
I'll touch on a few highlights from the quarter that give me great confidence that we're on a path to deliver attractive long-term growth. First, we have a number of products across general medicine, oncology and inflammation that have strong momentum and still plenty of room to grow. These include Repatha, which was up 33%; EVENITY, up 35%; BLINCYTO, up 26%; and TEZSPIRE, up 80%. With BLINCYTO, we expect an approval in June that should accelerate our efforts to integrate into earlier treatment lines for acute lymphoblastic leukemia.
With TEZSPIRE, we'll share data later this month that reflect the attractive potential of this medicine in chronic obstructive pulmonary disease. COPD is the world's third leading cause of death. Clearly, new treatments are very much needed, and we're excited by TEZSPIRE's potential to make a difference there.
Second, our newest pillar of growth, rare disease, contributed nearly $1 billion of sales in the quarter, up 14% compared with the sales of these products from a year ago. We see significant upside potential for first-in-class early-life cycle medicines like TEPEZZA, KRYSTEXXA, UPLIZNA and TAVNEOS. And we're pursuing launches in new geographic markets, new indications and/or new formulations for each. As an example, we announced last week our imminent plans to file TEPEZZA for approval in the European Union.
Overall, the integration of Horizon, its people, products and pipeline is proceeding well, reflecting the strong fit between our organizations. Third, we are rapidly advancing a number of promising new medicines in our mid- and late-stage pipeline, spanning all 4 of our therapeutic areas. We are awaiting approval for tarlatamab, for example, and look forward to bringing this transformative innovation to patients with small cell lung cancer. Tarlatamab is the first T-cell-engaging therapy to demonstrate significant clinical activity against a common solid tumor, a watershed moment in a field that Amgen pioneered and continues to lead.
Looking to the rest of the year, we anticipate data readouts from 5 Phase III trials. In addition, we announced today the development of a biosimilar to KEYTRUDA as we look to build upon the global leadership we have established in biosimilars.
In sum, we have a broad range of medicines in hand today and coming through our pipeline that will enable us to meet the needs of millions of patients around the world and deliver strong growth through the end of the decade and beyond.
Now let me just add one other important update. Whereas we don't normally comment on interim data, especially for our Phase II trial, we recognize there is significant interest in obesity in MariTide, so we'll provide additional commentary today. The interim Phase II analysis for this study is complete, and we are very encouraged with the results that we've seen thus far and with the conduct of the trial. Following the interim analysis, I would say we're confident in MariTide's differentiated profile and believe it will address important unmet medical needs.
We are actively planning a broad Phase III program including obesity, obesity-related conditions and diabetes. Obviously, we expect to carefully complete our ongoing Phase II trial before then moving as swiftly as appropriate to establish the safety and efficacy of this potential medicine in Phase III trials. We've initiated activities as well to further expand manufacturing capacity with both clinical and commercial supply in mind.
Jay will provide a few additional remarks with respect to this ongoing study. And I would ask you to recognize that to protect the integrity of the study beyond this update, we would not expect to discuss these data in further detail before completion. As always, I want to thank our employees around the world for their commitment to our business and to the patients we serve. Jay, I'll turn it over to you.
James Bradner: Thank you, Bob, and good afternoon, everyone. Let me start with MariTide. Reiterating Bob's comments, we are very pleased with the results seen with MariTide thus far. And we're very pleased with the overall conduct of the ongoing Phase II trial. All arms remain active, patient dropout has not been an issue, and we're fully on track for top line 52-week data from this 11-arm Phase II study in late 2024.
We're seeing a differentiated profile of MariTide and are confident that it will address important unmet medical needs, obesity, obesity-related conditions and diabetes. We look forward to completing the ongoing Phase II study and working with regulators to move rapidly to the broad Phase III program.
Later this year, we plan to initiate an additional dedicated Phase II trial investigating MariTide for the treatment of diabetes in patients with and without obesity. This new trial is not a gating step for our Phase III program in patients with obesity. Informed by dose and schedule insights from the ongoing Phase II obesity study, the dedicated Phase II study in diabetes conforms to regulatory requirements for Phase III and is the next step towards a diabetes indication for MariTide.
In terms of patient experience, we expect to deliver MariTide in a convenient, handheld, patient-friendly auto-injector device with a monthly or even less frequent single-injection administration, assuming eventual approval. Across the portfolio, we are presently prioritizing differentiated medicines, those that stand to provide the greatest benefit for patients. Given the profile we've seen with AMG 786, we will not pursue further development. Instead, in obesity, we're differentially investing in MariTide and a number of preclinical assets.
Beyond MariTide, in the first quarter, we rapidly advanced our diverse clinical pipeline of potentially first-in-class or best-in-class programs. Looking ahead, the remainder of 2024 promises to be an exciting time for research and development with 2 PDUFA dates in June for tarlatamab in small cell lung cancer and BLINCYTO in adult acute lymphoblastic leukemia as well as 5 Phase III data readouts. Each of these milestones could represent a significant advance towards our mission to deliver groundbreaking treatments to patients in real need.
Moving to olpasiran. We're pleased to announce that we've completed enrollment of the OCEAN(a)-Outcomes trial, a Phase III cardiovascular outcome study of olpasiran, our potentially best-in-class Lp(a)-targeting small interfering RNA medicine. Reflecting both our commitment to patients suffering from cardiovascular disease and the strong interest of the medical community, we successfully enrolled 7,297 patients across the globe in just 15.5 months. To our knowledge, this is the fastest-enrolling Phase III outcome study of its size. And to remind, Lp(a) is a genetically defined cardiovascular risk factor, which is elevated in approximately 20% of individuals and for whom no effective or targeted therapies currently exist.
In oncology, we continue to deliver on high-conviction targets with differentiated therapies capable of delivering a large effect size for patients. Starting with tarlatamab, a first-in-class BiTE molecule targeting DLL3 for small cell lung cancer. We remain on track with an FDA priority review for a June 12 PDUFA date.
We're excited about tarlatamab as potentially the first selective therapy for small cell lung cancer. Based on the remarkable activity observed as a single agent in patients receiving second and third-line therapy, we are rapidly advancing tarlatamab in a frontline treatment with 3 Phase III studies now initiated in both extensive stage and limited stage disease.
The rationale for studying tarlatamab in earlier lines of the context of lower tumor burden draws from our experience with BLINCYTO in B-cell ALL. There, we saw a dramatic improvement in overall survival in minimal residual disease-negative patients. These BLINCYTO data provide evidence that directing the T-cell in this manner is an effective means of finding and eliminating residual cancer cells, which are primarily the drivers of recurrent disease. We're hopeful we can build on this insight with tarlatamab, where comparable activity in early-stage small cell lung cancer patients would very meaningfully improve outcomes for patients facing the challenge of this aggressive cancer.
In sum, we regard tarlatamab as a major advance as the first bispecific T-cell engager to demonstrate efficacy in a common solid tumor, further establishing the broad potential of our bispecific T-cell engager platform. Our first-in-class STEAP1 CD3 bispecific molecule, xaluritamig, has also demonstrated unambiguous activity in the solid tumor, namely prostate cancer, continues to advance following a presentation of encouraging Phase I data last fall. We have now fully enrolled the monotherapy Phase I dose expansion and continue to enroll patients in reduced monitoring and outpatient cohorts. Further, combination studies with xaluritamig in novel hormonal therapies are progressing in dose escalation studies with near-term plans to initiate dose expansion cohorts.
To round out oncology, we are rapidly advancing AMG 193, our oral PRMT5 inhibitor targeting MTAP null solid tumors. We've moved forward with monotherapy dose expansion studies and have initiated 2 additional Phase I studies targeting MTAP null tumors in thoracic, gastrointestinal, biliary tract and pancreatic cancers, exploring relevant combinations with standard of care.
In our inflammation portfolio, we are encouraged by the results of the COURSE Phase IIa proof-of-concept study, which investigated TEZSPIRE in patients with moderate to very severe COPD. This study was designed to test TSLP inhibition across an intentionally broad range of eosinophil levels, irrespective of inflammatory drivers, emphysema, chronic bronchitis and smoking status. While TEZSPIRE achieved a clinically meaningful 17% reduction in the annualized rate of moderate or severe COPD exacerbations compared to placebo, this result fell short of statistical significance likely owing to the broad overall patient demographic.
However, even greater reductions in COPD exacerbations were observed in a planned subgroup of patients with baseline blood eosinophil counts greater than 150 cells per microliter with a trend for further reduction in a small number of subjects with baseline counts greater than 300. We're excited by these data, which will be presented in an oral session of the American Thoracic Society Annual Meeting later this month.
Together with our partner, AstraZeneca, we are actively planning for Phase III development of TEZSPIRE in COPD. Beyond COPD, we continue to explore TEZSPIRE in separate Phase III studies in eosinophilic esophagitis and chronic rhinosinusitis with nasal polyps, where top line data are expected in the second half of this year.
The ROCKET Phase III program for rocatinlimab, a first-in-class anti-OX40 monoclonal antibody, has successfully enrolled over 2,800 patients with moderate to severe atopic dermatitis. Indeed, 3 of the 8 studies in the rocatinlimab ROCKET study program are now fully enrolled. The Phase III Horizon study, part of this ROCKET program, evaluates rocatinlimab monotherapy versus placebo in adults with moderate to severe atopic dermatitis and remains on track for top line data readout in the second half of this year.
Beyond atopic dermatitis, we continue to broadly explore rocatinlimab in additional indications and have initiated a Phase II study in moderate to severe asthma with plans to initiate a Phase III study in prurigo nodularis in the second half of this year. We're encouraged by the advancements of our rare disease pipeline as well with several mid- to late-stage opportunities.
Starting with UPLIZNA, we anticipate important Phase III data readouts this year in myasthenia gravis and IgG4-related disease, both diseases with significant unmet need and where we have the potential to make a real difference for patients.
Dazodalibep, an innovative CD40 ligand inhibitor fusion protein, has entered Phase III for Sjogren's disease with 2 studies now enrolling patients. This follows encouraging Phase II data with efficacy across patients with moderate to severe systemic disease and patients with high symptom burden. Dazodalibep is the first therapy to demonstrate efficacy in the latter patient population.
Lastly, in our biosimilars portfolio, we've initiated a Phase III study of ABP 234, a biosimilar candidate to KEYTRUDA, in subjects with advanced or metastatic non-squamous non-small cell lung cancer. We're also pleased to announce that WEZLANA, our biosimilar candidate to STELARA, has received a positive CHMP opinion.
In closing, I'd like to thank my Amgen colleagues for their strong sense of service to patients facing serious illness and their commitment to growing the impact of both our research and our business to our portfolio of potential first-in-class and best-in-class medicines. And I'll now turn it over to Murdo.
Murdo Gordon: Thanks, Jay. I'm pleased with our performance in the first quarter. Strong execution resulted in sales growth of 22% year-over-year, with robust volume growth across the 4 therapeutic pillars of our business. We drove compelling growth across our regions with 10 products delivering at least double-digit volume growth, including Repatha, EVENITY, TEZSPIRE, TAVNEOS and BLINCYTO. Our integration of the legacy Horizon business continues to progress well with that portfolio generating $914 million in the quarter.
Sales in our general medicines business, including Repatha, Prolia, EVENITY and Aimovig grew 18% year-over-year in the first quarter, driven by volume growth. Repatha sales increased 33% year-over-year to a record of $517 million for the first quarter, and Repatha is now well on its way to becoming a multibillion-dollar business. In the quarter, we saw year-over-year volume growth of 44%, partially offset with 13% lower net selling price.
Expanded formulary coverage for Repatha in the U.S. has accelerated volume growth. This was partially offset by lower net selling price resulting from higher rebates to support and expand access for patients. We expect this expanded formulary coverage, along with the removal of prior authorization requirements by several payers, will lead to increased cardiologist and primary care physician adoption.
Outside the U.S., we also delivered strong growth, helping even more patients reduce their cardiovascular risk. EVENITY had record sales of $342 million for the quarter. And in the U.S., volume growth was supported by an expansion of EVENITY prescribers. In Japan, EVENITY continues to be the segment leader with 46% of the bone builder market. And while we're happy with the growth of EVENITY, there are many women who remain at risk of a fracture due to their postmenopausal osteoporosis. And we see exciting growth potential for EVENITY to combat this risk, and we'll continue to apply our proven experience in bone health to ensure EVENITY reaches all the patients who need it.
Prolia sales grew 8% year-over-year. Volume growth continues to be supported by real-world evidence, reaffirming Prolia's superiority in reducing fracture risk when compared to alendronate in treatment-naive patients with postmenopausal osteoporosis, who are at high risk of fracture.
In our inflammation business, Otezla sales increased 1% year-over-year for the first quarter. In the U.S., we saw strong new patient volume growth early in the quarter. This was disrupted in February and March by the Change Healthcare cybersecurity issue, which created challenges for some patients trying to fill prescriptions at specialty pharmacies.
We've seen a return to accelerating new patient prescription growth in recent weeks. We see significant potential for future growth of Otezla, given its established efficacy and safety profile, excellent payer coverage with limited prior authorization requirements and, of course, ease of administration. To realize this potential, we've increased our investment in dermatology field force and Otezla direct-to-consumer media, focusing on efforts to educate physicians and patients on the importance of treating psoriasis systemically and the safety and efficacy profile of Otezla.
I'm also pleased that Otezla was recently granted pediatric exclusivity and approved by the FDA for the treatment of pediatric patients 6 years of age and older with moderate to severe plaque psoriasis who are candidates for phototherapy or systemic therapy. This is the first pediatric indication for Otezla.
Enbrel sales decreased 2% year-over-year for the first quarter, driven by volume decline, partially offset by higher inventory levels. Moving forward, we expect modest volume growth offset by declining net selling price. TEZSPIRE continues its strong trajectory with $173 million in sales in the first quarter. Sales increased 80% year-over-year, primarily driven by uptake of the prefilled single-use pen.
In our rare disease business, sales of TAVNEOS were $51 million in the first quarter. Sales increased 122% year-over-year, driven by volume growth. In the U.S., more than 3,000 patients have now been treated with TAVNEOS by over 2,000 health care professionals. Looking forward, we'll continue to leverage our expertise in nephrology and inflammation to bring TAVNEOS to even more patients with ANCA-associated vasculitis.
Sales for our biosimilars portfolio grew 12% year-over-year for the first quarter, with volume growth partially offset by lower inventory levels and net selling price decline. We expect continued growth in our biosimilars business to be driven by the addition of new molecules and additional launches.
In oncology, sales of our 6 innovative products, BLINCYTO, LUMAKRAS, Vectibix, KYPROLIS, Nplate and XGEVA, grew 4% year-over-year for the first quarter, driven by volume growth. BLINCYTO sales grew 26% year-over-year to a record $244 million for the first quarter, driven by broad prescribing across academic and community segments for patients with B-cell precursor acute lymphoblastic leukemia. The U.S. Food and Drug Administration has set a PDUFA date of June 21 of this year for its decision on approving BLINCYTO as a treatment for patients with early-stage CD19-positive, B-cell ALL. We see significant growth potential for BLINCYTO from utilization in frontline treatment.
LUMAKRAS sales increased 11% year-over-year for the first quarter to a record $82 million. We see future growth opportunities for LUMAKRAS coming from the launches in new markets and additional indications. Vectibix sales increased 6% year-over-year, driven by higher net selling price and volume growth, partially offset by unfavorable foreign exchange impact. KYPROLIS sales grew 5% year-over-year to a record $376 million for the first quarter, primarily driven by volume growth outside the U.S. Nplate sales decreased 12% year-over-year for the first quarter, primarily driven by volume decline in comparison to the first quarter of 2023, which included a U.S. government order of $82 million. Excluding the Q1 2023 U.S. government order, Nplate sales grew 13% year-over-year.
I'm pleased with our execution in the quarter and the momentum across the 4 pillars of our business. And we look forward to serving many more patients around the world who can benefit from our innovative therapies. And with that, I'll turn it over to Vikram.
Vikram Karnani: Thank you, Murdo. I am pleased to provide an update on rare disease, Amgen's fourth therapeutic pillar of growth, which delivered product sales of over $950 million in Q1. Beginning with TEPEZZA for the treatment of thyroid eye disease, or TED, first quarter sales were $424 million, reflecting growth of 5% year-over-year when compared to results from the legacy Horizon business.
As we discussed at our rare disease investor meeting a few months back, TED is often assessed using the clinical activity score, or CAS, which covers a number of different signs and symptoms, including pain, redness, swelling and function. And we now refer to TED in terms of high and low clinical activity score or high and low CAS. For the approximately 100,000 TED patients in the U.S. who could benefit from TEPEZZA, the majority of these patients, roughly 80%, are in low CAS settings. We continue to focus on this large number of low CAS patients not being appropriately treated.
As we previously discussed, one of the main hurdles in the patient journey in this setting is access. To help patients overcome that challenge, we have generated favorable medical policy changes for greater than 50% of U.S. covered lives, and we expect to continue this momentum throughout 2024.
In addition, we are expanding our reach among new prescribers, particularly ophthalmologists and endocrinologists who manage many low CAS patients. The impact of TED on quality of life is often underestimated. So our focus is on educating health care providers about the significant effects on patients, even those with less visible symptoms. In addition to our focus on educating ocular surgeons and ophthalmologists, we are increasing our strategic focus in endocrinology and creating a dedicated sales force to engage in this important space.
International expansion remains a meaningful long-term growth opportunity for TEPEZZA, which is currently approved in Brazil and Saudi Arabia. As a reminder, in January, we filed for high CAS approval in Japan. And our Phase III trial in low CAS is continuing to enroll. We have completed additional regulatory submissions in Australia, Canada, Great Britain and most recently with the European Medicines Agency. We initiated a Phase III subcutaneous study and see this as an opportunity to increase adoption and improve the patient experience with an alternative option to our current IV formulation.
KRYSTEXXA, for patients with chronic refractory gout, delivered $235 million in sales in Q1, representing 26% year-over-year growth, driven by volume growth from strong commercial execution. UPLIZNA, the fastest-growing biologic in NMOSD, delivered a record $80 million in net sales in Q1, representing 49% year-over-year growth. International expansion is also underway with UPLIZNA now launched in multiple ex-U.S. markets including Canada, which launched in January of this year.
The integration of the legacy Horizon business continues to be on track as we leverage Amgen's leadership in inflammation, world-class manufacturing and process development and extensive global footprint. Now I will pass it over to Peter for our financial update.
Peter Griffith: Thank you, Vikram. We're pleased with our performance and on track to meet our 2024 full goals and long-term objectives. Our strong growth outlook is driven across each of our 4 therapeutic pillars by our innovative pipeline and in-market portfolio products, which serve patients with serious illnesses around the globe. I'll review our first quarter results before discussing our 2024 guidance.
As shown on Slide 23 of the slide deck, in the first quarter, we delivered $7.4 billion in total revenue, a 22% increase year-over-year. This reflects 25% volume growth, including over $900 million from acquired Horizon products and also key brands, including Repatha, TEZSPIRE, EVENITY, Prolia and BLINCYTO. Excluding the addition of Horizon, product sales increased 6% year-over-year, driven by 9% volume growth.
Our non-GAAP operating expenses rose by 33%, reflecting investments in Horizon acquired products, along with other late-stage pipeline medicines, including rocatinlimab, MariTide and tarlatamab. As a result, our Q1 operating margin was 43%, consistent with our guidance on the fourth quarter earnings call. Our non-GAAP OI&E resulted in $549 million expense, up $334 million year-over-year, almost entirely due to increased interest expense from debt issued for the Horizon acquisition, partially offset by higher interest income and gains from debt repurchases.
Our non-GAAP tax rate decreased 2.4 percentage points year-over-year to 15.4%, primarily due to the change in earnings mix, the inclusion of the Horizon business, and net favorable items in the quarter. In the first quarter, the company generated $0.5 billion in free cash flow, a decrease from $0.7 billion in the previous year, primarily impacted by a planned $800 million tax deposit to the IRS to stop the accrual of interest on uncertain tax positions, as we discussed on our fourth quarter earnings call.
As a reminder, there is no change in our belief in the merits of our legal position as we prepare for trial later this year. This impact on free cash flow was partially offset by the timing of working capital items. The Horizon integration is on track, and we expect to reach our pretax $500 million synergy target by year 3 post acquisition. We also expect to achieve roughly 50% of this synergy target in our annual run rate by the end of this year 2024. We expect accretion to non-GAAP EPS in 2024 and anticipate maintaining strong cash flow generation while we continue to execute on our deleveraging plan to return to our pre-acquisition efficient capital structure by the end of 2025.
We remain on track to achieve the pre-acquisition leverage ratio, normalized for certain other noncash items, including fair value, market value adjustment of equity investments and Horizon acquisition-related costs. We remain committed to our multiple capital allocation priorities. We continue to prioritize investing in the best innovation, both internally and externally, with increased spending on late-stage programs, including olpasiran, bemarituzumab, MariTide and rocatinlimab.
Second, we continue investing in our business for long-term growth, including expanding capacity in our state-of-the-art manufacturing facilities. Our North Carolina site is expected to be operational by 2026. And Amgen Ohio opened in the first quarter and is utilizing artificial intelligence and extensive robotics to boost operational efficiencies.
We're actively integrating generative AI across the enterprise to spearhead innovation and reinforce our leadership in the industry. This strategic commitment to innovative technology enables us to lead advancements, streamline drug development and enhance patient care more effectively.
Finally, we returned capital to shareholders as we paid dividends of $2.25 per share in the first quarter. This represented a 6% increase over that paid in each of 2023's 4 quarters.
Turning to the outlook for the business for 2024 on Slide 25. We expect our 2024 total revenues in the range of $32.5 billion to $33.8 billion and anticipate non-GAAP earnings per share between $19 and $20.20. I'll mention a few considerations as you model the remainder of 2024. Our non-GAAP R&D expenses are expected to increase by approximately 25% year-over-year versus our prior guidance to you roughly 20% year-over-year. We're making incremental investments based on our confidence in our late-stage pipeline.
Our R&D investment reflects our commitment to innovation, accelerating our pipeline, focusing on advancing multiple potentially first-in-class and best-in-class medicines, including supporting MariTide, 2 PDUFA dates scheduled for June and 5 Phase III data readouts throughout the year. Total non-GAAP operating expenses over the second and third quarters are expected to grow at a rate comparable to the first quarter. The fourth quarter rate will normalize with a comparable expense base in the fourth quarter of 2023 since the Horizon transaction completed in early October 2023.
We continue to anticipate our operating margin will improve over the next 3 quarters. We expect OI&E to be roughly $2.6 billion, which includes the interest expense related to the $28 billion of debt raised for the Horizon acquisition. We expect the non-GAAP tax rate to be in the range of 15% to 16%, primarily being driven by a more favorable jurisdictional mix of income, which includes the full year benefits associated with the inclusion of the Horizon business. Our capital expenditures guidance remains unchanged at approximately $1.1 billion in 2024. We've initiated activities to further expand manufacturing capacity for MariTide.
We project full year Neulasta sales of approximately $500 million. Our long-term outlook remains robust. I am grateful to our 27,000-plus colleagues worldwide for their dedication to serving patients. So this concludes the financial update. I'll hand it now back to Bob for our Q&A session.
Robert Bradway: Okay. Thank you, Peter. And before you open the line, Julianne, let me just point out that, obviously, we have a lot of exciting opportunities here. And we're excited about the ways we think we can make a difference for patients. In terms of the opportunity in obesity, again, we recognize that there's significant interest. And we provided today's update to keep you apprised of our plans in this area. But I would just reiterate, we're focused on successfully completing and maintaining the integrity of the ongoing Phase II studies.
So as we turn to Q&A, just bear in mind that we're going to have to be very limited in what we can say beyond what we've already delivered in our prepared remarks on obesity and MariTide. But with that in mind, Julianne, maybe you could remind our callers of the process for asking questions.
Operator: [Operator Instructions] Our first question comes from Salveen Richter from Goldman Sachs.
Salveen Richter: On MariTide here, just given the move forward to Phase III, can you just remind us what you were looking to learn in the Phase II trial and likely did here, but that enabled you to kind of get confident here with the program on the [ forward ]?
Robert Bradway: Sure. Salveen, thanks for the question. Why don't you jump in, Jay?
James Bradner: Yes. Thanks, Salveen, for your question. Look, we're benefiting from a really well-designed and well-executed Phase II study, a study that can teach us a lot about this medicine and how it's best dosed and received. And we're seeing from these data in aggregate a broad and differentiated profile that will guide and also encourage a Phase III clinical investigation.
Operator: Our next question comes from Michael Yee from Jefferies.
Michael Yee: I appreciate the update. I think we all do. Just to clarify or to ease any investor concerns, is it safe to say that your interim looked at all doses and you feel comfortable including the highest doses and safety metrics, including bone? And all of that was looked at to date?
James Bradner: Thanks a lot, Michael. I'll take this one as well. Again, a very well-designed and well-executed study, a study that's replete with measurements. This is an ongoing study, so we have to be careful to avoid in introducing an inadvertent bias or unblinding. And so we just can't comment on individual characteristics, but we're very pleased with the results to date. We're moving rapidly forward with the Phase III program as well as the diabetes Phase II. I would reiterate that all the arms remain active, and we haven't had an issue with patient dropout to date.
Robert Bradway: I think, again, Michael, as Jay said, it's a well-designed study, and you can be sure that we review the data carefully.
Operator: Our next question comes from Terence Flynn from Morgan Stanley.
Terence Flynn: Great. Jay, you mentioned on MariTide seeing a differentiated profile. Recognize you're limited in what you can say. But as we think about areas of differentiation, it's clearly efficacy, tolerability and dosing interval. So just wondering if you can comment on which of those areas you're differentiated on? And then what benchmark are you looking to? Is it semaglutide, tirzepatide, both of those?
Robert Bradway: Thanks, Terence. Again, we can appreciate the desire to get into that detail. But maybe, Murdo, do you want to speak to the competitive differentiation? And then Jay, if there's anything you feel appropriate to elaborate on, you can jump in after Murdo.
Murdo Gordon: Yes. Thanks for the question, Terence. Thanks, Bob. Obviously, we're watching the in-market products very closely with respect to differentiation. And we're also looking at products that are in the clinic being developed. And we continue to feel very confident in our ability to have a differentiated and broad profile for MariTide as we develop it in this Phase II and as we consider our broader Phase III development program.
James Bradner: Yes. I'd just add, this is, Terence, a very exciting, very dynamic area. We follow the development of obesity medicines very closely. And I think in this case, the actions we're taking speak for themselves. We're hard at work planning a comprehensive and competitive Phase III program.
Operator: Our next question comes from Jay Olson from Oppenheimer.
Jay Olson: Congrats on all the progress and thanks for providing the update. Maybe just to shift gears a little bit to tarlatamab. With the potential launch rapidly approaching, can you just talk about the work you're doing to prepare for that launch and the strategy behind the initial launch in the late line and then the clinical and commercial work to go behind expanding the profile and potential for tarlatamab?
Robert Bradway: Yes, let's take that in 2 pieces. And maybe, Murdo, you can talk about the launch. And then I'm sure, Jay, you'd like to elaborate on the thinking for the clinical development of this.
Murdo Gordon: Sure. Jay, thank you for the question on another exciting product in our portfolio, one that I think will deliver a lot of benefit for patients with small cell lung cancer, which is a very, very difficult diagnosis with very little in the way of highly effective treatments that deliver any kind of durable response in small cell. So we're anxiously awaiting approval from the FDA, but we are well prepared and have been for some time across our field organizations. All our field personnel, including their medical teams, are trained and prepared.
We have very clear plans to reach treating physicians in very short order post approval. We have a very clear understanding of making sure that we can provide broad access to tarlatamab when it's approved. And we feel really good about this. This is a very important moment not just for Amgen but for the treatment of patients with small cell lung cancer where, quite frankly, the survival in the late-stage setting is really dismal and is a matter of single-digit months. And so we have a huge opportunity here to impact, and we're not wasting any minute, any hour or any day in our planning to do that.
James Bradner: And Jay, thanks for highlighting the potential of this medicine, which we consider a major advance. The treatment of this disease has really not meaningfully evolved since I trained as an oncologist in the mid-90s with upfront chemotherapy and meaningful but incremental benefit to immuno-oncology therapy with PD-L1 agents today. And so this is the case where time just can't move fast enough to get this medicine into earlier lines of therapy. And so we have initiated 3 Phase III studies.
And as you asked, I'll just give an architecture of them briefly. We have a study that will compare to tarlatamab to standard of care chemotherapy. And this is in the second line dedicated patients with a primary endpoint of overall survival, and this study is enrolling. We really want to get this medicine tested in frontline therapy, where, as you must know, patients progress so quickly that a great many of them never reach the chance to receive second and third-line therapy. And so in a pair of trials, one for extensive-stage small cell lung cancer and one for limited-stage small cell lung cancer, we'll study the contribution of tarlatamab immediately following upfront therapy with response.
We've learned through the development of these BiTE molecules that they work best when they're given as early as possible in the course of treatment for a disease. That has been the case with ALL as we move into frontline. And we've also learned that they work best when there is a low burden of disease. And so the design of these 3 Phase III studies will bring this medicine to earlier patient therapy lines. And I'll say there's been intense interest and great hope in this community. And so we expect to enroll these studies expeditiously.
Operator: Our next question comes from Mohit Bansal from Wells Fargo.
Mohit Bansal: I have a question regarding the manufacturing of AMG 133. Could you help us understand how complicated or simpler it is versus the traditional GLP-1s peptide base in terms of complexity as well as cost? And what kind of investment do you think we should be expecting as you go -- as you embark on this journey?
Robert Bradway: Mohit, I don't think we're intimidated about the challenge on the manufacturing or the process development front. I think, again, we've established ourselves firmly as a world leader in biotherapeutic manufacturing. And as you know, this is a therapy that's based on a antibody backbone. So it's right down the middle of the fairway for us. We've -- not lost on us that these competitors who are in the market now have found it difficult to maintain supply of these medicines, and I'm sure that's not lost in the patients either.
And we're determined to do our best to make sure that we uphold our long tradition of supplying every patient, every time in the marketplace. So again, we think this is down the middle of the fairway in terms of the technical challenges that we need to address. We think that -- we look forward to being able to do that. And again, as I said, maintaining our track record of every patient, every time.
In terms of your question about what it will require from us over time, obviously, to the extent that, that becomes meaningful, Mohit, we'll have the opportunity to address it down the road. But as Peter said in his remarks, our capital expenditure guidance for the year embraces the activity that we have underway to make ourselves ready for the clinical and commercial challenge that we see imminently.
Operator: Our next question comes from Umer Raffat from Evercore ISI.
Umer Raffat: I'll spare all my curiosities on your ongoing trial. But I will ask this. One, on manufacturing capacity. I'm curious, is your aim to have 1 million to 2 million patients worth of capacity or 5 million to 10 million? You can imagine from a modeling perspective, from a CapEx side, this would be relevant, knowing obviously how much manufacturing experience and capacity you guys have. And then secondly, the -- is it a pen device? I know you mentioned it's a "handheld patient-friendly auto-injector" which is a single injection. But is it a pen device or is it something else?
Robert Bradway: Yes. So Umer, I don't think we're going to say anything more about the delivery -- expected delivery device at this point. I think we were as clear as we could be. And we think it will be patient-friendly and convenient. And with respect to the quantity of patients that we expect to serve, we recognize that the unmet need here is very large, and we want to be in position to supply the patients that we think will be interested in the differentiated profile of our medicine.
I would point out to you and I hope you're aware that we are already serving millions of patients today around the globe with our biotherapeutics. So again, we're used to supplying many millions of patients with antibody-based therapies. I think we're pushing up on 8 million Prolia patients right now worldwide. So we understand what it takes to supply large quantities of antibody therapies and what it means to do that with successful delivery devices.
And I'm sure it's not lost on all of you that the fact that, as Jay said, the delivery dosing schedule is likely to be monthly or less frequently implies far fewer injection devices than competitors who, for example, are administering a weekly therapy. So again, all in all, we recognize the reasons for your questions on supply. But I hope you recognize as well the reasons why we're confident that we'll be up to that challenge.
Operator: Our next question comes from Gregory Renza from RBC Capital Markets.
Gregory Renza: Congrats on the updates as well. And just a question on your larger obesity and cardiometabolic strategy. Certainly, with the news on 786 and as you speak to MariTide's efforts on convenience, how are you thinking about oral options within your portfolio now that you are certainly levered towards MariTide as the lead asset? I'm just curious how oral options should fit in with the portfolio longer term.
James Bradner: Gregory, thank you. This differentiated profile that we're seeing with MariTide really raises the bar for Amgen obesity medicines. And the profile for 786 just did not meet that bar in our assessment. We do have a pipeline, a strong pipeline of earlier assets. There are incretin as well as non-incretin based. Some are injectable and some are oral. And we believe that the heterogeneity, the diversity of the marketplace of -- and honestly, the different types of patients that will need medicines for obesity and all the obesity-related conditions demands medicines with different profiles, and we are hard at work on that.
Operator: Our next question comes from Tim Anderson from Wolfe Research.
Timothy Anderson: On MariTide, I'll ask a question on differentiation that I think you should be able to answer, which is, can you remind us what in the past you felt would be differentiating based on what the Phase I showed? So I'm not asking you to comment on what you just recently saw, but just a reminder of past comments on what you felt the data seemed to show in that front. Less frequent dosing frequency, of course, is the obvious one, but what else?
Murdo Gordon: Yes. Tim, I think we've been fairly consistent on what we believe an opportunity is to differentiate in the market, both in the past and obviously as we see the interim analysis of these results. We think that we have a broad opportunity to differentiate with MariTide. And by that, I mean a broad differentiated profile on a number of fronts. And we continue to believe that we will be able to move into the market with a differentiated product, establish MariTide as a really good opportunity to address unmet medical needs and provide access for millions of patients as we go forward.
Operator: Our next question comes from Yaron Werber from TD Cowen.
Yaron Werber: Congrats on the update. So I'm just going to ask a question I think you can answer on -- it's a little technical in nature. In the interim analysis for MariTide, was it blinded or not blinded? And then just remind us, is there a dose titration in that study?
James Bradner: Sure. This is Jay, Yaron. Thank you. The interim analysis, we as R&D leaders have had an ability to see the assigned treatment arms of the study. But importantly, this interim analysis is blinded to investigators and to participants to preserve the integrity of the study.
Operator: Our next question comes from Geoff Meacham from Bank of America.
Geoffrey Meacham: Thanks for the question. Yet another one on MariTide. Just given Amgen's cardio portfolio and focus, do you have any updated thoughts on expanding the program beyond just diabetes and obesity? Obviously, recognizing that you now have a better picture of the safety and tolerability profile.
James Bradner: Yes. Thank you, Geoff, for asking and allowing a clarification. What we're observing with MariTide and what we intended for the development of MariTide continues at pace. And we're preparing for a broad Phase III program that can work to address the unmet needs in obesity and a number of obesity-related conditions and, as you heard, in diabetes as well.
Operator: Our next question comes from Evan Seigerman from BMO Capital Markets.
Evan Seigerman: I'm not going to ask on MariTide, although I am tempted to. I actually want to ask one on rocatinlimab. So with the Horizon ROCKET studies upcoming, can you just talk us through what the differentiations you want to see? And how would you position this asset versus, say, the entrenched Dupixent and RINVOQ in the atopic dermatitis space?
Robert Bradway: Two pieces. Maybe Jay can address the clinical perspective on differentiation. And then Murdo, to the extent it's appropriate, you can jump in on how to think about positioning it.
James Bradner: Yes. It sounds as though, Evan, you're close to this work. But as you know, rocatinlimab is an OX40-directed monoclonal antibody, afucosylated IgG1, a strong ADCC. We have a program called ROCKET that has over 2,800 patients enrolled. And so to address differentiation, I'm going to limit that maybe scope to the atopic dermatitis space. And here in the Horizon, the so called Horizon study, it's a Phase III randomized controlled trial. It's in moderate to severe atopic dermatitis. It's 726 patients actually enrolled. And in this case, it's rocatinlimab every 4 weeks against placebo with a 24-week treatment readout. We have endpoints at 16 and 24 weeks. We will -- it's always apples to oranges to compare between trials, but we hope to observe and expect to observe in moderate to severe atopic dermatitis a very competitive profile with strong efficacy and excellent patient experience and tolerability. Here, we think about Dupixent and follow that work in its development closely. And Murdo, I leave it to you to talk through how to best think about differentiation.
Murdo Gordon: Yes. Thanks, Jay. And thanks for the question, Evan. We are studying, as Jay mentioned, a broad population of patients in atopic dermatitis. So we will have some patients that will have previous biologic experience as well as bio-naive. So we will know how to position this product effectively in the market. I would just -- I would perhaps use the recent experience of how we launched TEZSPIRE and differentiated against Dupixent in a different indication using a highly differentiated mechanism and the fact that prescribers in this area are looking for alternatives to nonresponsive patients and to bio-naive patients. So we feel good about the opportunity here. But obviously, we have to await data and see the readouts of the clinical trials.
Operator: Our next question comes from Chris Schott from JPMorgan.
Christopher Schott: Can you just elaborate a little bit more on TEZSPIRE and its potential role in COPD post the Phase II data? And maybe as part of that, how broadly do you expect to study this compound in Phase III, I guess, given the efficacy across the different eosinophil counts that we saw in the Phase II program?
James Bradner: Yes. Thanks for the question, Chris. It's Jay again. And so the Phase II COPD data will be presented in an oral presentation, as I mentioned, at the American Thoracic Society Meeting later this month. And so as that work and its abstract are presently embargoed, there is a natural limit to what I'm able to share. But what I will remind, as you asked more mechanistically, is that TSLP comes from this family of what are called alarmins. And they do just what it sounds like they do.
An epithelium, inflamed or irritated or activated, that's inflamed releases TSLP and triggers what's called type 2 inflammation. There are a number of signaling factors that participate in type 2 inflammation. But then, TSLP then converges down in this type 2 T-cell inflammatory milieu in response also involving eosinophils. And that's why we often invoke that measurement in clinical investigation.
The rationale for COPD is as strong as it is for asthma. But COPD, if you must know, is a much more heterogeneous disease than asthma. And so the design of this clinical trial appreciated and understood that and built into it some predefined stratifications for analysis, one of which was this eosinophil threshold of 150 cells per microliter.
And so we look forward to sharing the full data. We have already disclosed that there's clinically meaningful activity of the molecule in this randomized controlled trial. And so please expect more at the ATS. You asked about the more broad development. You are right that TSLP is not only a feature of an inflamed airway epithelium but other epithelial surfaces as well. Hence, our interest to develop it in eosinophilic esophagitis as well as chronic rhinosinusitis with nasal polyps. And both of these diseases are characterized molecularly by type 2 inflammation.
Operator: Our next question comes from James Shin from Deutsche Bank.
James Shin: This one is a little bit off the reservation. It's for Jay and on oncology. It's for AMG 651, the EGFR CD3. Just wanted to get your thoughts on that. I think there's going to be some data coming up soon, and there's some other data that's come out recently from peers.
James Bradner: Yes. Well, I would say this, James. Thanks for the question. We have a large experience of developing CD3 bispecifics. And we have learned over time to tune the potency of engagement to the cell surface antigen to the degree of engagement and activation of the CD3. And there is no news to share with you at this moment. We continue to study this and other solid tumor-targeting T-cell-engaging bispecifics, really buoyed by the confidence and the guidance from tarlatamab and xaluritamig. So I would expect more in the future on that medicine as well as other solid tumor-targeting bispecific T-cell engagers.
Operator: Our next question comes from Kripa Devarakonda from Truist Securities.
Srikripa Devarakonda: I have a question on TEPEZZA in TED. Can you please talk about where you are with this subcu program? I think the Phase III is ongoing. Just a little bit of update on that. And as you continue to treat more patients with TED, what are you hearing about concerns around safety concerns? And is that having any impact on uptake?
Robert Bradway: We'll take it in 2 parts. Jay, you can address the clinical questions. And then to the extent that, Vikram, you want to share any thoughts on the marketplace, jump in.
James Bradner: Yes, thanks for the question. The development of a subcutaneous administration of TEPEZZA is a major priority for Amgen R&D in the program. We have initiated a Phase III study. This will be -- this is in moderate to severe active TED. And the design is akin to what we have reported already with the intravenous label-enabling studies completed to date. And Vikram, if you want to speak to the clinical experience.
Vikram Karnani: Yes, I think -- so thanks for the question. I think the question was around AEs and if that is limiting growth. And I imagine, Kripa, that you're maybe specifically referring to hearing loss or about hearing loss.
So let's start at the top. TEPEZZA, it very effectively treats TED, which we all now is a pretty severe and debilitating disease. IGF-1, we know is going to be involved in hearing function. So during the clinical assessment and the clinical development of TEPEZZA, we very carefully have -- we looked at -- we assessed hearing function. We now have included this in the warnings and precautions section of the PI, along with a recommendation for assessment and monitoring. It's important because patients who use TEPEZZA should be monitored for any specific experience with hearing impairment.
We're also working with professional societies to increase education. And while many physicians do use a baseline hearing assessment, getting it in the label helps standardize this approach, okay? So after working through the management of this with HCPs, this has not generally turned to be a barrier for growth as physicians generally understand the favorable risk-benefit profile of TEPEZZA.
Robert Bradway: Thank you. So Julianne, we're pushing up to the appointed bottom of the hour here, but we still have a few questions in the queue. So we'll take a couple more to try to get through your questions. If we don't get to everybody, obviously, Justin and his team will be around this evening to answer any questions. But let's try and click through these, the ones we can quickly, Julianne.
Operator: Our next question comes from Michael Schmidt from Guggenheim Partners.
Michael Schmidt: I had one on BLINCYTO, which has recently gained some commercial momentum recently. And there was some interesting academic data reported last week in Nature Medicine showing some activity in RA. And so I was just wondering if you have any plans? Or how are you thinking about potentially developing BLINCYTO or maybe other BiTEs in autoimmune?
Robert Bradway: Sorry. In autoimmune disorders?
Michael Schmidt: Yes.
James Bradner: Thanks for your question. With very deep expertise here in CD19-directed therapeutics, with deep and committed expertise in inflammation and autoimmunity, we've been following this space very closely, the early suggestive evidence from CAR T-cell therapy and, more recently, this work that's been reported in systemic sclerosis. And as you noted, 6 patients with quite refractory rheumatoid arthritis is very exciting to see. And so you can imagine that we're well organized around this opportunity. And we found that work quite inspiring and we'll have more to report in the future.
Justin Claeys: Julianne, I think we've got time for one more question.
Operator: Our last question will come from Gary Nachman from Raymond James.
Gary Nachman: Great. So back to MariTide, I have to finish with that. As you're planning for the Phase III studies, do you have a sense of when you could start those? How big those might be? And anything about design and overall timing relative to other Phase III studies in this space? And any strategies you have to accelerate those studies as quickly as possible and how you'll incorporate both U.S. and ex U.S. in the program?
Robert Bradway: So Gary, again, we appreciate it. I can understand why you'd be asking those questions. As I said in my remarks, we will do our level best now to successfully complete the Phase II study and then work swiftly with regulators to agree the program that establishes safety and efficacy in Phase III, and we'll do that as swiftly as we can. We recognize there's a huge unmet need still in the marketplace, and we believe we have an asset that can help address that. But Jay, I don't know whether you feel you can say anything more specific, but jump in if you do.
James Bradner: Yes, I'd say the same, Bob. Gary, as you know, this is one part, collecting the data that regulators rightly expect, and ongoing conversations around the design. This study is moving as rapidly as possible within -- this program is moving as rapidly as possible within the organization, you can rest assured.
Robert Bradway: Okay. Well, again, let me thank you all for joining the call and reiterate that Justin and his team will be around if you have any further questions. We look forward to having an opportunity to talk to you in the summer after the second quarter and provide update on the flow of information that we expect to generate between now and then on the many programs that we've referred to on the call. So thank you for your interest. Appreciate it.
Operator: This concludes our 2024 Q1 earnings call. You may now disconnect. |
ES | 1 | 2,024 | 2024-05-02 00:00:00 | Operator: Good morning, and thank you for attending the Eversource Energy Q1 2024 Earnings Call. My name is Elissa, and I will be your moderator. [Operator Instructions]
I would now like to pass the call to our host, Matt Fallon, Eversource Energy's Director for Investor Relations. Matt, please go ahead.
Matthew P. Fallon: Good morning, and thank you for joining us. I am Matt Fallon, Eversource Energy's Director for Investor Relations. During this call, we'll be referencing slides that we posted yesterday on our website.
As you can see on Slide 1, some of the statements made during this investor call may be forward-looking. These statements are based on management's current expectations and are subject to risk and uncertainty, which may cause the actual results to differ materially from forecasts and projections. We undertake no obligation to update or revise any of these statements.
Additional information about the various factors that may cause actual results to differ and our explanation of non-GAAP measures and how they reconcile to GAAP results is contained within our news release, the slides we posted last night and in our most recent 10-K.
Speaking today will be Joe Nolan, our Chairman, President and Chief Executive Officer; and John Moreira, our Executive Vice President, CFO and Treasurer. Also joining us today is Jay Buth, our Vice President and Controller.
I will now turn the call over to Joe.
Joseph Nolan: Thank you, Matt, and thank you all for joining us on the call this morning. Let me begin with an update on the sale of our offshore wind business. I am pleased to report that we are on track to close the sale of the 3 projects over the coming months. We are progressing well on the approvals necessary to close these transactions, as shown on Slide 3. We have filed all regulatory approvals with the New York Public Service Commission and FERC for the sale of South Fork Wind and Revolution Wind to Global Infrastructure Partners. And we recently executed the purchase and sale agreement for Sunrise Wind with Orsted.
For Sunrise Wind, we have also filed applications for regulatory approvals with the New York Public Service Commission and FERC. We anticipate these approvals will take about 90 days. On the construction front, I can't tell you how excited and proud I was of my Eversource colleagues as I stood alongside New York Governor Hochul to flip the switch to energize South Fork Wind in March.
We will certainly capitalize on lessons learned from South Fork, a first-of-its-kind project here in the United States. The same construction processes will be used for the Revolution Wind project where onshore and offshore construction is underway.
Now that our offshore wind risk is largely behind us, we are very excited about the future of Eversource delivering safe and reliable electric, natural gas and water service to our 4.4 million customers.
Turning to Slide 4. Eversource is moving forward as a pure-play regulated pipes and wires utility business, doing what we do best, delivering clean energy safely and reliably to our customers every day. When we are doing what we do best, our customers are the direct beneficiaries. A good example of this came in early April when a late winter storm caused significant damage across the Northeast.
Through our investments in technology, including smart switches and other reliability innovations, we were able to restore 85,000 customers in New Hampshire within 5 minutes, greatly reducing the impact of the storm to many customers in that area. This amazing response received numerous accolades from customers and personal acknowledgment from Governor Sununu. We take tremendous pride in our emergency response organization in our ability to stand up our emergency response teams for timely restoration.
Eversource teams from all 3 states responded to the storm damage in New Hampshire, minimizing customer outage time. Our resiliency investments help to minimize customer outage impacts. Our preparation enables us to hit the ground running in front of potential severe weather events in our emergency response plan, supports scalable and efficient restoration for those customers who are impacted. And we work tirelessly to communicate that timely recovery of storm costs is critical to support these efforts.
Turning to the Clean Energy Future. As you can see on Slide 5, the states we serve have very aggressive greenhouse gas reduction goals. Both the transportation sector and residential and commercial heating sectors are the largest contributors to greenhouse gas emissions. Although the region has acted by reducing carbon emissions from power generation, we have a long way to go on heating and transportation to achieve the state's targets by 2050.
To meet these targets, we project that average household electric demand will double in the summer and more than triple in the winter. That's why it's critical that we all work collaboratively and get started today on making achievement of these targets a reality.
Moving to Slide 6. Achievement of Massachusetts' decarbonization goals are being addressed in part through the Electric Sector Modernization Plans, or ESMP. This is the most comprehensive clean energy plan in the nation with planning processes and requirements that will provide the pathway for the state to achieve its clean energy objectives. The Eversource ESMP is a product of our system planning process, incorporating the state's assumptions for projected demand growth from electric vehicles and electric heating.
To develop our ESMP, we have analyzed expected electric growth down to the circuit level to identify grid investments needed over the next 5 years and beyond. These infrastructure investments will convert our distribution grid into the platform for the clean energy transition. It will increase electrification capacity by 180% and will allow for the adoption of 2.5 million electric vehicles, 1 million heat pumps and 5.8 gigawatts of solar generation, thereby making Massachusetts a leader in delivering clean energy to its homes and businesses.
In New Hampshire, we are focused on a number of regulatory initiatives and are evaluating ways to advance clean energy initiatives such as large-scale utility-owned solar development. For example, New Hampshire state legislators are working on a bill that would institute structural reforms to New Hampshire's Energy Facility Site Evaluation Committee or the SEC, reducing the size of the SEC from 9 members to 5 and eliminating unnecessary process to improve efficiency and to lead to more consistent outcomes. In turn, this will lead to an accelerated citing and permitting process for these clean energy initiatives.
Turning to Connecticut. State policy leaders have a vision of solar expansion, electric vehicle adoption and future renewable purchase power agreements as part of its clean energy transition. We are a strong supporter of these efforts to enable the clean energy future for our customers, and we certainly are looking to partner with the state collaboratively and productively to achieve this important vision for our customers.
While we continue to work diligently to support state policy leaders on thoughtful and reasonable policies aimed at increased adoption of clean energy technologies and the reduction of carbon emissions, we have serious concerns with the lack of alignment between state policy and regulatory decisions implementing that policy. As it stands, regulatory policies in Connecticut discourage investment and utility innovation as well as our participation in a wide range of clean energy initiatives that rely on our balance sheet, in our capital resources.
Upfront program funding by the utilities does not work where cost recovery is continually deferred and delayed into the future on certain terms. Without recognition that our funding sources rely on a secure and predictable cost recovery path, we cannot move forward to put additional capital resources on the table.
We are encouraged by PURA's decision last month to provide timely reimbursement of deferred public policy costs through the company's electric annual rate adjustment mechanism. Decisions that adhere to law and legislative policy are critical to assure a constructive regulatory environment in Connecticut and to make the vision of a clean energy future a reality for our customers.
Looking forward to the future, we remain committed to our extensive outreach plan across Connecticut, furthering our efforts to engage collaboratively and productively with Connecticut's leadership.
Lastly, I want to thank my Eversource colleagues for their unwavering commitment and dedication to our customers. I have the utmost confidence in our team to deliver safe and reliable energy service to our customers with daily progress toward a clean energy future.
I will now turn the call over to John Moreira to walk through our financial results.
John Moreira: Thank you, Joe, and good morning, everyone. This morning, I will discuss our first quarter financial results, give you a regulatory update and cover drivers for our cash flow enhancement.
I'll start with the first quarter results on Slide 7. Our GAAP and recurring earnings for the quarter were $1.49 per share compared with GAAP and recurring earnings of $1.41 per share last year. Breaking down the first quarter earnings results of the $1.49 per share into segments, our Electric Transmission earned $0.50 per share compared with earnings of $0.45 share in 2023. Improved results were driven by our continued investments in our transmission system to address capacity growth for customers and connect clean energy resources to the region.
Our Electric Distribution earnings were $0.48 per share compared with earnings of $0.47 per share in 2023. Higher revenues primarily due to a base distribution rate increase at NSTAR Electric were partially offset by higher operating expense, higher interest expense and increased property taxes and depreciation.
Our Natural Gas Distribution business earned $0.54 per share compared with $0.49 per share in 2023. Natural Gas Distribution earnings increased due to higher revenues from capital cost recovery mechanisms, a base rate increase at NSTAR Gas and lower operating expenses. Our Water Distribution segment contributed $0.01 per share compared with flat earnings in 2023.
Eversource Parent & Other Company earnings were a loss of $0.04 per share compared to breakeven results in 2023. The lower results were due primarily to higher interest expense and the absence of a net benefit in the first quarter of last year from the liquidation of a renewable energy fund.
Overall, our first quarter earnings were in line with our expectations, and we are reiterating our 2024 EPS guidance of $4.50 to $4.67 per share as well as our longer-term 5% to 7% EPS growth rate.
Turning to regulatory items on Slide 8. Starting with Massachusetts, we filed our Electric Sector Modernization Plan with the Massachusetts Department of Public Utility in January. And we expect to have a decision on our plan in the August timeframe. Our ESMP calls for an incremental $600 million capital investments for interconnection of solar resources through 2028. As a reminder, this $600 million is incremental to our $23.1 billion capital investment forecast we announced back in February.
In New Hampshire, we are very busy on the regulatory front. In March, we submitted our documentation for a prudence review of $232 million of storm costs related to storm events from August 2022 through March of 2023. We anticipate that review will be completed later this year. In addition, we anticipate filing a rate review in New Hampshire this summer, with temporary rate relief going into effect 90 days after the filing.
Closing out the regulatory update is Connecticut, where we received the final decision on our annual rate adjustment mechanism 2 weeks ago, for new rates to become effective July 1 of this year. The major drivers of the $873 million increase are recoveries of purchase power contracts and protected hardship uncollectible accounts, both of which are costs required by law.
These under-collected costs in Connecticut, which were approximately $400 million in 2023, contributed significantly to a reduction in our 2023 FFO to debt ratio. This rate impact will be significantly offset by lower energy supply costs that will also go into effect July 1 of this year. We appreciate PURA's decision to provide timely reimbursement to the company of these state policy costs as required by law, reducing the pressure on our balance sheet to finance these costs for a longer time period.
Timely recovery of these costs reduces the total amount that customers will pay through avoidance of carrying charges on these balances. In March, we resubmitted our request for a prudence review of approximately $635 million of Connecticut storm costs relating to weather events that occurred from 2018 through 2021. The vast majority of these costs represent payments to outside line and tree crews to assist in the restoration, resulting from 24 significant storm events during that period. We are currently in the discovery phase of the proceeding. As a reminder, recovery of these costs will coincide with new distribution rates following our next general distribution rate proceeding.
In early April, following the Superior Court decision on our Aquarion rate case, we filed for a review of that decision by the Appellate Court along with a request to transfer the appeal directly to the Connecticut Supreme Court. We are requesting that the Connecticut Supreme Court hear this case due to the critical legal issues raised by the Aquarion rate decision. Without proper resolution of these issues, there will be a negative impact on utility investment and customers long term.
As Joe mentioned, we are committed to our extensive and ongoing outreach efforts that have been pivotal to educating key leaders and communities on the necessity for stable regulatory policies. We are also demonstrating our commitment to support the state's policy leaders who seek to move the state forward with thoughtful and reasonable policies aimed at reducing carbon emissions and achieving increased adoption of clean energy resources.
A successful path to a clean energy future will require a substantial ramp-up in planned proactive distribution infrastructure investment rather than piecemeal approach as well as sound public policies and adherence to legal principles to enable that investment. However, the existing gap between the state's vision of a transition to a clean energy future and the regulatory framework discouraging investment is an obstacle for Connecticut's progress on climate change, the clean energy transition and even core service goals.
As a result, we have taken a hard look at our capital deployment priorities and are implementing necessary cuts to our Connecticut investment levels in 2024 and over the next 5 years. In 2024, we are reducing our capital expenditures by nearly $100 million. And we have notified PURA of our unwillingness to put capital at risk in relation to advanced meter infrastructure and electric vehicle programs.
In total, we are expecting to reduce capital investment in Connecticut by $500 million over the next 5 years. Until we see Connecticut's regulatory decisions come back into alignment with law and state policy, our decisions on the deployment of our valuable capital resources have to be based on our current experience with regulatory outcomes for utility investment.
With that, I do want to emphasize that we are confirming our 5-year capital expenditure forecast of $23.1 billion across all business units. Substantial, consistently emerging infrastructure needs across our system provide ample opportunity for capital deployment in lieu of using those valuable resources in Connecticut.
I will now cover a number of drivers that are expected to enhance our FFO-to-debt ratio from 2023 to 2025. As you can see on Slide 9, the under-collection of 2023 deferred state policy costs, which will now be recovered as a result of the 2024 annual rate adjustment decision in Connecticut as well as other under-recoveries of regulatory deferrals across all states of approximately $200 million, contributed to the lower FFO to debt that we experienced in 2023.
We expect other enhancements in 2024 and 2025 that include the sale of South Fork and Revolution Wind assets to GIP. Upon closing of the sale to GIP, we anticipate receiving approximately $1.1 billion of cash proceeds from this transaction. In addition to the GIP sale proceeds, we anticipate utilizing our tax equity investment in South Fork Wind, which we expect will bring around $500 million of cash over the next 24 months.
Lastly, collection of storm costs in Massachusetts and New Hampshire, planned rate increases at our utilities, the sale of our Sunrise Wind project to Orsted, equity issuances and cash flows from a potential sale of our water business will drive the enhancement of 2023 FFO to debt to 14% to 15% targeted by 2025.
Moving on to our equity issuances. In the first quarter of 2024, we raised approximately $75 million through our existing ATM program. And we issued 550,000 treasury shares. We continue to anticipate our equity needs to be up to $1.3 billion over the next several years.
Also, as we announced in February, we are undertaking a review of our Water Distribution business. Proceeds from a successful sale are assumed in our long-term financing plan, reducing the level of equity that would otherwise be needed. We continue to prepare materials needed to launch the first phase of this process.
Closing out on Slide 10, as I mentioned earlier, our $23.1 billion 5-year capital forecast and our forecasted financing plan drive our 5% to 7% EPS growth rate through 2028 based off of our 2023 recurring EPS of $4.34 per share.
I'll now turn the call back to Matt for Q&A.
Matthew P. Fallon: Thank you, John. Elissa, we are now ready for questions.
Operator: [Operator Instructions] The first question comes from the line of Shahriar Pourreza with Guggenheim.
Shahriar Pourreza: Joe, I guess what -- just firstly, what CapEx are you guys actually cutting in Connecticut? Where are you kind of redeploying? And is that redeployment actually accretive just given the cost of capital differences?
Joseph Nolan: Thank you, Shahriar. Over the past decade, we've spent a significant amount of money on electric reliability for our Connecticut customers. Our best-in-class engineering has moved months between interruptions from 10 months to nearly 2 years. So clearly, our investments have paid huge dividends for our Connecticut customers. However, the regulatory decisions over the past few years are misaligned with the law and the state policy. And without a secure and predictable cost recovery path, we cannot continue to put additional capital resources on the table. So our investment objectives in Connecticut have been centered around safety and reliability.
As you'd expect, we will not reduce our safety spending. Therefore, the reduction will likely come from reliability areas. As John has mentioned, we have ample opportunities for capital deployment on our system. So we are -- we feel very, very good about that. And yes, it would be accretive.
Shahriar Pourreza: Got it. And Joe, can you cut more if need be?
Joseph Nolan: Well, we are going to be very thoughtful and deliberate about it. Obviously, we've had a great track record down there. I will tell you that the reliability numbers in that state are best-in-class. I don't think you'll find it. You'll find it really anywhere else around the country. So I'm very proud of that. But if we continue to see this negative regulatory environment, we're going to have to look at everything.
John Moreira: I would also add, Shahriar, that as a reminder, we do have a resiliency program in place, which we get timely recovery of up to $300 million of distribution investments at CL&P, which has been very, very critical for us to achieve this performance level that Joe just mentioned.
Shahriar Pourreza: Got it. And then -- and maybe just a quick one for John. John, just the up to $1.3 billion of equity is obviously still in plan. And obviously, that level is going to be dictated by the water sale outcome. I guess how are you thinking about the means of issuances? Are you thinking more in systematic terms or kind of prefunding spending and the balance sheet ahead of time, so ATMs versus maybe rip the bandage off block?
John Moreira: Our view, and that will continue to be our position, is to be opportunistic in exploring and utilizing our ATM program to accomplish that. As I've said time and time again, an ATM program gives us tremendous flexibility. And we were very successful in executing at least through month $75 million. We've done quite a bit more over the past couple of weeks.
Operator: The next question comes from the line of Carly Davenport with Goldman Sachs.
Carly Davenport: I wanted to just start on the FFO to debt walk, thanks for the detail there. I guess, first, could you just remind us of the cadence of the 2023 under-recoveries hitting the cash flow statement this year? And then how should we just think about -- as we think about the other drivers that you'd identified, sort of the split between the impacts between the $1.8 billion and those other drivers?
John Moreira: Sure. So the under-recovery, as highlighted on Slide 9, Carly, for 2023 across all of the utilities with the biggest impact being CL&P and Connecticut, was approximately $600 million. So if you were to normalize, where we landed at the end of 2023 from an FFO to debt using -- at Moody's was approximately 9%. So that would drive that up as we've indicated on the slide about 200 basis points.
So with the favorable order that we received a couple of weeks ago on the annual rate adjustment mechanism, we feel good that both that cash plus more related to 2024 costs will start to come in the door effective July 1 through April 30 of next year, so a 10-month recovery which is very, very helpful to us.
And then the other items, what we've tried to do is to highlight where we -- as it relates to our offshore win, what we have already identified and have disclosed to you all, that would significantly move us up closer to the 14% to 15% range by the end of 2025, but certainly building up towards that range towards the -- towards that time period.
Carly Davenport: Got it. Okay. Great. And then maybe just on the Massachusetts ESMP process. What are sort of the next milestones for us to look out for their? And then just more broadly, how do you think about opportunities for the other states that you serve to adopt sort of similar frameworks?
John Moreira: Sure. So I'll start with Massachusetts. So hearings on that docket just basically concluded. So now we get into the briefs and reply briefs. But one thing I want to point out to, based on the legislation that was passed a couple of years ago, the Clean Energy legislation, the DPU does have to render a decision by that August timeframe that I stated in my formal remarks.
So as we move forward, the $600 million that I highlighted in my formal remarks is really what will materialize if we do get a favorable approval from the DPU that will materialize within our forecast period, but there's further investments that will be needed beyond our current forecast period that we've also have highlighted in our filing. So obviously, Massachusetts continues to be very proactive in identifying opportunities to really make sure that the goals that the state has established is realistically and proactively accomplished.
In Connecticut, as Joe mentioned, we would love to support their Clean Energy strategy. But as we have both indicated in our formal remarks, it will require collaboration and cooperation by us -- by the utilities in Connecticut as well as the authority.
And then lastly, New Hampshire, as we mentioned, we are having discussions with the state on utility-owned solar. We will likely be proposing an investment opportunity in the months to come. As you -- as I mentioned in my formal remarks, we do plan to file for a rate review this summer.
Joseph Nolan: In all of that solar investment, just to keep in mind would be regulated investment -- solar investment, utility-owned, very similar to the model that we have here in Massachusetts, Carly.
Operator: The next question comes from the line of Nick Campanella with Barclays.
Nicholas Campanella: So just kind of sticking with Connecticut here and just the fact that you're cutting investment there, but you also had this rate order -- this outcome on Aquarion, just how do you kind of see that kind of affecting the process that you're running there to potentially monetize the asset?
And just maybe you can kind of update us on that process, your confidence level that whatever happens there, there wouldn't be additional equity kind of coming into the plan that you outlined today?
John Moreira: Well, the appeal process, obviously, we would love to have a positive data point. But the appeal process will continue to make its way. You're probably looking at, at least a year in the making, but we are continuing to move forward with launching Phase 1 of the process relatively soon. And then, we'll make the decision at that point.
Nicholas Campanella: Okay. So still moving ahead, it seems. I appreciate that. I guess just a follow-up on Carly's question just around the FFO to debt, just -- the South Fork's tax equity investment would probably be, I would guess, more onetime in nature to the, I guess, cash flow improvement. But just -- I just wanted to kind of confirm like net of these kind of one-time items, you still see this path getting you to 14% to 15%.
And what's really kind of driving that net of the one-time issues?
John Moreira: Yes. No, we certainly do, Nick, the tax equity. We actually think, as I stated, 24 months. That's probably a bit conservative. I think that will probably lead into 2026. We do have other tax benefits that we want to utilize for us before we tap into those ITCs. So that can be elongated a bit, which is great.
And then longer term, yes, that does fall off the cliff. But we have other items that will certainly kick in. We are sitting on a pretty large deferred storm balance. So I see those costs coming in, in potentially '26, certainly '27 and beyond to really maintain that high level of FFO to debt.
Nicholas Campanella: And then just one last one for me just on Sunrise. I know that you're not giving the price, but -- last quarter, there was negative book value. I don't believe that the queue is out, but is that still the case or something that you can kind of talk about? Or do we have to wait for the sale agreement to be public for you to revise that?
John Moreira: It does. And that's really -- we have to follow the accounting rules, and the accounting rules basically says that if you have a contingent gain, you have to wait to get your cash, right? So that, therefore, the transaction has to close. So where probably, I would say you should expect a true-up of those balances to occur likely in the third quarter of this year.
Operator: The next question comes from the line of Jeremy Tonet with JPMorgan.
Jeremy Tonet: Maybe just continuing with Slide 10 here real quick. Thanks for all the color provided. Just want to confirm the major drivers, everything on the right hand of that slide, that's all treated as FFO and not debt reduction when you talk about the walk from -- into 14% to 15%.
John Moreira: Yes. No, it's a mixed bag. So obviously, what's more critical is that we have the cash coming in, right, which will displace debt and obviously enhance our operating cash flows.
Jeremy Tonet: Got it. And so maybe just pivoting towards Aquarion here in just a little bit more detail, I guess, on where you guys are in the process right now and how you -- what you prioritize here, pace of transaction versus value that you can achieve or just any other thoughts on the parameters of how you see this process unfolding.
John Moreira: Sure. I would frame it this way. It's not about a mad dash to the finish line. It's about a thoughtful process that we will run for the greatest value that we possibly can harvest. So that's what's important to us, is obtaining the greatest maximum value we possibly can. So if its transactions takes a bit longer, we are fine with that. The rating agencies are fully aware of the timeframe that we've mapped out with them. And obviously, they are comfortable with that.
Jeremy Tonet: Got it. And then just to confirm real quick here, the sales proceeds are going to be helping FFO in this illustration here. I just want to make sure I was straight on that.
John Moreira: Absolutely, absolutely because it displaces debt.
Operator: The next question comes from the line of Steve Fleishman with Wolfe Research.
Steven Fleishman: Just maybe tie up one more question on Aquarion on the -- you mentioned appealing to the Supreme Court. Is there like a timeline? I don't know if you already filed that or when would you file that and when would you know if they take the case.
John Moreira: We filed that early April, that request. So we feel good that the Supreme Court will take the case and that it will just expedite the whole process. Once the court accepts that, then you're probably looking at a 9- to 12-month process, is what we're estimating.
Steven Fleishman: Okay. But you're not going to hold off the sale process to wait for that, you just move forward.
John Moreira: No. No, we're not. I was going to say, Steve, in the meantime, we are expecting to implement the original rate change, and we actually accounted for that in the first quarter this year. Once we get that, then the company can move forward with the filing for their WICA program, which will give them much -- which will give them about 30%, 35% of their annual capital program cost recovery on.
Steven Fleishman: Okay. And then just on Connecticut Regulatory Environment. I appreciate the decisions being made there. Early in the year, there had been talk about the governor may be kind of expanding the commission and some changes there. Is that still being considered at all? And just -- I know you've been on an initiative to try to highlight these issues. Just do you feel like you're making any progress in resonating on the kind of quality of the regulatory environment being kind of investable?
Joseph Nolan: Yes. Steve, a couple of things, the governor has the ability to appoint 5 commissioners. He has vacillated over that, and I'm not really sure at this point whether he wants to take it up to 5. As you know, all 3 commissioners remain in hold-over status, and I'm not really quite sure what the current plan is around that. Obviously, we have grave concerns about the environment there. I think you know that. I think everyone knows that.
We enjoy a very productive working relationship in our other 2 jurisdictions where we are so aligned that no light shines between kind of the state's initiatives and our initiatives. And when you collaborate, I think you should have tremendous outcomes. You look at the benefits that Massachusetts is achieving. You look at the progressive moves that are taking place up in New Hampshire as we collaborate with those folks. And they really understand it.
And it's going to take that type of collaboration as we look to electrify our system and move away from carbon fuels. But if we don't collaborate, it makes it very, very difficult. I mean we've have operated this way. In my 40-year history, we've always had strong working relation. So it's a disappointment to me, and it's a priority to me as we try to focus on Connecticut and to see if we can't get aligned and get on the same page so that we can move the agenda.
Connecticut has a phenomenal opportunity to be really a leader in clean energy. We built that port down there. We collaborated. That clean energy port down there should put them on the map for clean energy. But unfortunately, it's been a real challenge. But I just want to assure you and all of our investors that this is something I take very seriously, and I will continue to work at it 7 days a week until such time as we can get some constructive change.
Steven Fleishman: Okay. Appreciate that. And then lastly, on the New Hampshire Solar opportunity, I know -- solar in New England tends to be a decent amount, kind of capital cost, just not as much available land, all that stuff. So just any sense on kind of size and investment opportunity there for the New Hampshire Solar?
Joseph Nolan: Yes. I've got to tell you, one of the challenges -- first of all, we don't really have a sizing at this point. We're really in the first inning of this game, but the fact that they are interested around utility on solar, I take great confidence. But I will tell you the one thing there's no shortage of in the state of New Hampshire is land. And so that's where I see great opportunity.
And I also see the proximity to our infrastructure. It makes it very easy as well. One of the challenges that a lot of folks early in the solar days was folks would want to build, but they'd be in rural areas where there wasn't any load. But we have opportunities in New Hampshire with sizable tracks of land that would allow us to obviously collaborate. It has to be a partnership. It has to be a community that's interested in this, but I do see great opportunity up there.
So we're really in the first inning. I think we'll be able to update you probably on the second, third quarter calls around how that's going. But I think the most important thing for us is to get a model in place in New Hampshire for utility-owned solar that is fair for us and is fair for the customers.
Operator: The next question comes from the line of Andrew Weisel with Scotiabank.
Andrew Weisel: In Connecticut, another question here, I agree the state policies and regulatory environment are not aligned. So I understand you're reluctant to put capital to work. My question is, what exactly is it that you're looking for? What would it take to get you more comfortable with the regulatory setup? Is it a qualitative good faith kind of conversation? Are you looking for something more explicit like preapprovals for spending on AMI and EVs?
Joseph Nolan: Yes. Well, we're looking for preapproval, looking for our regulatory recovery, a roadmap for the recovery of odd dollars that we have spent. As you know, the filing that we just got approved there for $800-plus million, that was money we spent on behalf of the customers in Connecticut. These were state-mandated requests that we did. And so we expect to get paid for that.
And if the state wants to have AMI, we expect to have an orderly recovery process for our investments, just like we have in Massachusetts, and that's all we're looking for that if we spend dollars, we want to know we're going to get the dollars back. We don't want to be chasing those dollars. We don't want to have uncertainty around it. And I know that everybody on this call doesn't want uncertainty. And so you could have my assurance that we will not spend dollars until such time as we have a constructive regulatory environment that allows us to get fair treatment in the recovery of our dollars that we've spent on behalf of the customers in Connecticut to bring better service.
Andrew Weisel: Okay. Is that something you think could be done in the regulatory arena or would that require legislation?
Joseph Nolan: No, I think we can do it in the regulatory arena. Certainly -- I mean, we're aligned with the governor, we're aligned with this other agencies. So we can have a collaborative effort that we submit a filing for all on the same page. Even the Attorney General, we have very, very strong relations there. But we just have to get pure, aligned with all of the other interests around the state so that we can get a constructive roadmap to move forward.
Andrew Weisel: All right. Sounds good. Then on FFO to debt, if I could elaborate, I know this has been asked a few times, and I appreciate the details on Page 9. Maybe this is a silly question. But if the $600 million from under-recoveries adds 2%, you triple that to $0.8 billion. How come the impact to FFO to debt goes up by -- double or less? What dumb guy math might have get, it would be a 3:1 ratio in the dollars and the percentages. So what are the offsets there?
John Moreira: Well, keep in mind that in that 300 to 400 basis point movement, it does include other cash flow items that we have not quantified in that $1.8 billion, Andrew, and then additionally, when the cash comes in, it's going to impact both the numerator and the denominator accordingly. So it's not a one for one.
Operator: The next question comes from the line of Anthony Crowdell with Mizuho.
Anthony Crowdell: Just quickly on Slide 12, you had issued some parent debt already in the -- for the year. Do I think that's going to -- that's for the maturities at the bottom of this slide or the maturities you may also refinance and that's going to be incremental debt? And let me know if that's not clear.
John Moreira: No, you're thinking about it correctly. So it's where the maturity is listed on that slide. We do have $900 million that's due on June 27, and then, we have another $450 million in the fall. Also, in January -- early January, we have another $350 million -- $300 million coming due. So it's more of the prefunding. So with the proceeds from the transactions that I highlighted, we should be out of the debt and capital markets for quite some time.
Anthony Crowdell: Great. And then just to stay on the mark with Connecticut questions. I know sometimes when utilities ramp up CapEx or they may be doing some new projects, they talk to policymakers, some regulators prior to it and get a feel of just the policymakers are on board with this increased capital that they're spending. I'm curious if something happened in Connecticut where you had similar discussions on actually to lowering of CapEx.
Joseph Nolan: Yes, we've had discussions about our investments. I mean we started talking about AMI 3 years ago, and we're all on the same page, and everybody wanted AMI. We talked about investment in EVs, electric vehicles, infrastructure. So we were totally aligned with, certainly, key leaders down there. So we continue to have that dialogue. And right now, we have dialogue where we share with them that we can't keep moving forward unless we get the certainty around it. I mean, costs have increased since the time we began talking about AMI. If we would get on with the show, that would have saved our customers money, but this delay doesn't help matters. We're kicking it off here in Massachusetts. We're going to be putting in the AMI meters and infrastructure, and it's -- the customers are going to benefit from that.
Operator: The next question comes from the line of Durgesh Chopra with Evercore.
Durgesh Chopra: John, just for investors, and I was trying to think about the implications if you don't move forward with the Aquarion water sale. Can you just help clarify what does that do to the equity? Could the equity -- if you don't move forward with the sale, could the equity be higher than $1.3 billion? Or is that the max, and then if you do, do a sale, that number moves lower?
John Moreira: Well, there's still a lot of things in flux, and I'm not -- we're not moving off of the $1.3 billion equity needs until we have more clarity, so as things evolve over the coming year. But right now, our position is to kind of work preparing the potential sale for Aquarion and get through Phase 1 and see what -- how that -- see what that looks like.
Durgesh Chopra: Understood. And then just to be clear on the FFO to debt, I know a lot of questions have been asked, you get to that 14% to 15% by 2025 with or without the Aquarion sale? Am I thinking about it the right way?
John Moreira: No, no. If you look at the left-hand side of that slide on the bottom, we have other drivers. Those other drivers are cash inflows that we have not quantified. But yes, yes, yes. No, we have assumed -- as I continue to reiterate, in our financing plan that we have assumed the sale of Aquarion.
Durgesh Chopra: Perfect. Okay. And then just one hopefully quick follow-up. Anything to kind of note in terms of the construction process or costs on revolution in Sunrise? Any updates versus your past disclosures there?
Joseph Nolan: Yes. No, it's too early right now, but we continue to stay close to it, and we'll keep you updated. We did start though. The good news is we're in the ground, and construction is underway. So we're excited, and we're going to utilize the same practices that we successfully deployed in the construction of the South Fork project, which, as you all know, though, all 12 of the turbines are up, and they're running. And we're very, very proud that we are the first offshore wind provider in the United States.
Operator: Our final question comes from the line of Travis Miller with Morningstar.
Travis Miller: Real quick one, staying on CL&P here. If you take out your depreciation or maintenance CapEx, how much of that additional CapEx is covered under an existing rider or tracker or something like that outside of a base rate? You mentioned energy efficiency. Is there other CapEx?
John Moreira: The biggest CapEx is the $300 million system hardening that we've had in place for quite some time. So that has helped the timely cost recovery and has helped Connecticut get to a much better situation from a reliability standpoint. So I would say that a good chunk of the -- as you pointed out, the maintenance depreciation would be covered by that.
Travis Miller: Okay. Okay. And then kind of a real quick follow-on on some of the other questions. Do you expect the clean energy policy overall, not necessarily just the rate setting, but clean energy policy overall in Connecticut will be a political issue this year? Or is that something for years down the road?
Joseph Nolan: Yes. No. I mean the legislative session is going to end next week. So I don't expect that you could see anything at that point. But I think the dialogue will continue, as we'll remain engaged for the rest of this year and into the future until such time as we are all on the same page and we can find out what's important to this state that we can invest in and get a fair return and fair -- really a level playing field. That's all we're looking for.
Matthew P. Fallon: Sorry, Elissa, I just want to thank everybody for their time, and please follow up with IR with any additional follow-up questions that we can help out with. And I'll turn it back over to Elissa.
Operator: Thank you. This will conclude today's conference call. Thank you all for your participation. You may now disconnect your lines. |
MELI | 1 | 2,024 | 2024-05-02 00:00:00 | Richard Cathcart: Hello, everyone, and welcome to the MercadoLibre Earnings Conference Call for the quarter ended March 31, 2024. Thank you for joining us. I'm Richard Cathcart, MercadoLibre's Investor Relations Officer.
Today, we will share our quarterly highlights on video, after which we will begin our live Q&A session with our management team.
Before we go on to discuss our results for the first quarter of 2024, I remind you that management may make or refer to and this present may contain forward-looking statements and non-GAAP measures. So please refer to the disclaimer on screen, which will also be available in our earnings materials on our Investor Relations website.
With that, let's begin with a summary of our results.
Martin de Los Santos: Hello, everyone. I'm pleased to report another quarter of solid results with excellent operational and financial performance in Brazil and Mexico. Both countries posted GMV growth, approximately 30% year-on-year as we carry over a strong momentum from Q4. This above market growth is being driven by several factors, to improvement of user experience we minimized as a highlight, our strategic investment in chip infrastructure, which are driving faster growth in specific target regions and a well-executed marketing campaign that is leveraging on the awareness we generated in Q4 around peak season.
In addition, our advertising business continues to grow nicely and reached regular levels of GMV penetration in all of the markets where we operate. Mercado Pago also had a solid performance in Mexico and Brazil. Some of the highlights being the acquiring business growing at accelerated rate sequentially in both countries. We had a solid credit growth portfolio surpassing the $4.4 million and growing strongly from last year and a strong quarter for Mercado Pago credit card. We issued 1.5 million cars during this quarter. The TPV reached $1.9 billion, growing 133% from last year.
In summary, in Q1, we delivered a strong operational performance in commerce and fintech both in Brazil and Mexico, which has offset the negative impact of a weak macro in Argentina, and the peso devaluation in the country.
Before turning to our financial performance in more detail, I'd like to highlight that there are a couple of reporting updates that have taken effect in this quarter. Investors can find a summary of the impacts on our financials in this quarter, shareholders letter and a full reconciliation in our earnings presentation.
My comments today will refer to the numbers that are comparable to the figures we reported in Q1 last year. Consolidated revenues grew at a fast pace on the back of the strong operational momentum that I mentioned earlier. Brazil and Mexico, had an outstanding quarter and the revenues growth was sufficient to offset the impact of headwinds in Argentina.
Income from operations grew strongly year-on-year, once again, with margin expansion being driven by Mexico and Brazil. This reflects the combination of growth, scale and cost efficiency that drives operational leverage. And our long-term ambition is to continue delivering both growth and profit, and we are confident in our ability to achieve that.
Net income grew at a faster pace than income from operation as lower FX losses in Argentina were partially offset by lower operational income in that country. Furthermore, the reporting updates I mentioned earlier, have a broadly neutral impact on net income.
Overall, we are very pleased with the performance of the business in Q1 despite the headwind from Argentina. And this is a great way to kick off MercadoLibre's 25th anniversary.
Now I'll pass over to Richard for more on the solid foundations we have built over the past 25 years, looking ahead for the next 25 years of MercadoLibre.
Richard Cathcart: In 2024, MercadoLibre will celebrate its 25th anniversary. And we look back on the progress we've made in the merchandise, commerce and financial services in Latin America.
Today, Meli is the leading technology company in the region and a major tech company globally, and is being recognized for its innovation, growth and impact in the region.
In addition to business growth and impact, MercadoLibre has a consistent track record of generating shareholder value since our IPO in 2007. We look forward to the next 25 years with great confidence and optimism as we still see plenty of opportunities to continue to grow and fulfill our mission in a region that provides us with a large addressable market.
In Latin America, e-commerce is far from mature and financial services are right for disruption. We are the leading e-commerce platform in the region, which has significant potential for growth from new buyer and higher frequency as engagement and penetration of retail rise.
By building the fastest and most extensive delivery network in the region and by offering the widest assortment and the best UX, we have become a natural destination for buyers and sellers. This drives a uniquely powerful and self-reinforcing network effect as sellers invest to maximize their sales by capitalizing on our traffic, while buyers receive an ever-improving value prop, which drives more traffic and growth.
We're also building one of the largest retail media platforms in the region, which leverages our extensive first-party data to offer advertisers unique audience targeting capabilities and complete full funnel strategy. We are challenging the status quo in financial services and by offering a wide array of easy-to-use services for individuals and merchants, large markets underserved by incumbents, we have become one of the region's leading fintechs.
Our ecosystem is our competitor advantage in fintech services. Its data is uniquely rich and enables us to cross-sell. It's also enabled us to have a better view of credit risk and operate a business, which matches the lowest cost to serve in the region. We have built a highly profitable acquiring business on the back of the technology and know-how developed for our marketplace. We are one of the largest fintech in this market and are well placed for market share gains across the region.
We are also building Meli Más with the ambition of being the largest and most valued loyalty in the region by leveraging our ecosystem to offer unique benefits. Technology is at the heart of everything we do. And having one of the largest teams of engineers in the region shows nonstop innovation and product development.
We have a diversified mix of revenue with ample opportunities for growth monetization. Our scale, financial discipline and tech growth mentality, mean we have low-cost structures with solid and sustainable profitability. MercadoLibre's powerful intrinsic impact on the people we serve encourages entrepreneurship and promotes financial inclusion. We are proud of the achievements over the last 25 years, but our mission is far from complete. As a leader in an e-commerce market that is far from mature and one of the leaders in the financial services market that is right for disruption, we are confident and optimistic in our future growth. As we look forward to the next 25 years, we are confident that the best is yet to come.
Operator: Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Joining us for the Q&A are Martin Delos Santos, CFO; Osvaldo Gimenez, FinTech President; and Ariel Szarfsztejn, Commerce President.
Operator: [Operator Instructions] Our first question comes from Andrew Ruben with Morgan Stanley.
Andrew Ruben: Congratulations on the 25 years. It's helpful on the table you provide in the release that breaks down the peso-denominated and non-peso EBIT. Just thinking about the Argentina business, the units down 5%. It didn't strike us as a major decline, but you had a big hit on EBIT. So was hoping you could walk us through the situation during the quarter where you had mismatch between revenue and costs?
And perhaps if you could, even how the business evolved on a month-over-month basis within given how fast moving the Argentina macro situation has been?
Martin de Los Santos: Andrew, this is Martin. Yes. As you know, we -- in Argentina, we faced -- 2 things happened. The devaluation of Argentina, which reduced the size of our business. And as you know, Argentina is high margin -- EBIT margin business operation. And then we have the macro situation that obviously puts some pressure in terms of consumption. We've seen reduced volume and demand even though, as you know, we manage a marketplace, which is very resilient to this type of situation. So I think we outperformed the consumption in general in the country, but we did suffer some loss of volume in Argentina in the commerce side of the business.
In terms of cost mismatch, I think we saw some inflation in terms of our shipping cost in Argentina. There was some pressure on that line of our P&L. And then to wrap up the situation in the country. On the fintech side, the business performed extremely well. We continue to have a very strong brand in Argentina. Assets under management growing 64% year-on-year. We doubled the number of users of our investment products. The acquiring business in Argentina growing 300% more than inflation and then active users also growing at 31% year-on-year. So overall, I think that's what you can -- you see in terms of operating income.
And then when you go below operating income, as the double effect -- exchange rate situation in Argentina has been normalizing. We see significantly lower FX losses in Argentina. So that's compensated in the net income line of the P&L.
So overall, I would say that Argentina was a headwind in terms of EBIT, partially compensated at the net income level because of the lower FX and lower taxes that we paid this quarter in Argentina. But obviously, we had an extraordinary quarter in Brazil and Mexico that I'm sure we'll go in more detail later on the call.
Operator: Our next question comes from Bob Ford with Bank of America.
Robert Ford: Happy anniversary, and congratulations on a great quarter. Can you quantify the impact from the shift of Easter on the marketplace as well as Pago and Brazil and Mexico?
And then in Argentina, what percent of GMV is done by sellers with less than 10,000 [indiscernible] per month? And how much would that -- would the proposed tax cuts represent to those smaller sellers in terms of GMV. And what do you need before you're willing to turn the key on interoperability in Argentina in terms of economics, security or any other issues?
Martin de Los Santos: Bob, it's Martin here. Let me take the first part. I think you were asking about the effect of Easter on our volume. But as you know, we always see a reduced volume on those days because typically, in our countries, it's 4 consecutive holiday days. I mean this quarter, in particular, was a little bit stronger because last year, Easter fell on Q2 and this year fell in Q1. So if you look at the numbers for March, there were affected by those 4 days. So there was a little bit of loss of volume, which will eventually reverse next quarter because the opposite happens that will play in favor of April probably. So that's in terms of the...
Robert Ford: 5% is that fair, given the -- is that what we should think about it?
Martin de Los Santos: We [indiscernible] the month-by-month numbers. But I'd say in March, we probably lost 5 or 6 percentage points in that particular month. We'll see what happens in April when we announce Q2.
Osvaldo Giménez: Bob, let me answer the part of the interoperate to question in Argentina. So as you know, we built a QR code network that is extremely successful in Argentina, and a few years back, we were required to interoperate in account-to-account transactions, which we have been doing for a few years -- 2 or 3 years now, and that is working very well.
And now what -- there's a mandate that we need to also interoperate for credit card transactions which are a minor part of our transactions in Argentina and the majority are account to account. So this is a minor part of that volume is credit card transactions.
And the way we built the network is there was not a -- when we built it a few years back, there was not a standard for critical transactions. We do those transactions in a way with our process as online payment transactions. And so to be able to interoperate, we need 2 things. On the one hand, there's a technical requirement that those transactions need to be tokenized for the network to be secure.
And on the other hand, is we need to agree on commercial terms with the counterparties, which are likely to be -- will be banks and other wallets. We are in that process. We have -- already on our side, we are able to process tokenized transactions, but we have not yet received those. And meanwhile, we are negotiating with the banks about if there will be some sort of interchange or fee for the wallets involved in these interoperable transactions.
Martin de Los Santos: Bob, I think to answer your last question regarding Argentina, obviously, we are observing and analyzing the reform that's going on right now to see what the impact would be on our merchants. And then the number of merchants, I think you are referring to smaller merchants is a number that we don't disclose specifically.
Operator: Our next question comes from Marcelo Santos with JPMorgan.
Marcelo Santos: I wanted to ask you about the profitability of Argentina. There was a very steep decline in the EBIT contribution of Argentina versus what you reported last year. I just wanted to understand, is this kind of a new ongoing level, a new level for Argentina, given this new currency reality? Or was there something more like one-off in this quarter that could be reversed in the next couple of quarters? Just because Today, Argentina is the way you disclose almost the same profitability as the rest, why it used to be much more profitable? So I just wanted to understand that. Thank you.
Martin de Los Santos: Martin here, Marcelo. Thank you for your question. I think we mentioned before, Argentina had some tough macro situation. The devaluation also didn't help because when you look at the revenue books of Argentina, because of the devaluation by definition, strong relative to the other countries. Also had some tough macro and demand issues that affected, in particular, the commerce side of the business.
But then also Brazil and Mexico grew extraordinarily high -- sorry, high rate. Just to put it in perspective, the EBIT of Argentina decreased year-on-year, as you mentioned, but the EBIT outside of Argentina grew by 185 percentage points. So almost double the EBIT coming from other countries. So as a result of that, you can see the current -- the share of EBIT coming from Argentina now is at 19% compared to a year ago, that was about 60%.
So I think Argentina, again, the devaluation is behind us that we see macro effect in Q1, and we'll have to see how the rest of the year plays out. But again, we think that in terms of the EBIT contribution it's a little bit normalized for the other reasons that I mentioned earlier today. That as we have the exchange rate higher than it used to be with the devaluation is more normalized because of its lower FX losses, but on a net income level, the variance is not so high, okay?
So I will focus a lot more on net income as the main metric to evaluate the results of MercadoLibre. As we have been saying in the past, we were mentioning there was a little bit of a distortion in the EBIT because of the FX in Argentina now is behind. So I think in terms of the FX distortion, I could say that it's something that is a new normal, and now we have numbers that are more normalized in terms of EBIT results.
Operator: And your next question comes from Irma Sgarz with Goldman Sachs.
Irma Sgarz: I'd like to ask about Meli Más and logistics. Thank you for the use for commentary in the shareholder letter. Now as you get further into the rollout of the Meli Más program. Where are you in terms of logistics network efficiency gains from the uplift to overall volume and units per shipment? And are the costs from greater free shipping subsidies that you provide there now more than offset or -- by those efficiencies? Or will that take more time as you adjust the flow of the network and the overall engagement still rises. I'd also be curious if there's any notable differences in take-up and engagement with that program between Brazil and Mexico.
Martin de Los Santos: Irma, Martin here. Yes, we have seen very good adoption of Meli Más both in terms of adopting the MELI Delivery Day for those members that -- those users are enrolled into the Meli Más program. But also, we have seen incremental engagement and volume on our platform.
So the results that we are expecting in terms of growth driven by Meli Más, we are seeing them there. And we are super excited with those results. Obviously, that increases a little bit the cost of our shipping operations. We estimate that year-on-year, have the number here to share with you. It does put some pressure on margin. I think it adds 20 basis points as a percentage of GMV of course, but it's more than compensated value -- incremental value that we're generating through Meli Más.
And then in terms of your first part of the question, optimization, we think we are still at very early stages of optimizing Meli Más. Remember, Meli Más comes with MELI Delivery Day, which is day in a week that the user chooses to get their products. So as we continue to scale the Meli Más, we will be able to lower cost of shipping by optimizing the way we group certain products and the way we optimize the delivery cost of getting the products to our users. So it's early stages, but very optimistic and very encouraged by the results of engagement and adoption so far.
Irma Sgarz: Yes. That's very exciting. And may I just ask about also the reacceleration in TPV growth in Brazil. You highlighted new devices and -- and we know that you've been shifting up a market, but I was hoping to just get a bit more detail on the drivers of this acceleration and the direction of the incremental margin that comes attached to the revenues on this?
Osvaldo Giménez: So there were 2 components to the acceleration of TPV in Brazil. I would say the most relevant one -- the more relevant one is online payment. We have been able to -- I think there are several quarters in a row now where we have been able to accelerate the growth of online payments in Brazil, mostly by adding several larger merchants, big merchants and increasing the share of wallet we do with them. And there are several drivers for this, but definitely better performance and better approval rates.
We are very encouraged by how we see these operations continuing. And then on the point-of-sale business, as we mentioned in prior calls, we have been changing a go-to-market strategy, and that is having a good effect, and we are seeing that business growing at an accelerated rate on a quarter-on-quarter basis. So both -- mostly online payments, but also to some degree, the point-of-sale business are accelerating in Brazil.
Martin de Los Santos: And just to complement that, in terms of monetization, as we disclosed on the investor presentation, you can see that we continue to increase the cross-selling of credit to our acquiring users. So that continues to improve the profitability of that business.
Operator: [Operator Instructions] Our next question comes from Geoffrey Elliott with Autonomous.
Geoffrey Elliott: The change in Mercado Envios from agent to principal, the accounting impacts of that are all very clear. So thank you for that. But from a business point of view, what was the objective there? What does this mean in practice for the -- what does it mean in practice on the business side? And why you're doing it? Why you made this change in terms of conditions.
Ariel Szarfsztejn: Geoffrey, this is Ariel here. So we see the process on the opposite. So over the last 4 or 5 years, we've been switching from operating purely with national post offices and carriers across Latin America into building our own logistics network. And basically, that process has already occurred.
So -- what we've done now is adjusted our terms and conditions, bearing ourselves the responsibility for the execution, which is something we've been already doing. So there's nothing new in terms of the way we operate. I think that process has occurred already, and we are just now adjusting contractually and formally the way we've been operating for quite some time.
Geoffrey Elliott: Okay. So it sort of reflects kind of you taking the risk rather than a national postal service taking the risk?
Ariel Szarfsztejn: Say that again?
Geoffrey Elliott: So essentially, you're taking the risk on the shipping rather than the national postal service in the different countries, and that's why you've made this change.
Ariel Szarfsztejn: We already had the risk. So this is what we've been doing since we launched our own last mile operation in 2019, since which have been taking over warehouses operations, our line costs, et cetera, et cetera. So nothing new, no risk profile changes. Right now, it's just formalizing something that has been happening already.
Martin de Los Santos: I would say that there's no change operationally. There's no incremental risk. This is just an accounting adjustment that we make. And it reflects better the way the business is running.
Operator: Our next question comes from Neha Agarwala with HSBC.
Neha Agarwala: Just quickly on the credit business. We saw a continued decline in the 90-day NPL, but there was an increase in the early delinquency, which you mentioned is partly because of the shift in the mix of business cohorts. Could you please elaborate on that as to why they the early delinquencies have increased? And what do you mean by a shift to riskier cohorts. Thank you so much.
Osvaldo Giménez: So there were 2 components to the increase in early delinquencies. On the one hand, as you mentioned, we have been taking more risk going to riskier segments. And the reason we are doing that is because our models are better at forecasting risk and rightly evaluating the risk of each user. And therefore, we are also pricing this accordingly.
And so even though there are higher NPL, these credits have been priced with an adequate spread. So it's not a source of concern there. And the other factor that happened was the last week of March, the last week of the quarter ended with 4 days that were either weekend or holidays. And therefore, collections were typically lower than typical. Because in the last 4 days of the month, there was an invoice that we had been due in those days that was passed over to the following months, and there was a small effect for the fact that -- Good Friday and Good Thursday were the last 2 nonworking days of the month.
Neha Agarwala: If I can ask another question, when I look at your average interest rate, and this is excluding the increase in provisions, there has been a drop of about 800 basis points quarter-on-quarter on the average interest rate for your loan book. I understand part of that is probably driven by the expansion in the credit card portfolio. But given the fact that you're moving into riskier cohorts, which are priced accordingly, why such a sharp decline quarter-on-quarter?
Martin de Los Santos: It's Martin here. I think -- well, firstly, when we compare year-on-year, the NIMAL margins, I think is what you're referring to is improving despite the fact that we have a larger share of credit cards, which, as you know, is lower NIMAL product.
On a sequential basis, typically Q1 -- actually, let's put the way, Q4 tends to be a good quarter for credits because of a very strong collections because of the 13 months in the quarter and the year. So Q4 is a good month for collection. Q3 is seasonally a lower month for collections. So that's normal. It's something that is expected, in addition to 2 other things happening. Speed in terms of growth of our credit card portfolio is also contributing to that and also the fact that we accelerated originations of other products, and that generates more provisions upfront. Remember, we provision 100% of the losses upfront when we originate. So we have a Q like Q1, where we accelerated sequentially originations, that tends to put pressure on margin. Like Osvaldo mentioned, there's nothing to worry about. We continue to have very strong EBIT margin animal margin at 31.5 percentage points. So it's something that is under control and as expected.
Neha Agarwala: Your outlook on the credit business changed or modified slightly in the last month given that we are now looking at probably a higher for longer kind of rate scenario in both Brazil and Mexico.
Martin de Los Santos: Sorry, Neha, could you repeat the question, please?
Neha Agarwala: With your outlook in terms of picking up in originations in both Brazil and Mexico, has that changed over the last month given that we are probably now looking for a higher for longer rate scenario in both countries?
Martin de Los Santos: No, it hasn't. We continue to have the same strategy as we have in the past, which is to continue to cautiously increase our credit book as we feel more confident in terms of our underwriting capabilities, as Osvaldo mentioned. And then also, we are focusing a lot on growing our credit card, which is a critical product for or fintech strategy because it has all -- many benefits in addition to the credit card, users that pick on -- start using the credit card, use most of our other fintech products to bring their salaries into our account. They might take a loan, they might get insurance, and start using the debit card and so on. So it's an important part of our strategy.
Osvaldo Giménez: With regards to interest rates being a little bit higher, expectations then being higher -- as I -- relatively very small factor when compared to the spreads we have.
Martin de Los Santos: Just to complement that, the fact that our loans are typically short maturity allow us to adjust very rapidly to changing interest environment. So...
Operator: Our next question comes from Maria Clara Infantozzi with Itaú BBA.
Maria Infantozzi: I wanted to explore the potential of monetization of logistics services ahead given that you showed consistent improvement in the average speed of delivery and also accelerated penetration for another quarter. So does the company intend to start being more vocal on charging for the procurement services. How far are we from such a scenario?
Ariel Szarfsztejn: Maria Clara, Ariel here. Thanks for your question. I think there's no change in strategy for us. As we've been saying over the last few quarters, we know that there's an opportunity in the long run to increase our monetization on our shipping infrastructure.
For now, we remain focused on a, capturing the most out of the efficiencies potential that we have, which means continue driving productivity gains and reducing costs; b, I would say, getting sellers to operate with our network, particularly continue improving our fulfillment penetration, which has been going up consistently and three, being disciplined regarding passing through inflation increases. But we know we have another lever for the longer term as to continue monetizing. We just don't think it's the right time.
Operator: Our next question comes from Marvin Fong with BTIG.
Marvin Fong: Congratulations on 25 years. So a couple of questions. I'd like to get a little more detail on origination side. I believe it was about the same growth rate as last quarter in dollar terms. But just curious if how much Argentina factored into that. So perhaps you can give us some detail by country. Like how originations performed, did accelerate versus last quarter?
And then second question, just on MELI Delivery Days. I believe you gave us some disclosure about how many of your shipments are generated by that channel. Just curious if you could give us an idea, is that all a significant money favor for you guys? Or is it really just designed to kind of lower stress on the network, but it's not particularly saving on cost. And additionally, just maybe some idea of where that percentage can go over time?
Osvaldo Giménez: And Marvin, in terms of origination, most of the acceleration is coming from Brazil, where we are very comfortable with how our models are performing, and we see increased demand for loans. In Argentina, we continue to be cautious. We have accelerated versus last quarter -- we have grown versus last quarter, but we are at a rate which is significantly low -- in dollar terms, significantly lower than what it was prior to the elections. And in Mexico, we are growing on a year-on-year basis, but the origination was similar to that of prior quarter.
Martin de Los Santos: And I would add to that, that we had a devaluation in the middle. So that also affects the growth rates in Argentina when you compare year-on-year basis. But we'll continue to have a very healthy book in Argentina is probably the lowest NPLs [indiscernible], but we are cautious, as Osvaldo mentioned.
Ariel Szarfsztejn: Marvin, Ariel here. Regarding MELI Delivery Day, I think for the first time in our investor presentation, we have provided you with some details on slow shipment share. So you can see that -- more than 5% of our shipments were delivered with a slow method. Most of which is coming from MELI Delivery Day, which basically means that we saw a good adoption of MDD whenever buyers were using the Meli Más offering to get free shipping in low ASP items.
To your question on economics, I think we are seeing savings coming from that delivery model as more and more, we can consolidate items in the same box and the same delivery route, but still, we think that there's ample room for the program to continue scaling and driving costs down even more through more density in routes, more items per box or even incremental transactions that could be delivered in the same delivery as well. So good progress so far. We are excited with the results that we've seen, but the opportunity there is also relevant.
Operator: Our next question comes from Craig Mauer with FT Partners.
Craig Maurer: Happy anniversary. I wanted to ask about the ad penetration rate that moved up from 1.6% to 1.9%. Was this related to the GMV coming down Argentina? Or was this an actual improvement in adoption?
Ariel Szarfsztejn: Ariel here again. So we had a very strong quarter in ad. As you said, penetration went up 30 basis points Q-on-Q and revenues grew 64% in dollars year-over-year, almost 100% in constant currency. I think the increase in penetration is definitely not coming only from Argentina. We saw a consistent increase in penetration across every country and Mexico actually presented the highest growth, both in terms of dollars and in terms of revenues as a percentage of GMV. So overall, excited what happened this quarter and more importantly, convinced that the opportunity we have in front of us remains to be big, and we have many levers to continue capturing that.
Craig Maurer: Can you just remind if there's any seasonality in that number that we should be watching out for?
Ariel Szarfsztejn: No, we don't think there's a specific reason on seasonality. We made several product improvements, both in terms of the algorithms that we use for the bidding processes, we made changes in our placements in our sales results. So many moving parts that did help us get some acceleration there.
Operator: And our next question comes from Kaio Prato with UBS.
Kaio Penso Da Prato: Good evening. Hello, everyone. Thanks for the opportunity for questions. I have 2 here on my side, please. First, 2 questions on the fintech, okay. First, on the accounting reclassification that you made this quarter, if you could explain the rationale behind this change and why did you decide to do this now?
And the second is related to Mexico. If you could please help us understand the strategy behind the Fintech business there, specifically on the banking business. Is your plan is to compete with the fintechs that are growing there or if this should be much more financial for the marketplace business. Because looking to the financial [indiscernible] there, seeing they're not having a banking license to make the business much more difficult than in Brazil, for instance. You need some partners public for investment, lending. I just would like to understand you view on this and if you are planning any [indiscernible] through your license there as well?
Martin de Los Santos: Martin here. In terms of the reporting update, as we explained in the investor letter, what we did is basically, in the past, we had the interest income and cost from the whole operation below EBIT as we -- the Mercado Pago business evolved from being a wallet to being more of a digital banking business, A lot of the business was the float that we had on that particular operation, which we brought above within EBIT right now. So we now recognize the interest that we generated as revenue and the cost that we generate as cost of goods sold.
And that's better reflection, better reporting in terms of the nature of our business. And in fact, this is the way we have been managing our business for quite a while. So I think this is an improvement in terms of disclosures and this is the reason why we did this at this point.
Osvaldo Giménez: Building on Martin's comment, definitely the time value of money has been an integral part of how we price our fintech services. Everything we do from acquiring from when we pay sellers and even more so now with a larger offering in terms of fintech services. So we believe that this reflects better how we look at the business and how this business is really a financial business. .
With regard to the second question about Mexico and our strategy, our strategy is to be the largest fintech in Mexico. We will offer a full-fledged solution of products from -- acquired on the one hand, to fintech services on the other one. There, we -- for a long time now, we have been able to offer our wallet. And on top of that, we have been doing quite for several years and America for several years.
Last year ago -- 3 quarters ago, we launched our credit card, which is growing very, very strongly, and we work together with a third party to offer remunerated account, which is basically a money market. But money is available 24/7 in the Mercado Pago account. So we have a full offering, and we believe there's a huge opportunity that Mexico right now is going through a transformation similar to the one -- the market underwent in Brazil in the last 5, 7 or 10 years where our financial inclusion will increase a lot. With access to pay, we increased a lot, and we have a huge opportunity to be the leaders in this market.
Kaio Penso Da Prato: Okay. This is clear. Any plans for a potential upgrade in your license in Mexico?
Martin de Los Santos: Yes. Today, we are working with the Mexico license that we are able to do what we have to do. We regularly reevaluate whether in the future, we might need license. And if so, once we do anything, we will let you know.
Operator: Our next question comes from Jamie Friedman with Susquehanna International Group.
James Friedman: I wanted to ask a question about Argentina. So it looked like FX-neutral growth in Argentina came in slower than inflation. And I think in your prepared remarks, attributed that to reduced consumer demand. So I'm just trying to gauge that. Is that trend something that you are contemplating to continue? Because in the past, the pattern has been that Argentina revenue would consistently outgrow inflation. So is this a new reality that we need to consider?
Martin de Los Santos: Martin here. I think we can talk about this quarter in which we saw a recession in Argentina slowdown in consumption, as you clearly mentioned, growth was high in nominal terms, but below inflation. And in fact, in dollar terms, was also decreased from last year.
As we are monitoring the situation in the country, and we'll deal with the macro situation as it goes within the year. But as I mentioned earlier, we operate a marketplace that is very resilient to these type of situations. We have seen [indiscernible] past not in Argentina, but in other markets and we'll come out strong. We have a very strong brand, and we'll continue to manage the country as it is on the fintech side of the business. As I mentioned earlier, we are performing extremely well in Argentina, given the market conditions. On the commerce side, we are outperforming the general retail industry.
Osvaldo Giménez: Let me complement on the fintech side. I'd say we have seen some deceleration in the point-of-sale business. However, the QR code, the wallet continues to grow very strongly and above inflation, and we have been cautious on the credit side. And...
James Friedman: And then if I could just follow up, switching gears on the Slide 18, and I apologize if you answered this, but I might have missed it. But the gross margin compression of 3.9% related to the change in shipping conditions, terms and conditions, what was that about?
Martin de Los Santos: Yes. I think that's the fact that the margin is decreased because we have higher rates. So what we try to do in that space is try to explain, to try to normalize the change that we include to better understand the results of this quarter. So because we had roughly $300 million more revenues that we will have had not made this change, that effectively increases the denominator. So that reduces the margin, and this is what we adjusted there.
Operator: This concludes the question-and-answer session. I would now like to turn it back to Martin de los Santos, CFO.
Martin de Los Santos: Thanks, everybody, for joining. As we mentioned, we are very excited about the first quarter of our 25th year, particularly with the results that we saw in Mexico and Brazil, which we saw tremendous growth, both in terms of fintech and commerce with also improving profitability. As we mentioned, the EBIT margin of Brazil and Mexico combined doubled year-on-year and that's the result of the commerce business doing very well in terms of ads, shipping efficiencies, business that continues to improve profitability.
And then the fintech business in Brazil and Mexico is also thriving, growing credit portfolio, growing very nicely and improving profitability as well as acquiring business performing extremely well. And then as we continue to grow, we also gain operational leverage that is going through our P&L. As we mentioned on the bottom line in terms of net income, very strong net income growth year-on-year. So again, very excited about the results and looking forward to talking to you next quarter.
Operator: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. |
QCOM | 2 | 2,024 | 2024-05-01 00:00:00 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Qualcomm Second Quarter Fiscal 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 1, 2024. The playback number for today's call is (877) 660-6853, International callers, please dial (201) 612-7415. The playback reservation number is 13745532.
I would now like to turn the call over to Mauricio Lopez-Hodoyan, Vice President of Investor Relations. Mr. Lopez-Hodoyan, please go ahead.
Mauricio Lopez-Hodoyan: Thank you, and good afternoon, everyone. Today's call will include prepared remarks by Cristiano Amon and Akash Palkhiwala, in addition, Alex Rogers will join the question-and-answer session.
You can access our earnings release and a slide presentation that accompany this call on our Investor Relations website. In addition, this call is being webcast on qualcomm.com, and a replay will be available on our website later today. During the call today, we will use non-GAAP financial measures as defined in Regulation G, and you can find the related reconciliations to GAAP on our website.
We will also make forward-looking statements, including projections and estimates of future events, business or industry trends or business or financial results. Actual events or results could differ materially from those projected in our forward-looking statements. Please refer to our SEC filings, including our most recent 10-K, which contain important factors that could cause actual results to differ materially from the forward-looking statements.
And now to comments from Qualcomm's President and Chief Executive Officer, Cristiano Amon.
Cristiano Amon: Thank you, Mauricio, and good afternoon, everyone. Thanks for joining us today. In fiscal Q2, we delivered non-GAAP revenues of $9.4 billion. Non-GAAP earnings per share of $2.44, was above the high end of our guidance. Revenues from our chipset business of $8 billion, reflect strong premium tier demand for Android smartphones and continued momentum in automotive.
Licensing business revenues were $1.3 billion. During the quarter, we also made significant progress on our leading technology and product road maps as well as executing on our growth and diversification opportunities. Let me share some key highlights from the business.
As we drive intelligent computing everywhere, we're enabling the ecosystem to develop and commercialize on-device GenAI applications across smartphones next-generation PCs, XR devices, vehicles, industrial edge, robotics, networking and more.
To that end, we recently launched the Qualcomm AI Hub, a gateway for developers to enable at scale commercialization of on-device AI applications. It features a library of approximately 100 pre-optimized AI models for devices powered by Snapdragon and Qualcomm platforms, delivering 4x faster inferencing versus nonoptimized models.
As AI expands rapidly from the cloud to devices, we are extremely well positioned to capitalize on this growth opportunity, given our leadership position at the edge across technologies, including on-device AI. In automotive, the Snapdragon Digital Chassis is the industry's leading technology solution, and we're pleased to announce that our design win pipeline has increased to approximately $45 billion.
We're growing faster than the addressable market and remain on track to achieve more than $4 billion of automotive revenues in fiscal '26. In premium and high-tier smartphones, our Snapdragon mobile platforms continues to set the bar for performance and on-device GenAI capabilities.
Recently launched flagship Android devices powered by Snapdragon 8 Gen 3 are seeing strong demand globally, especially in China. We are extending the most sought after 8 Series capabilities, including on-device AI to a broader range of flagship and high-tier smartphones with the new Snapdragon 8S Gen 3 and Snapdragon 7 Plus Gen 3 mobile platforms launching in the second half of 2024. In cellular modems, we have again established a new industry benchmark with the Snapdragon X80, the world's most advanced 5G Modem-RF System. The X80 supports 5G advanced, the next era of 5G in addition to direct to mobile 3GPP compliant satellite communications and leading Release 18 features.
Additionally, our networking solutions continue to gain traction as the WiFi 7 transition expands to the enterprise. We are excited about the upcoming launches of next-generation Windows AI PCs powered by Snapdragon. The Snapdragon X Elite is the leader in performance on device AI and power efficiency for the Windows ecosystem and is optimally positioned to lead the transition to true AI PCs.
I'm also pleased to share that we recently expanded our compute portfolio with the Snapdragon X Plus platform. which is designed to address a broader range of device tiers. In XR, we're seeing good momentum in augmented and virtual reality. In particular, the Ray-Ban Meta glasses powered by our Snapdragon AR1 Gen 1 platform continue to gain traction with consumers. Additionally, the Meta Horizon OS running on Snapdragon is now open and available to third-party hardware makers.
This is a significant milestone as they will expand the device ecosystem. Finally, at the Embedded World Conference in Germany, we announced 2 new solutions for the industrial IoT ecosystem. The Qualcomm QCC730 micro-power WiFi SoC in the Qualcomm RB3 Gen 2 platform. The QCC730 is specifically designed for IoT connectivity in battery power, industrial, commercial and consumer applications, featuring 88% lower power consumption than previous generations.
In the RB3 Gen 2 platform is a complete hardware and software solution designed for a wide range of products, including various types of robots, drones, industrial handheld devices and more. The RB3 is supported by the recently announced AI hub and also feature support for Qualcomm Linux, a comprehensive package of operating system, software and developer tools for our IoT platforms.
In summary, we're very pleased with the continued progress on our growth and diversification strategy. Beyond handsets, we have established leadership positions across automotive, XR and networking and we are well positioned to do the same in PCs, industrial and edge AI. We're optimistic about the opportunities ahead for the company and will continue to execute on our plan to deliver long-term growth and value for shareholders.
I would now like to turn the call over to Akash.
Akash Palkhiwala: Thank you, Cristiano, and good afternoon, everyone. I'll start with our second fiscal quarter earnings. We are pleased to announce another quarter of strong non-GAAP results with revenues of $9.4 billion and EPS of $2.44, which was above the high end of our guidance range. QTL revenues of $1.3 billion and EBT margin of 71%, were in line with our expectations. .
QCT delivered revenues of $8 billion and EBT margin of 29%, which was at the high end of our guidance range, reflecting strength across handset and automotive. QCT handset revenues of $6.2 billion included the benefit of flagship Android smartphone launches powered by our Snapdragon Gen 3 mobile platform.
QCT IoT revenues increased 9% sequentially to $1.2 billion, which was slightly better than our expectations. We had another record quarter in QCT Automotive, with revenues increasing by 35% on a year-over-year basis, reflecting increased content in new vehicle launches with our Snapdragon Digital Chassis products. We returned $1.6 billion to stockholders during the quarter, including $731 million in stock repurchases and $895 million in dividends.
During the quarter, we also announced an increase in our quarterly dividends from $0.80 to $0.85 per share, consistent with our commitment to dividend growth. Lastly, the sale of the restraint control system business successfully completes the divestitures of the non-Arriver businesses related to our acquisition of Veoneer. We are very pleased with this acquisition, and the Arriver team is executing on the development of our computer vision and drive policy ADAS software stack, targeting vehicle launches starting in late '25. Now turning to guidance. Our forecast for global 3G, 4G, 5G handset units remains unchanged for calendar '24. We estimate that global handset units will be flat to slightly up on a year-over-year basis.
This includes expected growth of high single digit to low double-digit percentage in 5G handsets. For the third fiscal quarter, we are forecasting revenues of $8.8 billion to $9.6 billion, and non-GAAP EPS of $2.15 to $2.35. In QTL, we estimate revenues of $1.2 billion to $1.4 billion and EBT margins of 69% to 73%, reflecting normal seasonality for handset units.
In QCT, we expect revenues of $7.5 billion to $8.1 billion and EBT margins of 25% to 27%. Consistent with our previous comments, we anticipate QCT handset revenues to decline by mid-single-digit percentage sequentially, reflecting a seasonal trend due to the absence of flagship handset launches in the quarter.
We expect QCT IoT revenues to grow sequentially by low to mid-single-digit percentage as we continue to see a gradual recovery from the macro factors impacting the industry. Following a record performance in the second fiscal quarter, we expect QCT Automotive revenues to grow by low double-digit percentage quarter-over-quarter as the increase in our design win pipeline continues to materialize into revenue. Lastly, we expect non-GAAP operating expenses to be approximately $2.2 billion.
In closing, we are pleased with our execution and financial performance for the first half of the fiscal year. Specifically, we saw year-over-year handset revenues from our Chinese OEM increased by greater than 40% in the first half of fiscal '24, reflecting our strong competitive positioning and recovery of demand.
Looking forward, our technology leadership positions us to continue to execute on our diversification strategy across IoT and automotive. In IoT, we look forward to normalization and demand across our customer base exiting fiscal '24. In addition, we're excited about the launch of our next-generation AI PCs powered by our Snapdragon X Elite and X Plus platforms from all leading PC OEMs starting in mid-'24.
These PCs will deliver industry-leading processor performance, advanced on-device GenAI features and extended battery life. In automotive, we are pleased that our design win pipeline has increased from $30 billion in September '22 and to approximately $45 billion, providing confidence in executing to our long-term revenue targets.
This concludes our prepared remarks. Back to you, Mauricio.
Mauricio Lopez-Hodoyan: Thank you, Akash. Operator, we are now ready for questions.
Operator: [Operator Instructions] One moment please for the first question from Matt Ramsay with Cowen.
Matthew Ramsay: Cristiano, I wanted to ask you a question about sort of handset, modem and RF architecture as we move into sort of the era of AI in handsets and mobile devices, where I think it's likely that the compute system and the memory system of the phone take up more battery life potentially as we try to compute some of these applications for AI inference on the device.
And I wonder if that how that changes your potential opportunity for your modem business integrated with your RF business. There was a -- one of your competitors talked about socket lost last night, and I think it went to you guys. I wonder if you might comment on how or why. But I think it's a bigger picture question as the compute subsystem of the phone puts pressure on the modem and RF does that give you opportunities for further integration.
Cristiano Amon: Well, let me unpack this. I think as far as modern-RF, we believe we have a very competitive RF front end portfolio, and we have been really delivering unique features across the modem RF, especially on power. I -- as a general comment, not related to AI, but as general comment. I think as you look at RF AI running on device and AI running on the cloud modem becomes more important, especially things like latency of response or hybrid AI models has a new importance of real-time connectivity.
So we're starting to see more and more the modem becoming more important. The real advantage for Qualcomm is not only on the modem-RF, even though I think we're very proud of having the leadership position there is the fact that we actually created the ability to run AI pervasive on devices without compromising battery life. And that has been reflected within our NPU performance both on phones as well as PCs and cars. And I think that's the key, I think, technology leadership position for AI, which is the best possible performance per watt.
Operator: Our next question is from the line of Samik Chatterjee with JPMorgan.
Samik Chatterjee: Maybe if I can start with Cristiano asking sort of you mentioned the strong performance you're seeing in the China market, but maybe any more details in terms of just what you're seeing in the market relative to any specific numbers that you can share because there's been a lot of conflicting data points about the market being strong in 1Q and then maybe taking a breather.
So curious to understand what you're seeing on the ground there in terms of the China market. Also, it's always been sort of a leader in adopting new technology and it seems like the AI phones are doing well. So how much of the recent strength do you attribute to AI-led upgrade cycle versus a normal market rebound? And I have a quick follow-up after that.
Cristiano Amon: Thank you, Samik. So what moves to market for us premium and high tier. And I think what we're seeing in the China market is that the mix is improving. As the market has stabilized, when and return to some form of normality. What we really liked is that within that market, premium and high tier as a percentage continue to increase, and that's actually what's driving the results. And you -- and we are seeing the very first instances of on-device AI and GenAI being launched in premium devices, and that has been resonating well with the consumer. So it's a positive trend that we like.
The other color I'd like to add is, we have not seen signs of weakness in the Android premium market in China, especially with our OEMs. So a lot of the strength is really coming from premium devices from Xiaomi, Honor, Oppo, OnePlus, Vivo. And I think Huawei entering that market actually increased the overall TAM of premium Android.
Akash Palkhiwala: And maybe, Samik, to add a couple of quick data points on top. As we mentioned in our prepared remarks, first half of fiscal '24, our revenue from Chinese OEMs and grew by greater than 40% year-over-year, and that is also reflected in our third quarter guidance. So it's a trend that's holding up as we look forward. And then from a road map perspective, as you look into our new premium tier launches coming up later this year, in addition to GenAI, we'll have our Oryon custom CPU core's coming in as well. So we're very excited about the road map.
Samik Chatterjee: Got it. And for my follow-up, maybe Akash, this is more for you. I mean when you talked about the seasonality into the June quarter, handset seasonality is sort of the typical seasonality that you see and the aggregate results or revenue being better than seasonal is really being driven by autos here with the low double rate growth that you talked about.
Clearly, very strong sort of pipeline of wins, but how sustainable is this sort of pace of improvement quarter-over-quarter in terms of revenue. Just want to get a sense if this is when we start to see more sort of inflection in auto revenues given the strong pipeline you have and that drives better seasonal results going forward. even into the September quarter?
Akash Palkhiwala: Yes. From an automotive perspective, as you know, we've given out a target of greater than $4 billion revenue in fiscal '26. And what you're seeing is really our design win pipeline materializing into revenue on our way to that number. And so that's the framework as to how I think about it.
Two key kind of data points on our design win pipeline. So as you'll recall, the last number we had given was $30 billion in September -- about 18 months ago, September '22. The updated number that we just provided is $45 billion of design wins. So obviously, a very significant increase. And of note, within that, approximately 1/3 is driven by ADAS. So we're seeing tremendous success now in ADAS and that's adding to our design win pipeline.
Operator: Our next question is from Mike Walkley with Canaccord Genuity.
T. Michael Walkley: And maybe just building off the 40% increase in shipments to the Chinese OEMs holding through the June quarter guidance. just based on your expanding on device AI portfolio, is this level of demand sustainable into the back half of the calendar year? Or asked another way, do you expect the smartphone market to have kind of normal seasonal trends after the June quarter dip?
Akash Palkhiwala: Yes. So as you'll recall, Mike, we had said earlier that we expect the third quarter to be the low quarter from a financial perspective, just given the seasonality of our business. That still holds true. So as we go from third to fourth quarter and then into fiscal first quarter, which is the December quarter, we expect growth as new launches of phones happen across all major OEMs.
And as I said earlier, we're going to have the launch of our Snapdragon 8 Gen 4 chip as well, and we're extremely excited about what that chip does and the launches that will come through that chip later in the year. Specifically, as you think about fourth quarter, we expect the EPS growth from third to fourth quarter to be consistent with fiscal '23, and then we'll grow beyond that into the December quarter.
T. Michael Walkley: Great. That's very helpful. And maybe just for a quick follow-up on the IoT business. It sounds like March is the bottom, as you laid out. Can you maybe update us on the 3 segments, just what you're seeing in terms of the inventory correction?
Akash Palkhiwala: Yes. So Mike, we had talked about December fiscal first quarter as the bottom quarter. We grew from that into March by 9% sequential growth. which was better than our expectations. And then now we're guiding low to mid-single-digit growth into the September quarter. So it's -- as we had outlined at the beginning of the year, we would see improvement through the year, and that trend is holding, and we expect it to hold in the fourth fiscal quarter as well. In terms of different parts within IoT, consumer is more aligned with phones.
So we've seen that recover faster. And then the industrial networking is consistent with what our peers are seeing within those industries and the recovery time line is aligned with that.
If you kind of step back and think about our business there, we're pretty excited about new products that are coming out. So Cristiano talked about the PC set of products coming out later this year, device launch coming out later this year. But then in addition to that, we also have new products in industrial and WiFi 7 that will drive growth into this IoT segment as well.
Operator: Our next question comes from Stacy Rasgon with Bernstein Research.
Stacy Rasgon: For my first question, just on the PC outlook, it does sound like devices are going to be available for purchase in the back half. So like how much PC is actually in the Q3 outlook? And what should we expect for the PC in the numbers like into the second half and beyond, like when does PC actually get big enough for us to see it?
Cristiano Amon: Stacy, thanks for the question. We have a lot of product momentum right now and especially with all the launches, I would encourage everybody to go watch the Microsoft Build event, especially or what is happening with on device AI. There's a lot of product momentum and launches. As those devices started ramp up in volume. And since a lot of them are going to be back to school, it's going to be more of a fiscal '25 event in terms of being material within the IoT segment. Anything you'd like to add, Akash?
Akash Palkhiwala: Just maybe in our June quarter guidance, there isn't material PC volume forecasted in our numbers.
Cristiano Amon: One thing we're going to do -- sorry, just real quick. One thing we're going to do, like we provide an update on auto this quarter. We're going to provide a more detailed update next quarter on PC, especially as we're going to have those devices are launched.
Stacy Rasgon: Got it. That's very helpful. For my follow-up, I wanted to ask about Huawei revenues. So in the Q, it says that you're not expecting any further product revenue from Huawei beyond the end of the calendar year. So I know it's only low end 4G that's left, but like how big is that now in the numbers in the end? How much of that will be going away into the calendar year?
Akash Palkhiwala: Yes. So Stacy, if you look at Huawei, as you've seen, they have launched multiple tiers of 5G devices already with their own chips. And clearly, we don't participate in those devices. What we are shipping at this point is the license that we have is for 4G chips. And as you rightly pointed out, it's at the low end of the spectrum. What we outlined in the Q is since the devices will eventually transition all to 5G, we don't expect any revenue from Huawei product business in '25.
Operator: Our next question comes from the line of Chris Caso with Wolfe Research.
Christopher Caso: Question is on QTL. And it sounds like that you're starting to see some degree of improvement particularly among the China OEMs in the QCT business. But that has thus far hasn't translated to the QTL business. Can you talk about sort of the lag between the recovery in those segments and what your level of optimism or not is -- for sort of breaking out of this range in the QTL business. .
Akash Palkhiwala: Yes. So as you know, well, QTL business is really driven by the size of the market. And there is a cap on the total ASPs, up to which the royalty rate -- the percent royalty rate applies. So as we have seen the benefit on the QCT side is a lot driven by more units at the premium tier, especially above $400 in price. It does not -- it's not something that benefits the QTL business directly, the way the royalty program is structured. So that's the disconnect between the 2.
Christopher Caso: Got it. That's helpful. As a follow-up, with regard to the AI handsets, a lot of the questions that we receive on this is, sort of why? And what are the applications, what are the reasons for a consumer to upgrade their handsets to AI. Cristiano, you talked about the developer hub that you're running, perhaps that gives you some insight into what the developers are doing, what's going on in the pipeline that will drive these AI handset sales?
Cristiano Amon: Look, it's a great question. And I want to step back and say, in general, I think AI is going to benefit all the devices. I think AI when extends to running on device besides the benefit of working alongside the cloud. They have completely new use cases, privacy, security, latency, costs, personalization, et cetera. Here's how you should look into this. in the same way that when the smartphone started, you have a handful of apps that eventually grew to thousands and hundreds of thousands of apps, and that was really the user experience.
I think we're in the very early stage. And you're starting to see some of those use cases and you have exactly that moment. Some of the phones have 10 apps and they're growing. And one of the reasons we have the AI hub because this is a new, I think, moment for the industry. it works a little bit different. It's different than how you think about the traditional app store.
You have many models, many in the open source models, They can run on a device and they can be attached or built into any application. So I think we're starting to see is a lot of developer interest. As we said in the prepared remarks, we have over 100 different models, from -- models from OpenAI to Llama 3 and many, they're quantize and optimized to the NPU when they are optimized using the tool, they run 4x faster than the model without optimization.
And those models and those use cases started to be implemented in apps, whether it's an image or associated with a camera, it's associated with language. So we're in the beginning of that transition. We really like what we see because it's really creating a reason for people to buy a new device, it's going to be the same on PC. It's going to be the same as they come to cars as well and in industrial. So it's an exciting tailwind, I think, for our strategy of actually driving computing and connectivity at the edge.
Operator: Our next question is from the line of Timothy Arcuri with UBS.
Timothy Arcuri: I wanted to ask about the mix of the business. And as you said, Akash, China is holding up quite well. It's up 40% year-over-year in the fiscal first half. But it's within shouting distance of kind of where it peaked on a quarterly basis back in fiscal '22 when they were obviously over building at that time. So can you talk a little bit about what's happening there? How much of the year-over-year growth is units versus pricing?
Akash Palkhiwala: Yes. Thanks, Tim. It's -- as we said earlier, it's really the biggest benefit we are seeing is the mix being stronger. And as you know, we are competitive positioning is stronger at the higher tiers, and so that's helping us. The second is, when you look at generation over generation, the chips, especially at the premium tier are getting more capable as more -- not just GenAI, but other additional capabilities are being integrated into the chips and the strong competition between the OEMs. So there's demand for those capabilities.
So we're seeing that come through as well. And it's really a combination of those things that is driving strength versus a unit upside. The unit size we are seeing is very much aligned with the market forecast, which says flat market versus last year.
Timothy Arcuri: Got it. Okay. And then just as a quick follow-up. How sustainable are these RF wins that you've obviously gotten for this upcoming phone? Should we consider that as kind of part of the modem. So when the modem goes away, the RF wins also go away?
Akash Palkhiwala: So of course, we'll not talk about any specific customer here, but I think I'd go back to the very first question that Cristiano answered. The key thing for us is the modem-RF architecture and how when we develop the end-to-end together, it creates an advantage for us in terms of performance, in terms of time to market for our customers as well. And that's a sustainable advantage that will stay going forward for us.
Operator: Our next question is from the line of Tal Liani with Bank of America.
Tal Liani: When I look at your numbers, you bid the numbers mainly on handsets. It's both for QTL and QCT, of course. And I'm trying to understand how much of the outperformance is just China versus the rest of the world. So when you look at the rest of the world, what were the trends when it comes to your QCT shipments and QTL? And then within China, where are we in the recovery cycle, right? There is ongoing growth, but there is -- what we are seeing now in the first half of the year is mainly recovery from last year. So are you now at normal levels? And from here, it should trend normally based on demand? Or are we still recovering from the low of last year?
Akash Palkhiwala: Yes. So a couple of comments. First is on the overall picture across OEMs. So China saw a very significant benefit, but we had strength across other parts of the Android ecosystem as well. And so it's not something that was isolated to 1 or 2 OEMs. It was a broad trend that is just represented of the overall market and the mix shift that we discussed in the overall market.
On your second question, as we think about our strength in handsets, we are very optimistic that as we go forward, this is a trend that holds forward. This is not about inventory. As I said earlier, the units are actually aligned with the size of the market and the trends are really driven by mix and increased content.
Tal Liani: Got it. Okay. Second question, just on the AI. I don't know if it's possible to quantify at all. But if you look at the non-AI QCT contribution versus an AI QCT contribution, when AI is included in the mix, is there a number where it comes to the increase in content per phone. Does it mean that the semiconductor there is going to be more expensive, higher price for you? So even if the market doesn't grow, can you grow just by the market shifting to AI? That's theoretical, but I'm trying to isolate the impact of AI.
Cristiano Amon: A lot of people who [indiscernible]. But let me try to give you maybe an answer to help explain this. In first step, a lot of the increased content in ASP on QCT chipsets, including premium has been driven by the compute part. And it's more performance on the compute, CPU, GPU, the NPU.
Second, the NPU has been the largest area of silicon growth in those chips. So generation over generation, one of the largest improvements has been the NPU for AI, and AI is driving a lot of silicon content in those devices because the expected computational capability to run those models.
The benefit financially I think it's going to come probably in the way that you're starting to see the beginning of it right now, which improves the mix. Users want to buy a more capable phone that can run AI.
So it drives the market towards a richer mix of higher improvement here, share gains and then an upgrade cycle as people want to buy a new phone. That's how we should think about it in phones.
PC is a little different. As we enter the PC, I think the AI and the ability to run on device AI better than any of our peers on a laptop, I think it's going to be a tailwind to the capability.
Car, it builds more value on top of the platforms that were -- that are being commercialized and design win with the increase of the pipeline, especially in many of those platforms, we can do a softer upgrade to be able to run GenAI on those vehicles.
So I think that's how this is going to materialize for Qualcomm. The last part of my answer is industrial, which is a new area that we're trying to upgrade to higher performance from microcontrollers to high-performance computing connectivity. I think Edge AI is proving to be a key attribute of this market going forward.
Tal Liani: Our final question is from the line of C.J. Muse with Cantor Fitzgerald.
Christopher Muse: I guess I was hoping you could speak to QCT gross margins. They impressively held flat despite revenues down 5%. And I guess the real question here is not just how you did it this quarter, but how should we be thinking about as you bring on non-handset revenues to the model, what incremental gross margins might look like for QCT, particularly as we think about the AI PC and IoT as well as auto, given that growing backlog.
Akash Palkhiwala: Thanks C.J., yes, I think the first couple of quarters of this fiscal year, we've seen -- definitely seen strength in margin, and it's driven by the return mix that we've discussed on the call. What we're guiding for the third quarter is a sequential decline, again, reflecting kind of lack of flagship launches in the quarter. No change to what we've said on gross margins before. We've given a range, and we've been operating at the high end of the range, but no kind of fundamentally change on the framework of it going forward.
Christopher Muse: Great. As a quick follow-up, on the auto side, you talked about the higher reiterated the $4 billion plus. Should we be thinking about kind of amortizing that 26-plus percent growth equally into fiscal '25-'26? Or might that come in sooner with faster growth.
Akash Palkhiwala: Yes. So I mean, obviously, we are not kind of guiding quarters that far out at this point. But if you kind of take the current run rate and extend it forward towards the $4 billion target, kind of generally slope x -- slope growth increase between the 2 data points is a reasonable way of thinking about it.
Operator: That concludes today's question-and-answer session. Mr. Amon, do you have anything further to add before adjourning the call?
Cristiano Amon: Yes. Just a few questions, I think we're incredibly pleased with our technology and product road map evolution. And we're really looking forward to our next-generation PCs with Snapdragon as I said during the call, I encourage everyone to look at the announcement from Microsoft Build and how that's going to drive much more AI into the Qualcomm platform.
And I was just going to leave you all with a thought. One great things about the execution of the company. Every time we enter a new market or we set ourselves to go to a new market, and we end up building a very strong position. We went from mobile to RF front-end, we became #1. Same thing when we went to WiFi.
Automotive, it was something that we had ambition to build as part of the diversification. I think we're quickly becoming the industry partner of choice. We are -- believe that there is a long-term opportunity with virtual reality, augmented reality. And now we have the absolute majority of the designs. And with PC, we clearly build the leading platform, and we have the product momentum that we hopefully will translate in the financial in the coming year.
So I just wanted to state that we feel good about the company technology capabilities and how we're driving growth and diversification for shareholders. Thank you very much for your support. Thank you to all our employees, and I'm looking forward to talking to you in the next call.
Operator: Ladies and gentlemen, this concludes today's conference call. You may now disconnect. |
AMD | 1 | 2,024 | 2024-04-30 00:00:00 | Operator: Greetings, and welcome to the AMD First Quarter 2024 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Mitch Haws, Vice President, Investor Relations. Thank you. Mitch, you may begin.
Mitchell Haws: Thank you, and welcome to AMD's First Quarter 2024 Financial Results Conference Call. By now, you should have had the opportunity to review a copy of our earnings press release and the accompanying slides. If you have not had the chance to review these materials, they can be found on the Investor Relations page of amd.com. We will refer primarily to non-GAAP financial measures during today's call, and the full non-GAAP to GAAP reconciliations are available in today's press release and the slides posted on our website.
Participants on today's call are Dr. Lisa Su, our Chair and Chief Executive Officer; and Jean Hu, our Executive Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. Before we begin, I would like to note that Mark Papermaster, Executive Vice President and Chief Technology Officer, will attend the TD Cowen Technology, Media and Telecom Conference on May 29; and Jean Hu, Executive Vice President, Chief Financial Officer and Treasurer, will attend the JPMorgan Global Media and Communications Conference on Tuesday, May 21; the Bank of America Global Technology Conference on Wednesday, June 5; and the Jefferies Nasdaq Investor Conference on Tuesday, June 11.
Today's discussion contains forward-looking statements based on current beliefs, assumptions and expectations, speak only as of today and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statement in our press release for more information on the factors that could cause actual results to differ materially.
With that, I will hand the call over to Lisa.
Lisa Su: Thanks, Mitch, and good afternoon to all those listening today. This is an incredibly exciting time for the industry as the widespread deployment of AI is driving demand for significantly more compute across a broad range of markets. Under this backdrop, we are executing very well as we ramp our data center business and enable AI capabilities across our product portfolio.
Looking at the first quarter, revenue increased to $5.5 billion. We expanded gross margin by more than 2 percentage points and increased profitability as Data Center and Client segment sales each grew by more than 80% year-over-year.
Data Center segment revenue grew 80% year-over-year and 2% sequentially to a record $2.3 billion. The substantial year-over-year growth was driven by the strong ramp of AMD Instinct MI300X GPU shipments and a double-digit percentage increase in server CPU sales. We believe we gained server CPU revenue share in the seasonally down first quarter, led by growth in enterprise adoption and expanded cloud deployments.
In cloud, while the overall demand environment remain mixed, hyperscalers continued adopting fourth-gen EPYC processors to power more of their internal workloads and public instances. There are now nearly 900 AMD-powered public instances available globally as Amazon, Microsoft and Google all increased their fourth-gen EPYC processor offerings with new instances and regional deployments.
In the enterprise, we have seen signs of improving demand as CIOs need to add more general purpose and AI compute capacity while maintaining the physical footprint and power needs of their current infrastructure. This scenario aligns perfectly with the value proposition of our EPYC processors.
Given our high core count and energy efficiency, we can deliver the same amount of compute with 45% fewer servers compared to the competition, cutting initial CapEx by up to half and lowering annual OpEx by more than 40%. As a result, enterprise adoption of EPYC CPUs is accelerating, highlighted by deployments with large enterprises, including American Airlines, DBS, Emirates Bank, Shell and STMicro.
We're also building momentum with AMD-powered solutions powering the most popular ERP and database applications. As one example of the latest generation of Oracle Exadata, the leading database solution used by 76 of the Fortune 100, is now powered exclusively by fourth-gen EPYC processors. Looking ahead, we're very excited about our next-gen Turin family of EPYC processors featuring our Zen 5 core. We're widely sampling Turin and the silicon is looking great.
In the cloud, the significant performance and efficiency increases of Turin position us well to capture an even larger share of both first and third-party workloads. In addition, there are 30% more Turin platforms in development from our server partners compared to fourth-gen EPYC platforms, increasing our enterprise SAM with new solutions optimized for additional workloads. Turin remains on track to launch later this year.
Turning to our broader Data Center portfolio. We delivered our second straight quarter of record data center GPU revenue as MI300 became the fastest-ramping product in AMD history, passing $1 billion in total sales in less than 2 quarters. In cloud, MI300x production deployments expanded at Microsoft, Meta and Oracle to power Generative AI training and inferencing for both internal workloads and a broad set of public offerings.
For the enterprise, we're working very closely with Dell, HPE, Lenovo, Super Micro and others as multiple MI300X platforms enter volume production this quarter. In addition, we have more than 100 enterprise and AI customers actively developing or OpenAI MI300X.
On the AI software front, we made excellent progress adding upstream support for AMD hardware in the open AI Triton compiler, making it even easier to develop highly performant AI software for AMD platforms.
We also released a major update to our ROCm software stack that expand support for open source libraries, including vLLM, and frameworks, including JAKs, adds new features like video decode and significantly increases generative AI performance by integrating advanced attention algorithm support for sparsity and FPA.
Our partners are seeing very strong performance in their AI workloads. As we jointly optimize for their models, MI300X GPUs are delivering leadership inferencing performance and substantial TCO advantages compared to H100. For instance, several of our partners are seeing significant increases in tokens per second when running their flagship LLMs on MI300x compared to H100.
We're also continuing to enable the broad ecosystem required to power the next generation of AI systems, including as a founding member of the Ultra Ethernet Consortium, working to optimize the widely adopted Ethernet protocol to run AI workloads at data center scale.
MI300 demand continues to strengthen. And based on our expanding customer engagements, we now expect data center GPU revenue to exceed $4 billion in 2024, up from the $3.5 billion we guided in January. Longer term, we are increasingly working closer with our cloud and enterprise customers as we expand and accelerate our AI hardware and software road maps and grow our data center GPU footprint.
Turning to our Client segment. Revenue was $1.4 billion, an increase of 85% year-over-year, driven by strong demand for our latest-generation Ryzen mobile and desktop processors with OEMs and in the channel. Client segment revenue declined 6% sequentially.
We saw strong demand for our latest-generation Ryzen processors in the first quarter. Ryzen desktop CPU sales grew by a strong double-digit percentage year-over-year, and Ryzen mobile CPU sales nearly doubled year-over-year as new Ryzen 8040 notebook designs from Acer, Asus, HP, Lenovo and others ramped.
We expanded our portfolio of leadership enterprise PC offerings with the launch of our Ryzen Pro 8000 processors earlier this month. Ryzen Pro 8040 mobile CPUs delivered industry-leading performance in battery life for commercial notebooks. And our Ryzen Pro 8000 series desktop CPUs are the first processor to offer dedicated, on-chip AI accelerators in commercial desktop PCs.
We see clear opportunities to gain additional commercial PC share based on the performance and efficiency advantages of our Ryzen Pro portfolio and an expanded set of AMD-powered commercial PCs from our OEM partners. Looking forward, we believe the market is on track to return to annual growth in 2024, driven by the start of an enterprise refresh cycle and AI PC adoption.
We see AI as the biggest inflection point in PC since the Internet, with the ability to deliver unprecedented productivity and usability gains. We're working very closely with Microsoft and a broad ecosystem of partners to enable the next generation of AI experiences, powered by Ryzen processors, with more than 150 ISVs on track to be developing for AMD AI PCs by the end of the year.
We will also take the next major step in our AI PC road map later this year with the launch of our next-generation Ryzen mobile processors codenamed Strix. Customer interest in Strix is very high based on the significant performance and energy efficiency uplifts we are delivering.
Design win momentum for premium notebooks is outpacing prior generations as Strix enables next-generation AI experiences in laptops that are thinner, lighter and faster than ever before. We're excited about the growth opportunities for the PC market. And based on the strength of our Ryzen CPU portfolio, we expect to grow revenue share this year.
Now turning to our Gaming segment. Revenue declined 48% year-over-year and 33% sequentially to $922 million. First quarter semi-custom SoC sales declined in line with our projections as we are now in the fifth year of the console cycle. In Gaming Graphics, revenue declined year-over-year and sequentially. We expanded our Radeon 7000 Series family with the global launch of our Radeon RX 7900 GRE and also introduced our driver-based AMD fluid motion frames technology that can provide large performance increases in thousands of games.
Turning to our Embedded segment. Revenue decreased 46% year-over-year and 20% sequentially to $846 million as customers remain focused on normalizing their inventory levels. We launched our Spartan UltraScale+ FPGA family with high I/O counts, power efficiency and state-of-the-art security features, and we're seeing a strong pipeline of growth for our cost-optimized embedded portfolio across multiple markets.
Given the current embedded market conditions, we're now expecting second quarter embedded segment revenue to be flat sequentially, with a gradual recovery in the second half of the year. Longer term, we see AI at the edge as a large growth opportunity that will drive increased demand for compute across a wide range of devices. To address this demand, we announced our second generation of Versal adaptive SoCs that deliver a 3x increase in AI tops per watt and a 10x greater scaler compute performance compared to our prior generation of industry-leading adaptive SoCs.
Versal Gen 2 adaptive SoCs are the only solution that combine multiple compute engines to handle AI preprocessing, inferencing and post processing on a single chip, enabling customers to rapidly add highly performant and efficient AI capabilities to a broad range of products. We were pleased to be joined at our launch by Subaru, who announced they adopted Versal AI Edge series Gen 2 devices to power the next generation of their EyeSight ADAS system.
Embedded Design win momentum remains very strong as customers adopt our full portfolio of FPGAs, CPUs, GPUs and adaptive SoCs to address a larger portion of their compute needs. In summary, we executed well in the first quarter, setting us up to deliver strong annual revenue growth and expanded gross margin, driven by growing adoption of our Instinct, EPYC and Ryzen product portfolios.
Our priorities for 2024 are very clear: accelerate our Data Center growth by ramping Instinct GPU production and gaining share with our EPYC processors; launch our next-generation Zen 5 PC and server processors that extend our leadership performance; and expand our adaptive computing portfolio with differentiated solutions.
Looking further ahead, AI represents an unprecedented opportunity for AMD. While there has been significant growth in AI infrastructure build-outs, we are still in the very early stages of what we believe is going to be a period of sustained growth, driven by an insatiable demand for both high-performance AI and general purpose compute.
We have expanded our investments across the company to capture this large growth opportunity, from rapidly expanding our AI software stack to accelerating our AI hardware road maps, increasing our go-to-market activities and partnering closely with the largest AI companies to co-optimize solutions for their most important workloads. We are very excited about the trajectory of the business and the significant growth opportunities ahead.
Now I'd like to turn the call over to Jean to provide some additional color on our first quarter results. Jean?
Jean Hu: Thank you, Lisa, and good afternoon, everyone. I'll start with a review of our financial results and then provide our current outlook for the second quarter of fiscal 2024. We delivered strong year-over-year revenue growth in our Data Center and Client segments in the fourth quarter and grew 230 basis points of gross margin expansion. For the first quarter of 2024, revenue was $5.5 billion, up 2% year-over-year as revenue growth in the Data Center and the Client segment was partially offset by lower revenue in our Gaming and Embedded segment.
Revenue declined 11% sequentially as higher Data Center revenue resulting from the ramp of our AMD Instinct GPUs was offset by lower Gaming and Embedded segment revenues. Gross margin was 52%, up 230 basis points year-over-year, driven by higher revenue contribution from the Data Center and Client segment, partially offset by lower Embedded and Gaming segment revenue contribution.
Operating expenses were $1.7 billion, an increase of 10% year-over-year, as we continued investing aggressively in R&D and marketing activities to address the significant AI growth opportunities ahead of us. Operating income was $1.1 billion, representing a 21% operating margin. Taxes, interest expense and other was $120 million. For the fourth quarter of 2024, diluted earnings per share was $0.62, an increase of 3% year-over-year.
Now turning to our Reportable segment, starting with the Data Center. Data Center delivered record quarterly segment revenue of $2.3 billion, up 80%, a $1 billion increase year-over-year. Data Center accounted for more than 40% of total revenue, primarily led by the ramp of AMD Instinct GPUs from both cloud and enterprise customers and a strong double-digit percentage growth in our server process revenue as a result of growth across our sample products.
On a sequential basis, revenue increased 2%, driven by the ramp of our AMD Instinct GPUs, partially offset by seasonal decline in server CPU sales. Data Center segment operating income was $541 million or 23% of revenue compared to $148 million or 11% a year ago. Operating income was up 266% year-over-year due to operating leverage even as we significantly increased our investment in R&D.
Client segment revenue was $1.4 billion, up 85% year-over-year, driven primarily by Ryzen 8000 series processors. On a sequential basis, Client revenue declined 6%. Client segment operating income was $86 million or 6% of revenue compared to an operating loss of $172 million a year ago, driven by higher revenue.
Gaming segment revenue was $922 million, down 48% year-over-year and down 33% sequentially due to a decrease in semi customer and Radeon GPU sales. Gaming segment operating income was $151 million or 16% of revenue compared to $314 million or 18% a year ago.
Embedded segment revenue was $846 million, down 46% year-over-year and 20% sequentially as customers continue to manage their inventory levels. Embedded segment operating income was $342 million or 41% of revenue compared to $798 million or 51% a year ago.
Turning to the balance sheet and cash flow. During the quarter, we generated $521 million in cash from operations, and free cash flow was $379 million. Inventory increased sequentially by $301 million to $4.7 billion, primarily to support the continued ramp of data center and client products in advanced process node.
At the end of the quarter, cash, cash equivalent and short-term investment was $6 billion. As a reminder, we have $750 million of debt maturing this June. Given our ample liquidity, we plan to retire that utilizing existing cash.
Now turning to our second quarter 2024 outlook. We expect revenue to be approximately $5.7 billion, plus or minus $300 million. Sequentially, we expect Data Center segment revenue to increase by double-digit percentage, primarily driven by the Data Center GPU ramp; client segment revenue to increase; embedded segment revenue to be flat; and in the Gaming segment, based on current demand signals, revenue to decline by significant double-digit percentage.
Year-over-year, we expect our Data Center and Client segment revenue to be up significantly, driven by the strength of our product portfolio; the Embedded and the Gaming segment revenue to decline by a significant double-digit percentage. In addition, we expect second quarter non-GAAP gross margin to be approximately 53%. Non-GAAP operating expenses to be approximately $1.8 billion. Non-GAAP effective tax rate to be 13% and the diluted share count is expected to be approximately 1.64 billion shares.
In closing, we started the year strong. We made significant progress on our strategic priorities, delivering year-over-year revenue growth in our Data Center and the Client segment and expanded the gross margin. Looking ahead, we believe the investments we are making will position us very well to address the large AI opportunities ahead.
With that, I'll turn it back to Mitch for the Q&A session.
Mitchell Haws: Thank you, Jean. Paul, we're happy to poll the audience for questions.
Operator: [Operator Instructions] Our first question is from Toshiya Hari with Goldman Sachs.
Toshiya Hari: Lisa, my first question is on the MI300. You're taking up the full year outlook from $3.5 billion to $4 billion. I'm curious what's driving that incremental $500 million in revenue? Is it new customers? Is it additional bookings from existing customers? Is it more cloud? Is it more enterprise? If you can sort of provide color there, that would be helpful.
And then on the supply side, there's been headlines or chatter that CoWoS and/or HBM could be a pretty severe constraining factor for you guys. If you can speak to how you're handling the supply side of the equation, that would be helpful, too. And then I have a quick follow-up.
Lisa Su: Great. Thank you, Toshiya, for the question. Look, the MI300 ramp is going really well. If we look at just what's happened over the last 90 days, we've been working very closely with our customers to qualify MI300 in their production data centers, both from a hardware standpoint, software standpoint. So far, things are going quite well.
And what we see now is just greater visibility to both current customers as well as new customers committing to MI300. So that gives us the confidence to go from $3.5 billion to $4 billion. And I view this as very much -- it's a very dynamic market, and there are lots of customers. We said on the -- in the prepared remarks that we have over 100 customers that we're engaged with in both development as well as deployment. So overall, the ramp is going really well.
As it relates to the supply chain, actually, I would say, I'm very pleased with how supply has ramped. It is absolutely the fastest product ramp that we have done. It's a very complex product, chiplets, CoWoS, 3D integration, HBM. And so far, it's gone extremely well. We've gotten great support from our partners. And so I would say, even in the quarter that we just finished, we actually did a little bit better than expected when we first started the quarter.
I think Q2 will be another significant ramp. And we're going to ramp supply every quarter this year. So I think the supply chain is going well. We are tight on supply. So there's no question in the near term that if we had more supply, we have demand for that product, and we're going to continue to work on those elements as we go through the year. But I think both on the demand side and the supply side, I'm very pleased with how the ramp is going.
Toshiya Hari: And then as my follow-up, I was hoping you could speak to your Data Center GPU road map beyond the MI300. The other concern that we hear is your nearest competitor has been pretty transparent with their road map, and that extends into '25 and oftentimes '26. So -- and maybe this isn't the right venue for you to give too much, but beyond the MI300, how should we think about your road map and your ability to compete in Data Center?
Lisa Su: Yes, sure. So look, Toshiya, when we start with the road map, I mean, we always think about it as a multiyear, multigenerational road map. So we have the follow-ons to MI300 as well as the next, next generations well in development. I think what is true is we're getting much closer to our top AI customers. They're actually giving us significant feedback on the road map and what we need to meet their needs.
Our chiplet architecture is actually very flexible. And so that allows us to actually make changes to the road map as necessary. So we're very confident in our ability to continue to be very competitive. Frankly, I think we're going to get more competitive. Right now, I think MI300x is in a sweet spot for inference, very, very strong inference performance.
I see as we bring in additional products later this year into 2025, that, that will continue to be a strong spot for us. And then we're also enhancing our training performance and our software road map to go along with it. So more details to come in the coming months, but we have a strong road map that goes through the next couple of years, and it is informed by just a lot of learning in working with our top customers.
Operator: Our next question is from Ross Seymore with Deutsche Bank.
Ross Seymore: The non-AI side of the Data Center business, it sounds like the enterprise side has some good traction even though the sequential drop happened seasonally, Lisa. But I was just wondering what's implied in your second quarter guidance for the Data Center CPU side of things? And generally speaking, how are you seeing that whole kind of GPU versus CPU crowding out dynamic playing out for the rest of 2024?
Lisa Su: Yes, sure, Ross, thanks for the question. I think the -- our EPYC business has actually performed pretty well. The market is a bit mixed. I think some of the cloud guys are still working through sort of their optimizations. I think it's different by customer. We did see here in the first quarter, actually, some very nice early signs in the enterprise space, sort of large customers starting refresh programs. The value proposition of Genoa is very, very strong, and we're seeing that pull through across the enterprise.
In the second quarter, we expect overall Data Center to be up strong double digits. And then within that, we expect server to be up as well. And as we go into the second half of the year, I think there are a couple of drivers for us.
We do expect some improvement in the overall market conditions for the server business. But we also have our Turin launch in the second half of the year that will also, we believe, extend our leadership position within the server market. So overall, I think the business is performing well, and we believe that we're continuing to be very well positioned to gain share throughout the year.
Ross Seymore: And I guess as my follow-up, just switching over to the Client side. I noted you guided it up sequentially. Any sort of magnitude around that for the second quarter? And perhaps, more importantly, when you talk about the whole AI PC side of things, do you believe that's more of a units driver for you, an SAP driver, or will it be both?
Lisa Su: Yes. So I think, again, I think we're pretty excited about the AI PC, both opportunity in, let's call it, the near term and even more so in the medium term. I think the client business is performing well, both on the channel and on the MNC side. We expect clients to be up sequentially in the second quarter.
And as we go into the second half of the year, to your question about units versus ASPs, I think we expect some increase in units as well as ASPs. The AI PC products, when we look at the Strix products, they're really well-suited for the premium segments of the market. And I think that's where you're going to see some of the AI PC content strongest in the beginning. And then as we go into 2025, you would see it more across the rest of the portfolio.
Operator: Our next question is from Matt Ramsay with TD Cowen.
Matthew Ramsay: Lisa, I have sort of a longer-term question and then a shorter-term follow-up one. I guess the -- one of the questions that I've been getting from folks a lot is, obviously, your primary competitor has announced, I guess, a multiyear road map. And we continue to hear more and more from other folks about internal ASIC programs at some of your primary customers, whether they be for inference or training or both.
I guess it'd be really helpful if you could just talk to us about how your conversations go with those customers, how committed they are to your long-term road map, multigeneration, as you described it, how they juxtapose doing investments of their internal silicon versus using a merchant supplier like yourselves and maybe what advantages the experience across a large footprint of customers can give your company that those guys doing internal ASICs might not get?
Lisa Su: Yes. Sure, Matt. Thanks for the question. So look, I think one of the things that we see and we've said is that the TAM for AI compute is growing extremely quickly. And we see that continuing to be the case in all conversations. We had highlighted a TAM of let's call it, $400 billion in 2027. I think some people thought that was aggressive at the time. But the overall AI compute needs, as we talk to customers is very, very strong. And you've seen that in some of the announcements even recently with some of the largest cloud guys.
From my view, there are several aspects of it. First of all, we have great relationships with all of sort of the top AI companies. And the idea there is we want to innovate together. When you look at these large language models and everything that you need for training and inferencing there, although -- there will be many solutions. I don't think there's just one solution that will fit all. The GPU is still the preferred architecture, especially as the algorithms and the models are continuing to evolve over time. And that favors our architecture and also our ability to really optimize CPU with GPU.
So from my standpoint, I think we're very happy with the partnerships that we have. I think this is a huge opportunity for all of us to really innovate together. And we see that there's a very strong commitment to working together over multiple years going forward. And that's, I think, a testament to some of the work that we've done in the past, and that very much is what happened with the EPYC road map as well.
Matthew Ramsay: Lisa, as my follow-up, a little bit shorter term. And I guess, having followed the company super closely for a long time, I think there's been -- there's always been noise in the system from whether the stock price is $2 a share or $200. There's been kind of always consistent noise one way or the other, but the last 1.5 months has been extreme in that sense.
And so I wanted to just -- I got random reports by inbox about changes in demand from some of your MI300 customers or planned demand for consuming your product. I think you answered earlier about the supply situation and how you're working with your partners there. But has there been any change from the customers that you're in ramp with now or that you soon will be of what their intention is for demand? Or in fact, has that maybe strengthened rather than gone down in recent periods because I keep getting questions about it?
Lisa Su: Sure, Matt. Look, I think I might have said it earlier, but maybe I'll repeat it again. I think the demand side is actually really strong. And what we see with our customers and what we are tracking very closely is customers moving from, let's call it, initial POCs to pilots to full-scale production to deployment across multiple workloads. And we're moving through that sequence very well. I feel very good about the deployments and ramps that we have ongoing right now.
And I also feel very good about new customers who are sort of earlier on in that process. So from a demand standpoint, we continue to build backlog as well as build engagements going forward. And similarly, on the supply standpoint, we're continuing to build supply momentum. But from a speed of ramp standpoint, I'm actually really pleased with the progress.
Operator: Our next question is from Aaron Rakers with Wells Fargo.
Aaron Rakers: I apologize if I missed this earlier, but I know last quarter, you talked about having a -- securing enough capacity to support significant upside to the ramp of the MI300. I know that you upped your guide now to $4 billion. I'm curious how you would characterize the supply relative to that context offered last quarter as we think about that new kind of target for? Would you characterize it as still having supply capacity upside potential?
Lisa Su: Yes, Aaron. So we've said before that our goal is to ensure that we have supply that exceeds the current guidance, and that is true. So as we've upped our guidance from $3.5 billion to $4 billion, we still -- we have supply visibility significantly beyond that.
Aaron Rakers: Yes. Okay. And then as a quick follow-up, going back to an earlier question on server demand, more traditional server. As you see the ramp of maybe share opportunities in more traditional enterprise, I'm curious how you would characterize the growth that you expect to see a more traditional server CPU market as we move through '24 or even longer term, how you'd characterize that growth trend?
Lisa Su: Yes. I think, Aaron, what I would say is there are -- the need for refresh of, let's call it, older equipment is certainly there. So we see a refresh cycle coming. We also see AI head nodes as another place where we see growth in, let's call it, the more traditional SSD market. Our sweet spot is really in the highest performance, sort of high core count, energy efficiency space, and that is playing out well.
And we're also -- we've traditionally been very strong in, let's call it, cloud first-party workloads, and that is now extending to cloud third-party workloads, where we see enterprises who are, let's call it, in more of a hybrid environment, adopting AMD both in the cloud and on-prem. So I think, overall, we see it as a continued good progression for us with the server business going through 2024 and beyond.
Operator: Our next question is from Vivek Arya with Bank of America Securities.
Vivek Arya: Lisa, I just wanted to go back to the supply question and the $4 billion outlook for this year. I think at some point, there was a suggestion that the $4 billion number, right, that there are still supply constraints. But I think at a different point, you said that you have supply visibility significantly beyond that.
Given that we are almost at the middle of the year, I would have thought that you would have much better visibility about the back half. So is the $4 billion number a supply-constrained number, or is it a demand-constrained number? Or alternatively, if you could give us some sense of what the exit rate of your GPU sales could be. I think on the last call, $1.5 billion was suggested. Could it be a lot more than that in terms of your exit rate of MI for this year?
Lisa Su: Yes. Vivek, let me try to make sure that we answered this question clearly. From a full year standpoint, our $4 billion number is not supply capped -- I'm sorry, yes, it's not supply capped. It is -- we do have supply capability above that. It is more back half weighted. So if you're looking at sort of the near term, I would say, for example, in the second quarter, we do have more demand than we have supply right now, and we're continuing to work on pulling in some of that supply.
By the way, I think this is an overall industry issue. This is not at all related to AMD. I think overall, AI demand has exceeded anyone's expectations in 2024. So you've heard it from the memory guys. You've heard it from the foundry guys. We're all ramping capacity as we go through the year.
And as it relates to visibility, we do have good visibility into what's happening. As I said, we have great customer engagements that are going forward. My goal is to make sure that we pass all of the milestones as we're ramping products. And as we pass those milestones, we put that into the overall full year guidance for AI.
But in terms of how customer progression, things are going, they're actually going quite well. And we continue to bring new customers on, and we continue to expand workloads with our current customers. And so hopefully, that clarifies the question, Vivek.
Vivek Arya: Maybe one, not on MI, but maybe on the Embedded business. I think you sound a bit more measured about Q2 and the second half rebound, which is similar to what we have heard from a lot of the auto industrial peers. But where are you in the inventory clearing cycle? And if Embedded has a somewhat more measured rebound in the back half, what implication does that have on gross margin expansion? Can we continue to expect, I don't know, 100 basis points a quarter in terms of gross margin expansion because of the Data Center mix? Or just any puts and takes of Embedded and then what it means for gross margins in the back half?
Jean Hu: Vivek, thank you for the question. I think the Embedded business declined a little bit more than expected, really due to the weaker demand in some of the markets, very specifically, communication has been weak. And some pockets of industrial and automotive, as you mentioned, it's actually quite consistent with the peers.
Second half, we do think the first half is the bottom of Embedded business and will start to see gradual recovery in the second half. And going back to your gross margin question is, when you look at our gross margin expansion in both Q1 and the guide at Q2, the primary driver is the strong performance on the Data Center side. The Data Center will continue to ramp in second half. I think that will continue to be the major driver of gross margin expansion in second half. Of course, if Embedded is doing better, we'll have a more tailwind in the second half.
Operator: Our next question is from Timothy Arcuri with UBS.
Timothy Arcuri: I also wanted to ask about your data center GPU road map. The customers that we talk to say that they're engaged, not just because of MI300, but really because of what's coming. And it seems like there's a big demand shift to rack scale systems that try to optimize performance per square foot given some of the data center and power constraints. So can you just talk about how important systems are going to be in your road map? And do you have all the pieces you need as the market shifts to rack scale systems?
Lisa Su: Yes, sure, Timothy. Thanks for the question. For sure, look, our customers are engaged in the multigenerational conversation. So we're definitely going out over the next couple of years. And as it relates to the overall system integration, it is quite important. It is something that we're working very closely with our customers and partners on. That's a significant investment in networking, working with a number of networking partners as well to make sure that the scale-out capability is there.
And to your question of do we have the pieces? We do absolutely have the pieces, I think the work that we've always done with our Infinity Fabric as well as with our Pensando acquisition that's brought in a lot of networking expertise. And then we're working across the networking ecosystem with key partners like Broadcom and Cisco and Arista, who are with us at our AI data center event in December.
So our work right now in future generations is not just specifying a GPU, it is specifying, let's call it, full system reference designs. And that's something that will be quite important going forward.
Timothy Arcuri: And then just as a quick follow-up. I know this year it looks like it's going to be pretty back-half loaded in your server CPU business, just like it was last year. I know you kind of held our hands at about this time last year sort of on what the full year could look like and how back-end loaded it could be.
So I kind of wonder, could you give us some milestones in terms of how much server CPU could grow this year, how back-end loaded it could be? Is it like up 30% this year for your server CPU business year-over-year? Is that a reasonable bogey? I just wonder if you can kind of give us any guidance on that piece of the business?
Lisa Su: Yes. I mean, I think, Tim, I think the best way to say it is our Data Center segment is on a very, very strong ramp as we go through the back half of the year. Server CPUs, certainly, Data Center GPUs, for sure. So I don't know that we're going to get into specifics, but I could say, in general, you should expect overall at the segment level to be very strong double digits.
Operator: Our next question is from Joe Moore with Morgan Stanley.
Joseph Moore: I wonder if you could address the profitability of MI300. I know you said a couple of quarters ago that it would eventually be above corporate average, but it would take you a few quarters to get there. Can you talk about where you are in that?
Jean Hu: Yes. Thank you, Joe. Our team has done an incredible job to ramp MI300. As you probably know, it's a very complex product, and we are still at the first year of the ramp, both from yield, the testing time and the process improvement, those things are still ongoing. We do think over time, the gross margin should be accretive to corporate average.
Joseph Moore: Great. And then as a separate follow-up. On the Turin transition on server, I know when you had transitioned in generally, you said it could take a little while, that there were significant platform shifts and things like that. Turin seems to be much more kind of ecosystem compatible. How quickly do you think you might see that product ramp within our server portfolio?
Lisa Su: Yes. Joe, I think from what we see, look, think Turin is the same platform so that does make it an easier ramp. I do think that Genoa and Turin will coexist for some amount of time because customers are deciding when they're going to bring out their new platforms. We expect Turin to give us access to a broader set of workloads. So our SAM actually expands with Turin, both in enterprise and cloud. And from our experience, I think you'll see a faster transition than, for example, when we went from Milan to Genoa.
Operator: Our next question is from Stacy Rasgon with Bernstein Research.
Stacy Rasgon: For my first one, I wanted to address the MI300 ramp into Q2. So you said you've done $1 billion, give or take, in cumulative sales, which puts it at maybe, I don't know, maybe $600 million in Q1. You're guiding total revenues up about $225 million into Q2, but you've got Client up, you've got traditional Data Center up, you've got Embedded flat. Gaming is going to be down, but I'd hazard a guess that the client and traditional Data Center offset it, if not more. Does the MI300 ramp into Q2? Is it more or less than the total corporate ramp that you've got built into guidance right now that you're expecting?
Jean Hu: Stacy, thanks for the question. You always ask a math question. So I think, in general, it is more. The Data Center GPU ramp, it will be more than the overall company's $200-some million ramp.
Stacy Rasgon: Okay. So that means Gaming must be down like a lot, right, if client [indiscernible]
Jean Hu: Yes, yes, you're right. Gaming is down similar zip code like Q1.
Stacy Rasgon: Got it. Got it. That's helpful.
Jean Hu: So maybe -- yes, maybe let me give you some color about the Gaming business, right? If you look at the Gaming, the demand has been quite weak, that's quite very well-known and also their inventory level. So based on the visibility we have, the first half, both Q1, Q2, we guided down sequentially more than 30%. We actually think the second half will be lower than first half.
That's basically how we're looking at this year for the Gaming business. And at the same time, Gaming's gross margin is lower than our company average. So overall, will help the mix on the gross margin side. That's just some color on the Gaming side. But you're right, Q2 Gaming is down a lot.
Stacy Rasgon: Got it. That's helpful. For my second question, I wanted to look at the near-term Data Center profitability. So operating profit was down 19% sequentially on 2% revenue growth. Is that just the margins of the GPUs filtering in relative to the CPUs? And I know you said GPUs would eventually be above corporate average. Are they below the CPU average? I mean they clearly are, I guess, in the near term, but are they going to stay that way?
Jean Hu: Yes. I think you're right. It's -- the GPU gross margin right now is below the Data Center gross margin level, I think there are 2 reasons. Actually, the major reason is we actually increased the investment quite significantly to, as Lisa mentioned, to expand and accelerating our road map in the AI side. That's one of the major drivers for the operating income coming down slightly.
On the gross margin side, going back to your question, we said in the past, and we continue to believe the case is, Data Center GPU gross margin over time will be accretive to corporate average. But it will take a while to get to the Server level for gross margin.
Operator: Our next question is from Harlan Sur with JPMorgan.
Harlan Sur: On your Data Center GPU segment and the faster time to production shipments, given you just upped your full year GPU outlook, how much of it is faster bring up of your customers' frameworks driven by your latest ROCm software platform and maybe stronger collaboration with your customers' engineers just to get them to call faster? And how much of it is just a more aggressive build-out plan by customers versus their prior expectations given what appears to be a pretty strong urgency for them to move forward with their important AI initiatives?
Lisa Su: Yes. Harlan, thank you for the question. What it really is, is both us and our customers feeling confident in broadening the ramp? Because if you think about it, first of all, the ROCm stock has done really well. And the work that we're doing is hand in hand with our customers to optimize their key models. And it was important to get sort of verification and validation that everything would run well, and we've now passed some important milestones in that area. .
And then I think the other thing is, as you said, there is a huge demand for more AI compute. And so our ability to participate in that and help customers get that up and running is great. So I think, overall, as we look at it, this ramp has been very, very aggressive as you think about where we were just a quarter ago. Each of these are pretty complex bring ups. And I'm very happy with how they've gone. And by the way, we're only sitting here in April. So there's still a lot of 2024 to go, and there's a great customer momentum in the process.
Harlan Sur: Yes, absolutely. Just going back, just kind of rewinding back to the March quarter. So similar to the PC Client business, right, which declined at the low end of the seasonal range, if I make certain assumptions around your Data Center GPU business, x that out of Data Center, it looks like your Server CPU business was also down at the lower end of the seasonal range. By my math, it was down like 5%, 6% sequentially. Is that right?
And that's less than half the decline of your competitor. And if so, like what drove the less-than-seasonal declines? I assume some of it was share gains. It sounds like Enterprise was also better. Looks like you guys did drive a little bit more cloud instance adoption, but anything else that drove to a slightly better seasonal pattern in March for Data Center? Server?
Jean Hu: Yes. Harlan, this is Jean. I think the Server business has been performing really well. Year-over-year, it actually increased a very strong double digit. I think, sequentially, it is more seasonal, but we feel pretty good about continue gaining share there.
Lisa Su: Yes. And if I'd just add, Harlan, to your question, we did see strength in enterprise in the first quarter. And I think that has -- that offset perhaps some of the normal seasonality.
Operator: Our next question is from Tom O'Malley with Barclays.
Thomas O'Malley: I just wanted to ask on the competitive environment. Obviously, on the CPU side, you had a competitor talk about launching a high core count product in the coming quarter, kind of ramping now and more so into Q3. You've seen really good pricing tailwinds as a function of the higher core capital. Can you talk about what you're seeing in that market? Do you think that there's any risk for more aggressive pricing, which would impact your ASP ramp for the rest of the year?
Lisa Su: Yes. When we look at our server CPU sort of ASPs, they're actually very stable. I think we -- again, we tend to be indexed towards the higher core counts. Overall, I would say, the pricing environment is stable. This is about sort of TCO for sort of the customer environment and sort of our performance and our performance per watt, our leadership. And that usually translates into TCO advantage for our customers.
Thomas O'Malley: Helpful. And then just a broader question to follow up here. So I think you got asked earlier about the importance of systems. But on your end, how important is the Open Ethernet Consortium to you being able to move forward to systems? I know that, today, you obviously have some internal assets and then you can partner with others. But is there a way that you could be competitive before there is an industry standard on the Ethernet side? And can you talk about when you think the timing of that kind of consortium comes to market and enables you to maybe accelerate that road map?
Lisa Su: Yes. I think it's very important to say we are very supportive of the open ecosystem. We're very supportive of the Ultra Ethernet Consortium. But I don't believe that, that is a limiter to our ability to build large-scale systems. I think Ethernet is something that many in the industry feel will be the long-term answer for networking in these systems, and we have a lot of work that we're doing with internally as well as with our customers and partners to enable that.
Operator: Our last question is from Harsh Kumar with Piper Sandler.
Harsh Kumar: Lisa, I had two. One is for you and one perhaps for Jean. So we recently hosted a very large custom GPU company for a call. And they talked about kind of mega data centers coming up in the near to midterm, talking about nodes potentially in the 100,000-plus range and maybe up to 1 million. So as we look out at these kinds of data centers, from an architectural standpoint, it's not a situation where winner takes all, where if somebody gets in, they kind of get all the sockets?
Or will there reliance where your chip perhaps or your board can be placed right next to somebody else's board maybe on a separate line? Just help us understand how something like that would play out if there's a chance for more than 1 competitor to play in such a large data center?
Lisa Su: Yes. So I'll talk maybe a little bit more at the strategic level. I think as we look at sort of how AI shapes up over the next few years, there are customers who would be looking at very large training environments and perhaps that's what you're talking about. I think our view of that is, number one, we view that as a very attractive area for AMD. It's an area where we believe we have the technology to be very competitive there.
And I think the desire would be to have optionality in terms of how you build those out. So obviously, a lot has to happen between here and there. But I think your overarching question of. Is it winner takes all? I don't think so. That being the case, we believe that AMD is very well positioned to play in those, let's call it, of very large scale systems.
Harsh Kumar: That's wonderful. And then maybe a quick one for Jean. So Jean, I put everything into the model that you talked about for June, I get about more or less a $400 million rise in the June quarter over March. You mentioned that both MI300 and EPYC will grow. Curious if you could help us think about the relative sizing of those 2 segments within the growth? I'm getting -- the point I'm trying to make is I'm getting roughly about a $900 million number for MI300 for June. Is that -- am I in the ballpark? Or am I way off here?
Jean Hu: Harsh, we're not going to guide a specific segment below the segment revenue. I think the most important thing is that we did say Data Center is going to grow double digit sequentially. I will leave it over there. Subsegment, there are a lot of details.
Operator: There are no further questions at this time. I'd like to hand the floor back over to management for any closing comments.
Mitchell Haws: Great. That concludes today's call. Thanks to all of you for joining us today.
Lisa Su: Thanks.
Operator: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. |
SBUX | 2 | 2,024 | 2024-04-30 00:00:00 | Operator: Good afternoon. My name is Diego, and I will be your conference operator today. I would like to welcome everyone to Starbucks' Second Quarter Fiscal Year 2024 Conference Call. [Operator Instructions] I will now turn the call over to Tiffany Willis, Vice President of Investor Relations and ESG engagement. Ms. Willis, you may begin your conference.
Tiffany Willis: Welcome and good afternoon, and thank you for joining us today to discuss Starbucks' second quarter fiscal year 2024 results. Today's discussion will be led by Laxman Narasimhan, Chief Executive Officer; and Rachel Ruggeri, Executive Vice President and Chief Financial Officer. And for Q&A, we'll be joined by Belinda Wong, Chairwoman and Co-Chief Executive Officer of Starbucks China; Brady Brewer, Chief Executive Officer of Starbucks International; and Michael Conway, Chief Executive Officer of Starbucks North America.
This conference call will include forward-looking statements, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factors discussed in our filings with the SEC, including our latest annual report on Form 10-K and quarterly report on Form 10-Q. Starbucks assumes no obligation to update any of these forward-looking statements or information.
GAAP results in the second quarter fiscal year 2024 and the comparative period include several items related to strategic actions, including restructuring and impairment charges, transaction and integration costs, and other items. These items are excluded from our non-GAAP results. All numbers referenced on today's call are on a non-GAAP basis unless otherwise noted or there is no non-GAAP adjustment related to the metric. As part of our non-GAAP results, revenue, operating margin and EPS growth metrics on today's call are measured in constant currency, whereby current period results are converted into United States dollars using the average monthly exchange rates from the comparative period rather than the actual exchange rates for the current period, excluding related hedging activities. For non-GAAP financial measures mentioned in today's call, please refer to the earnings release on our website at investor.starbucks.com to find reconciliations of those non-GAAP measures to their corresponding GAAP measures.
This conference call is being webcast, and an archive of the webcast will be available on our website through Friday, June 14, 2024. Also for calendar planning purposes, please note that our third quarter fiscal year 2024 earnings conference call has tentatively been scheduled for Tuesday, July 30, 2024.
And with that, I'll now turn the call over to Laxman.
Laxman Narasimhan: Thank you, Tiffany, and thank you all for joining us this afternoon. Let me be clear from the beginning. Our performance this quarter was disappointing and did not meet our expectations. Our Q2 total company revenue was $8.6 billion, down 1% year-over-year. Our global comparable store sales declined 4% year-over-year, driven by a negative 3% comp growth in North America led by declining traffic and a negative 11% comp growth in China. Our global operating margins contracted by 140 basis points to 12.8%, and our overall earnings per share declined by 7% to $0.68.
While these results do not reflect our strengths, our capabilities or the opportunities ahead, we confront these challenges from a position of enduring strength. We have led the industry for more than 50 years because we have built a different kind of company, one that exceeds our partner expectations, one that delivers a distinctive and unique experience for our customers and one anchored in the love and craft of coffee.
As a result, our worldwide brand equity remains resilient and strong. Our leadership in coffee remains unmatched. Our global base of customers remains loyal. Our experiences are differentiated and elevated, our partners are talented and engaged. Our forward-looking product pipeline is highly appealing. Our distinctive store development capability continues to perform incredibly well. Our network of stores is healthy and robust. Our stores are executing better than ever with a stronger operating foundation. Overall, partner engagement is very strong. Our Triple Shot with 2 Pumps Reinvention strategy continues to deliver, and our possibilities as a company remain limitless.
Still, we face a challenging operating environment. Headwinds discussed last quarter have continued. In a number of key markets, we continue to feel the impact of a more cautious consumer, particularly with our more occasional customer, and a deteriorating economic outlook has weighed on customer traffic, an impact felt broadly across the industry. In the U.S., severe weather impacted both our U.S. and total company comp by nearly 3% during the quarter. The remainder of our challenges were attributable to fewer visits from our more occasional customers.
Turning elsewhere. We still see economic volatility in the Middle East, but we remain confident in the region's long-term growth opportunities. In China, we still see the effects of a slower-than-expected recovery, and we see fierce competition among value players in the market. But we are strengthening our premium position, and our team in China continues to execute with terrific rigor and heart as the market shakeout continues and as demand recovers and matures.
None of these realities are excuses. Some, like weather, are transitory. Others, like a more cautious consumer, may persist longer, but much is within our control. There are 3 execution opportunities in our U.S. business I want to expand on: first, meet the demand we have across dayparts to drive future growth; second, launch even more exciting and relevant new products while maintaining our focus on core coffee forward offerings; and third, reach and demonstrate more value for our occasional and non-Starbucks Rewards customers.
We understand how to do this, and we have what we need to deliver against our plans. So as we look to the second half of the fiscal year and beyond, we're accelerating our work on the underlying execution engines that power our business to realize these opportunities.
Let me talk you through each. First, meet the demand we have in the U.S. across dayparts. The morning daypart is likely what you think of when you think of Starbucks. It is our peak, and it represents about half our business. It's coffee forward, heavily routine-based and driven by strong loyalty. At our best, we bring in customers with distinctive coffee and a great experience. We convert them to Starbucks Rewards members. We build interest with new coffee innovations, and we encourage more frequent visits and food attached.
But we currently have a challenge meeting our peak morning demand in the U.S. For example, more than 60% of our morning business in the U.S. comes from Starbucks Rewards members who overwhelmingly order with a Starbucks app. What's interesting though, despite strong Mobile Order & Pay sales, we saw a mid-teens percent order in completion rate within the order channel this past quarter. In other words, customers using MOP put items into their cart and sometimes chose not to complete their order citing long wait times or product unavailability. Here lies opportunity.
We're intensely focused and actively working on improving operational throughput by providing our partners with the right processes and tools, and on giving our customers a better sense of when the order will be ready. Rollout of our equipment-driven Siren System is on track, but we're also fine-tuning the store processes that underpin this new equipment. We have been working for the past 6 months with the Toyota Production System Support Center to unlock additional capacity at our peak. And what we saw through store tests was a real near-term opportunity to fundamentally improve how we operate our stores.
The Siren craft system, as we're calling it, requires no capital. The technology solutions are relatively straightforward, and we are working to roll it out in North American stores over the coming months. In stores where we've used the Siren craft system to optimize operations, we have already seen an increase in peak throughput, which we estimate to be worth nearly 1 comp point annually. The Siren craft system also bolsters the highly incremental returns we expect from our equipment-driven Siren Systems as it is deployed in stores. Taken together, these new processes and new equipment systems act as complements and amplify efforts to unlock capacity at peak.
Additionally, we are revamping and investing in our Deep Brew technology to improve wait time estimates and provide more transparency for customers. They're efforts we began last quarter and built on the many improvements we've made to the Starbucks app over the last 12 weeks with introductions now on a 4-week upgrade cycle.
Another reason customers choose not to complete their order is product availability. For example, our Potato, Cheddar & Chive Bakes were a big hit with customers, but demand was so strong that we are currently only able to offer them in 2,000 of our U.S. stores. We are ramping up supply chain investments to further improve availability with an initial focus on our customers' favorite items.
In summary, we are working to increase throughput and improve product availability to enhance the customer experience, improve convenience and better capture existing demand. Over time, we believe these improvements will attract a larger subset of customers.
I also want to talk about unmet overnight demand. We see it as a tremendous and untapped incremental opportunity. Last quarter, we mentioned we were conducting a pilot program to serve customers overnight between 05:00 p.m. and 05:00 a.m. when our stores are traditionally closed. During this pilot test, we doubled our business. Building off that success, we are aggressively pursuing options to build a $2 billion business over the next 5 years. Overnight opportunities are incremental and create a complement to our existing delivery business, which grew by double digits in the U.S. this quarter with both ticket increase and transaction growth.
In addition to the overnight, we have unmet weekend demand potential. Starbucks attracts routine customers all week through the morning and the afternoon. While the weekend continues to attract our routine customers, we also see more families and kids. We are working to realize this demand potential to new product offerings, collaborations, marketing and enhancements to the store experience. As you can see, there is significant demand in the morning and even more potential during afternoon, overnight and the weekend we have yet to realize. And we are accelerating our execution engines to meet it.
Second, launch more relevant and exciting new products for our U.S. customers while maintaining our focus on core coffee-forward offerings. We are the leader in coffee. We are overwhelmingly focused on our coffee-forward products. Coffee continues to perform strongly. And for example, 63% of our beverage sales in the quarter were cold, up 1% from a year ago, driven by innovation.
And beyond our core, there is more. We know we are challenged to bring new innovations with frequency and strong appeal across other dayparts. This winter, we brought back pistachio lattes, rolled out Oleato nationally and launched a new core iced-shaken espresso. Our beverage is prepared with new breakfast products like our Potato, Cheddar & Chive Bakes. Some of our new products did well and drove positive customer buzz, but not all met our expectations. That reality, coupled with what our customers have told us, points to opportunity across both coffee and non-coffee. And by that, I mean refreshers, matcha and chai and across food to drive greater attach.
Later in the quarter, we saw improvement. Our lavender platform is extremely successful, including our lavender matcha, and it compares to some of the most successful launches we've ever had. But to cut through, we're working to drive even more buzz-worthy products and on strengthening the supply of products that become popular. These efforts take time, but our team is working with great energy and speed to make both happen.
We also invested in our brand over the past quarter to address recent misinformation. The work was effective in driving brand metrics, and our overall brand equity and affinity remains strong. As we look ahead, we have an opportunity to better amplify our new products and to drive more awareness and excitement for those products, particularly among our more occasional customers. As we will detail, we are accelerating the execution engines to help us drive more frequent and exciting product innovations, both in the core and beyond.
Third, reach and demonstrate more value for our occasional and non-Starbucks Rewards customers. We have loyal customers in the U.S., and they stay truly loyal in terms of frequency, transactions and the level of customization they sought with their purchases. We are a brand known for the premium value we provide. Our one-of-a-kind experiential Starbucks Reserve Roasteries, which elevate our brand and create lasting value, had strong transactions, fueled by innovation across our coffee platforms, other beverages and food. Throughout the quarter, brand perception of value for what I get, on average, remained strong, and our pricing decisions have been measured.
But in this environment, many customers are being more exacting about where and how they choose to spend their money, particularly with stimulus savings mostly spent. We saw this materialize over the quarter as customers made the trade-offs between food away from home and food at home. Against that tide, we need to be able to reach and communicate with our customers in a way that demonstrates our value, particularly through Starbucks Rewards and the Starbucks app.
We are accelerating back-end work on the Starbucks app to ensure we better connect with our more occasional customers. Starting in May, we will add new and exclusive in-app offers that create additional value for our customers. We'll also launch upgrades to the app that include significant improvements to our wait time algorithms. Then in July, we will begin opening the Starbucks app for all while making MOP available in more places outside our app. Following the milestone, more of our customers will be able to see our offers, including those that use guest checkout; and more customers will discover the strong value we provide, value that they will not see otherwise. More on that later.
These opportunities show that much is within our control. We are confident in our accelerated plans to strengthen the execution engines that power how we serve our customers, how we create and amplify a pipeline of new products and how we reach our customers through the Starbucks app. But let me be clear. It will take time to fully realize these opportunities.
Our Triple Shot with Two Pumps strategy is the way we will drive these plans forward over the long term. So let's talk about our progress made against each strategic pillar. Our first strategic pillar is to elevate the brand. We do this by driving compelling product innovation, building great stores and operating great stores. Above all, we maintain our leadership and innovation in coffee. In fact, just last week, we announced several steps to reinforce our leadership position to the lens of our partners, our customers and our farmers.
These include new investments in coffee farms to further scale open agronomy practices; new and exquisite whole bean coffees coming to our core and reserve stores; and new pop-up experiences in cities around the world to engage Gen Z and Millennial customers in the craft of coffee, which they love. Further, we are scaling the rollout of our Clover Vertica brewer to deliver the world's finest top-quality brewed coffee.
The Clover Vertica provides customers choice between 6 separate coffee roasts and blends, including decaf, brewed fresh on-demand any time of the day. And its rollout is paired to the global launch of our new Starbucks Milano Duetto light and dark roast blends in stores later this year. As mentioned, we are also driving more frequent and exciting product innovation, both coffee and non-coffee.
Our team has been working with remarkable speed and agility to create a product innovation pipeline that includes new flavors, textures and functional benefits. Investments in product development are already showing benefit. Our new lavender platform performed nearly as well this past quarter as the PSL. More recently, too, our new Spicy refreshers and Reserve Hot Honey beverages show that relevant product innovation can exceed expectations. At our new Roastery and Reserve stores, we are now introducing new products with more agility and speed. Notably, we're also making strides to cut our average product development cycle in half from our current time table of 12 to 18 months.
Looking to our innovation pipeline for the second half of the year, I'm excited by the number and types of products we're bringing to market. For summer, we are launching our first texture innovation, pearls. This is the first of more texture-based innovations that our customers can expect in the coming years. And we're launching a new functional product, a 0 to low-calorie handcrafted energy beverage. Both build on our coffee heritage and open entirely new vectors for additional future innovation.
And later this year, we will add up to 5 sugar-free customization options to our menu in response to both partner and customer requests. This will provide a lower calorie option for approximately 80% of our beverages. Our product innovation pipeline will also include more plant-based options as well, like our new plant-based ready-to-drink Frappuccino beverage that recently launched in U.S. grocery stores.
Beyond our beverage development pipeline, we're also focused on enhancements to food. As an example of the investment we're making in food quality, we recently launched a reimagined premium blueberry muffin. And for summer, we're launching a new egg, pesto and mozzarella sandwich. It combines protein with outstanding taste. We're also expanding grab-and-go choices available in our store lobbies to include more vegan, vegetarian and gluten-free options as well as kid-friendly options.
Taken together, our partner experience, unique customer experience and our core products are what differentiates us. Our pipeline is significantly stronger than last year, and product builds are being developed with partners and simplicity in mind. We're also investing in our supply chain to lower cost and ensure products are available and in-store for our customers.
Lastly, we continue to grow our global store footprint. Our store development capability is a core strength. This year, we will design and build more than 3,000 new stores globally, and we continue to do so in a financially accretive manner. Our new store openings continue to realize strong unit economics. AUVs and ROIs across our portfolio continue to drive strong returns and high incrementality. We're also leveraging learnings from international markets to meaningfully lower breakeven points for store formats scalable in emerging markets.
Moving on. Our second strategic pillar is further strengthening and differentiating our leadership position in digital. As mentioned, Starbucks Rewards and the Starbucks app play a central role in driving value for our customers. Our MOP set another record in the U.S., representing 31% of all transactions in the quarter. Our Starbucks Rewards members in the U.S. also grew by 6% over the prior year to nearly 33 million members.
The stickiness and evolution of our digital position provides a structural advantage. Building on this strength, we are mapping additional ways to engage customers as we work to double SR members over the next 5 years. As mentioned, we will begin opening the Starbucks app for all in July. This addresses the current gap in our ability to reach non-Starbucks Rewards members, allows us to deliver more value for the occasional customers and improves our ability to convert them to SR members.
It drives a better experience for our customers and is core to our growth. We know that SR customers visit more often and spend more. Upgrades in our queue include a guest checkout feature and sequential improvements that make our app an even more appealing gateway for all customers.
We also plan to invest $600 million over the next 3 years to further digitize our stores and better target customers in more personalized ways. This includes the installation of digital menu boards across the footprint of all our company stores in the U.S. and China. And we're making additional investments in our Deep Brew AI and machine learning platforms to further digitize and fine-tune how we operate our stores while delivering an improved digital customer experience and more personalized customer offers. Offers that are timely and relevant and flexible to location, inventory availability and weather. These investments, including a new revenue management system are foundational to successful execution.
In the near term, we continue to provide increasingly compelling offers like marketed pairings, including both beverage and food, that make occasions like lunch even more appealing. We continue to encourage and reward routinized behaviors across the day with exclusive offers for SR members. To better communicate the value we provide, we are working to drive offer awareness with omnichannel marketing. This campaign will remind customers that the best offers are in the app and will target more occasional and non-SR customers.
Our third strategic pillar is becoming truly global. Our international business remains an important part of our long-term growth strategy. Across the Middle East, we continue to work with the Alshaya Group to support the well-being of our partners and customers. Last month, The Starbucks Foundation and Alshaya Starbucks donated $3 million to the World Central Kitchen and their humanitarian efforts to provide food aid in Gaza. Last week, we also announced that every bag of whole bean Starbucks Odyssey Blend coffee sold at participating North American stores through June will benefit World Central Kitchen's efforts to address hunger around the world.
Turning our attention to China. Macro pressures resulted in traffic contraction this quarter. Performance was impacted by a decline in occasional customers, changing holiday patterns, a high promotional environment and a normalization of customer behaviors following last year's market reopening. Like the U.S., our decline in occasional customers was most noticeable in the afternoons and evenings.
Still, there are many bright spots. Starbucks remains the Chinese consumers' first choice in away-from-home coffee across city tier and age group. Our morning daypart in China registered growth fueled by coffee routines we've cultivated. Mornings are now larger than before the pandemic. Delivery also achieved positive comp. Starbucks Rewards membership expanded with active members now reaching a record 21 million. We're investing further to grow our SR members and their loyalty to drive greater engagement and lifetime value.
Beverage innovation is also strong and validates the opportunity we see to further drive the strength of our product pipeline in China. Through the quarter, we unveiled 27 new products fueling brand excitement and meaningful customer engagement, and monthly customer connection scores are at their highest ever as is partner engagement.
Our robust operating muscle led to sequential margin expansion amidst revenue headwinds, and we sustained very healthy and profitable unit economics and a double-digit store operating margin for a total store portfolio, including new stores. While recovery will remain choppy, our business has shown great resilience, and our fundamentals are very strong. We will win and lead in the premium market. We have built a strong and expanding customer base, a strong brand, a strong portfolio of highly profitable stores and strong capability to drive margin expansion.
We continue to execute on the 3 key elements of our China strategy, offering more coffee-forward, locally relevant product innovations, making significant investments in technology to increase omnichannel capability and digitize our stores, and increase the percentage of new store openings in lower-tier markets and new county cities where we see stronger new store economics.
We will weather through this dynamic and transitory period as the industry shakeout continues. Our confidence in the market opportunity and our ability to deliver remains unwavering as we play the long game in China. Elsewhere, we saw growth in many parts of our International segment, highlighting the resilience and diversity of our business portfolio. Excluding China, our International segment grew revenue and comp in the quarter bolstered by strength in Latin America, Asia Pacific and Japan. The Latin American region continued its strong momentum with double-digit system sales growth. Our Asia Pacific region drove revenue growth despite headwinds in the Indonesian and Malaysian markets. And revenue from our Japan business grew by double digits.
Across our International segment, we opened 230 net new stores this quarter. In total, our store count outside of North America is now more than 20,800, reflecting a year-over-year growth of 9%. We opened our 400th store in India, our 600th store in Indonesia and our 1,900th store in Korea. We are on track to operate 1,000 stores in India by 2028, translating 1 new store opening every 3 days.
As we expand to Honduras and Ecuador, our global footprint will grow to more than 39,000 stores across 88 markets, putting us well on the path to 55,000 stores by 2030.
Our fourth strategic pillar, 1 of our 2 pumps is unlocking efficiencies. In the quarter, our Triple Shot strategy continued to unlock meaningful efficiencies across the North American business, driving 150 basis points of store operational efficiencies. Additionally, we saw meaningful reductions in product and distribution costs, driven by supply chain improvements in procurement, transportation and sourcing.
Specifically in our U.S. stores, we're focused on creating a more stable environment for partners through investments in equipment innovation, process improvements, staffing, scheduling and waste reduction, all things our partners value and prioritize, creating a more satisfying work environment in our stores while derisking our business.
Today, our stores are running better than ever before, underpinned by the strong fundamentals our team has built. For example, we see meaningful improvement in drive-thru window times without adding more work for our partners, with even more to come as we layer in our Siren craft system. We are rebuilding and refining our supply chain and to unlock efficiencies in our factory in the back, we are leveraging technology in new ways. We have significant above-the-store opportunity to realize efficiencies in our supply chain. They are significantly higher than we initially thought, and we are ahead of plan and savings.
Through work to date, we have the confidence we need to extend our goal from $3 billion in added efficiencies over 3 years to $4 billion over the next 4. As a result of our investments and focused efficiency efforts, partner turnover reached a new low in the quarter. Store manager turnover has also improved, and both beat industry benchmarks by a wide margin. Average hours per partner continues to improve by double digits year-over-year, increasing engagement and their take-home pay.
That brings me to our fifth strategic pillar, reinvigorating our partner culture. From the beginning, Starbucks set itself apart as a different kind of company. Our unique culture is anchored in our mission, promises and values of craft, results, courage, belonging and joy. And at the heart of our business are our partners. They are central to the Starbucks experience and are delivering on our promise to uplift the every day for customers around the world. I see this every day and through my regular work in stores.
We continue to work to restitch the fabric of the green apron for all partners. Just last week, we gathered together to celebrate our first-ever Starbucks Promises Day. And next month, we will celebrate the tenth anniversary of our Starbucks College Achievement Plan with Arizona State University. Following commencement, more than 13,000 partners will have earned their bachelor's degree through the program, bringing to life our partner promise of a bridge to a better future. What's more, over 25,000 partners across more than 90% of our U.S. stores are currently enrolled in the program and are pursuing a bachelor's degree.
To close, we had a tough quarter. We need to do better, and we will. As I look forward, I'm confident we have the right strategy. We have terrific partners and a strong executive team that is deeply engaged and continues to lead. I thank each of our 460,000 green apron partners around the world for their remarkable work. We have real opportunity, and we are taking swift action to accelerate investment through the execution engines that will address the near term and drive our long-term success. These actions are funded by a highly profitable operations and productivity initiatives and is captured within our guidance. As these actions take hold, we expect our business to return to algorithmic growth and to achieve its long-term opportunity.
And with that, I will turn it over to Rachel to discuss our results in greater detail. Rachel?
Rachel Ruggeri: Thank you, Laxman, and good afternoon, everyone. As Laxman shared, our performance this quarter did not reflect what we're capable of as a company. We have an incredible brand, loyal customers globally, a strong portfolio of highly profitable stores and in connection with our partners and customers that's unlike any other in our industry. We know that we can and we will do better.
While it was a difficult quarter, we learned from our own underperformance and recognize the onus is on us to execute. We've sharpened our focus and with our comprehensive road map of well-thought out actions, the path forward is clear. With that, let me turn to our results.
Our Q2 consolidated revenue was $8.6 billion, down 1% from the prior year due primarily to a 4% decline in comparable store sales driven by lower transactions, partially offset by 8% net new company-operated store growth over the prior year. Q2 consolidated operating margin contracted 140 basis points from the prior year to 12.8%, primarily driven by deleverage, partner wages and benefit investments as well as promotional activities, partially offset by pricing and our continued execution against reinvention-related in-store operational efficiencies, which drove approximately 150 basis point savings in the quarter. Q2 EPS was down -- was $0.68, down 7% from the prior year, primarily due to the contraction of operating income in both the North America and International segments as a result of lower revenue.
I'll now provide segment highlights for Q2. North America revenue was $6.4 billion in Q2, flat to the prior year as 5% net new company-operated store growth was mostly offset by a 3% decline in comparable store sales driven by a 7% decrease in transactions partially offset by a 4% increase in average ticket. Our U.S. company-operated business posted a 3% comparable store sales decline in Q2, driven by a 7% decrease in transactions.
Consistent with Q1, the traffic decline was pronounced among more occasional customers with a more cautious consumer environment as a backdrop and also included an estimated 3% adverse impact from extreme weather, including some store closures. Partially offsetting the decline was a 4% increase in average ticket, reflecting pricing as well as the continued mix shift into cold beverages such as Iced Shaken Espresso and Matcha Tea Latte, which resonate with our customers.
Additionally, our new store performance remains strong, with both year 1 AUV and cash margin of recently opened stores projected to be in line with last year's newly opened stores, preserving high incrementality even with our expanding footprint. North America's operating margin was 18% in Q2, contracting 120 basis points from the prior year. The contraction was primarily driven by deleverage, partner wage and benefit investments as well as promotional activities, partially offset by pricing and reinvention-related in-store operational efficiencies.
While deleverage drove the overall contraction in the segment's margin, efficiencies generated through our reinvention efforts meaningfully countered the deleverage we experienced in the quarter. While our reinvention plan is intended to provide a more balanced growth model and margin expansion, we're pleased to see the benefits counterbalance, broader headwinds in our business as our partner staffing and scheduling investments continue to unlock in-store efficiencies.
The benefits continue to expand outside of stores as well, resulting in meaningful reduction in the segment's product and distribution costs as a percentage of revenue, partially driven by supply chain savings. We believe our strategies related to reinvention are working, creating more streamlined operations and tangible financial benefits across our business with more opportunity to come.
Moving to International. The segment delivered $1.8 billion in revenue in the quarter, roughly flat to the prior year, primarily as 12% growth in net new company-operated stores was offset by a 6% decline in comparable store sales driven evenly by transactions and average ticket. Revenue was also impacted by a decrease in licensed store revenues, largely resulting from the negative impacts to our business in the Middle East. Although our revenue was impacted, our long-term aspirations in international has not wavered as there was revenue and comp growth across the International segment when excluding China. This speaks to the strength of our broader international portfolio, driven by markets like Japan, Asia Pacific, Latin America and the Caribbean.
Shifting to China. In Q2, China's revenue declined 3%, driven by an 11% decrease in comparable store sales consisting of 8% and 4% declines in average ticket and transactions, respectively, partially offset by a 14% net new store growth. The market continued to recover slower than expected with further impacts from the timing of holiday-related travel trends. Despite the complex environment, the market opened 118 net new stores in the quarter while sustaining double-digit store operating margin for both new stores and the total portfolio, demonstrating the health and resilience of our brand in the market, positioning us well in the market long term. Total International segment operating margin was 13.3% in Q2, contracting 340 basis points from the prior year primarily driven by promotional activities, partner wage and benefit investments as well as sales mix shift partially offset by pricing in certain markets.
Shifting to channel development. The segment's revenue of $418 million in Q2 declined 13% from the prior year, largely in line with our expectations given the sale of Seattle's Best Coffee and SKU optimization. Importantly, we maintained the #1 share position in both U.S. at-home coffee and U.S. ready to drink.
As an example of innovation in China, we launched our Starbucks Refreshers platform with 2 flavors, the Pink Drink and the Purple Drink, to drive our much-desired cool portfolio beyond our stores, particularly among Gen Z. The segment's operating margin was 51.7% in Q2, expanding 1,610 basis points from prior year, driven primarily by growth in our North America coffee partnership joint venture income as well as lapping prior year impairment charges against certain manufacturing assets. The segment's operating margin is progressing in line with our original expectations, continuing to target the full year range of high 40% to low 50%, a very attractive financial model.
Now moving on to our guidance for fiscal year 2024. Given what we shared today, we're revising our fiscal year guidance, and I'll walk through both, one, what changed; and two, what remains the same in comparison to our previous guidance.
So first, what changed? Broadly, in the second quarter, our business underperformed as revenues in the U.S., China, Middle East and other markets were impacted more deeply than anticipated by the continued multifaceted headwinds. In addition to the second quarter performance, our exit rates of both revenue and comp growth across our key markets reflect continued headwinds.
To manage these headwinds, we have focused actions both to unlock capacity and track demand in the spirit of uplifting traffic as well as to further implement our Triple Shot strategy. Leveraging our learnings from the second quarter, and as Laxman discussed in detail, we're working to further elevate our brand through an integrated focus across product innovation and marketing, including strengthening our digital capabilities, delivering more value for our customers.
For instance, first, to unlock demand in the morning daypart in the U.S., we're working to improve store-related processes, leveraging our Siren craft system while also increasing product availability through improved inventory management. Second, to attract demand, particularly in the afternoon daypart, we're implementing a new and more frequent innovation cadence integrated with a broader multi-channeled marketing approach, inclusive of highly targeted personalized offers.
This shift is geared towards our more occasional customers to attract and inject them to our stores and apps. Now some of these actions will take time to fully materialize. However, through our investments in our customer experience and focused execution, we do expect to deliver some benefit in the current fiscal year. As a result of what has changed, our revenue and comp guidance as well as the related flow-through to margin and earnings is impacted. In addition, the continued headwinds impacted our global store growth expectations.
Now before I share the details of our revised fiscal year 2024 guidance, I'll share what remains the same. First, we have confidence in the effectiveness of our proven Triple Shot strategy, as our biggest opportunity lies in our execution.
Second, our efficiency efforts are tracking slightly ahead of our expectations. Year-to-date, we achieved 170 basis points of in-store operational efficiencies along with great progress out of store, positioning us to deliver our $3 billion savings target through fiscal year 2026 with line of sight to even more opportunity beyond that.
Third, while our Channel Development segment is the smallest of our segments, it complements our portfolio, capturing customer occasions beyond our stores; and our performance in that segment continues to deliver. Lastly, we must continue investing in the fundamentals and competitive moat of our business, our partners, our stores and our customers, as we believe these investments will drive long-term growth and industry leadership beyond these transitory headwinds.
Based on these facts, we are revising our full year fiscal 2024 guidance to: global revenue growth of low single digits from our previous range of 7% to 10%; global and U.S. comps of low single-digit decline to flat, both from the previous range of 4% to 6% growth; China comp of single-digit decline from the previous expectation of low single-digit growth in Q2 through Q4; global net new store growth of approximately 6% from our previous expectation of approximately 7%. We continue to expect our U.S. store count to grow by approximately 4% and now anticipate approximately 12% store growth in China from our previous expectation of approximately 13%; operating margin growth of approximately flat from the previous expectation of progressive expansion. Finally, we expect EPS and non-GAAP EPS growth of flat to low single digits from the previous range of 15% to 20%.
As a reminder, our guidance does not include any impact from foreign currency translation and assumes constant currency. As an additional insight into our fiscal year 2024 guidance, we expect sequential revenue growth from Q3 to Q4 with pressure on margin and earnings easing in Q4 as our action plans take hold. We continue to expect our full year effective tax rate in the mid-20% range. Lastly, we continue to expect approximately $3 billion in CapEx, most of which is ring-fenced for our direct investment in our global store portfolio, which, as we have shared, continues to drive highly attractive returns.
In summary, here are key takeaways from my discussion today. First, Q2 was a challenging quarter for us as headwinds consistently persisted throughout the quarter leading us to revamp our actions and response plans to both unlock and attract demand. Second, our Triple Shot strategy continues to deliver efficiencies even in the face of headwinds, reinforcing that we have the right strategy at the right time. Next, our fiscal year 2024 guidance has been revised to reflect our Q2 performance, year-to-date results as well as the near-term headwinds we're experiencing. We, however, remain confident in our long-term growth opportunity and thus, committed to our strategy and the related investments. And finally, our disciplined approach to capital allocation drives our financial fortitude, reflecting shareholder commitment underpinned by our best-in-class dividend. This allows us to preserve both balance sheet durability and flexibility, positioning us to successfully navigate this complex and dynamic environment.
Before I open the call to Q&A, I want to share my sincerest gratitude for my partners, both in and out of stores across the globe who show up every day living our values to deliver the differentiated customer experience that makes Starbucks so special for all of us. Thank you, partners.
Operator, you can now open the call to Q&A.
Operator: [Operator Instructions] with that, our first question comes from Sara Senatore with Bank of America.
Sara Senatore: I guess it's a two-part question about trends that you were talking about. The first is that you talked about weather as a headwind, and then you said that lavender late in the quarter was one of the strongest launches you've had similar to PSL. But your exit rate -- it sounds like you're saying your exit rate was largely unchanged. So I'm trying to reconcile what would appear to have been headwinds that aren't reoccurring and then very successful innovation with the guidance and the exit rates. That's the first part.
And the second is just in terms of the cautious consumer. Typically, I think what we'd see is check management, and you don't seem to be seeing that. I think mix is still a tailwind for you. So it seems to me that there's not as much evidence of consumer caution as perhaps just some of what you were talking about, the Starbucks specific, so if you could just comment on those.
Laxman Narasimhan: Sara, thank you for your question. Let me address both of them by pointing to the underlying pressures that we see consumers face just in terms of what they have available to spend. So there's no question that if you take some of these transitory headwinds out, which, of course, are not an excuse in any way, and you look at the underlying headwinds particularly around the pressures that consumers face particularly with the occasional customer, what we're seeing is that's where the challenge is. It's a challenge with their traffic and it's their challenge with them coming into our stores.
If you look at our most loyal customers, they're coming in often. They're seeing the value that we provide in Starbucks Rewards, in our app. They are premiumizing through customization as in the past. And so therefore, what you see there is you see a strong business with our loyal customers particularly those within the environments of the Starbucks app. What we are focused on is, first, how we meet the demand we already have through ensuring that our partners have the processes and the tools at the peak in order to meet the demand of customers who, at this moment, are choosing not to complete their transactions in Mobile Order, Pay.
The second thing is we're clearly launching new products, and our pipeline is very strong. And what we are doing, though, as part of that is the third element, is how we reach and deliver value to the more occasional customers as well as those that are not in the Starbucks Rewards ecosystem. And that's where the challenge lies. And that's how you reconcile the 2 points that you had made. So we have a lot in our control, and we are focused on it. And we're focusing on the execution of those 3 opportunities, as I laid out, in North America.
Operator: And our next question comes from Brian Harbour with Morgan Stanley.
Brian Harbour: When you talk about the more occasional customer, I'm curious, is that often a younger customer? And I think the broader question is just is there any sort of brand resonance issue with perhaps some of that customer base? Do you think there's sort of a product resonance issue with them? Is there more that needs to be done than just kind of accelerating the pace of new products and some of the other drivers that you talked about in the near term?
Laxman Narasimhan: Brian, thank you for your question. I think that if you look at our overall brand equity, it is and continues to be strong. If you look at the scores around value for what I get, strong. So if I look at the occasional customer, though, they're clearly making choices based on the economic pressures they face. What they look for from us is they look for variety. They look for the core. 50% of what we have in the afternoon, as an example, is coffee. So obviously, coffee is really important, and distinctiveness of coffee is very important. But they are looking for variety and they're looking for value.
And what we're focused on is ensuring that we find a way to connect with them, to bring them into our app ecosystem in order for them to see the value that we provide inside there. That's why you're going to see the actions we take in May. You're going to see the actions that we take in July as we open up the app to all. That is going to make them, particularly in North America, be able to see the value that we provide in a way that's much easier for them. And as they build loyalty over time, they will see even more value as they come into the system. So that's as far as North America goes and the steps that we are taking.
Operator: Our next question comes from Jeffrey Bernstein with Barclays.
Jeffrey Bernstein: Great. A broader question on the global unit growth, just more broadly, your confidence or, I guess, the prudence in maintaining what still is outsized growth with the headwinds seemingly large. Just wondering how you can be confident that the current challenges you're facing aren't, in part, due to maybe saturation or cannibalization.
And I guess that does end up pointing to China. And for China specifically, I think you mentioned healthy unit economics and double-digit restaurant margin. I was just wondering if, Rachel, maybe you could just talk about the specifics in terms of those sales, margins and returns that justify still that outsized growth in a very challenging China macro?
Laxman Narasimhan: Let me first -- I'll take on the first question of global unit growth and hand over to Rachel to talk specifically about your question on China margins. Jeff, what we see is we see very strong cash and cash returns and I think what we've done both in the U.S. but also in the expansion plans that we have internationally. And I think what you see is -- what we're focused on is ensuring that we have reduced the cost of our stores and stores investment. We have done a very good job in bringing efficiency to that. And so as we expand, we see very good cash-on-cash returns.
The reality is that the penetration we have in many of these markets and the headroom that we have internationally is very high. I mean I think, last time, we talked about the fact that, I think, we were just in 800 cities or -- in China and the opportunity for us in terms of counties is about over 3,000.
So I think we're like -- we're not really penetrated as much as we could be in a place like China, which is why we have confidence. As we look at the real estate options we have, the proposals that are coming together, the kind of cash returns we get are very strong. That's what gives us confidence in terms of the global unit growth. Rachel, do you want to take the second part?
Rachel Ruggeri: And if I would just add to that, when we look at the guidance that was given around our new store growth, particularly as it relates to China, that's really a very deliberate decision that we took to be able to increase the number of stores that we were opening in lower-tier cities and new counties where we see even stronger returns. So broadly, our returns are quite attractive, but they're even stronger in those lower-tier cities and the new counties. And as a result of that, that shift actually impacts our development pipeline. So there's a timing impact in terms of new store growth. So that's why we're at 12%, which we think is still a very strong growth and indicative of the opportunity that we see
[Technical Difficulty]
Operator: Are you still connected? One moment. Can you hear us?
Laxman Narasimhan: We can hear you.
Operator: And our next question comes from David Palmer with Evercore ISI.
David Palmer: First, I wanted to ask a clarification. You mentioned in your prepared remarks that you viewed some of the issues in China as transitory. I think you were speaking more about the competition than you were about the consumer with that comment. I think you mentioned something about a shakeout. I was wondering if you could double-click on that for us, what you're maybe seeing that would make you think that the environment there would be -- competitively would be a transitory one and they would get better that way.
And then from a beverage innovation standpoint, I'm wondering how you're viewing the pipeline. Lavender happened, Spicy Lemonade has happened. You have 2 new ones coming up. How are you viewing the pipeline differently than -- and how are you thinking about the process of R&D differently today? And how are you evaluating what you've done?
Laxman Narasimhan: I think we had some technical problems in hearing you, but let me just try and recap the question. Your first question was on competition in China and the comment around the shakeout that we are starting to see. And the second comment was on beverage pipeline.
So let me start with the competition in China. I think the growth has taken place in the mass area of the China business, of the China overall coffee and tea segment is, one, where we see just intense price competition. We're choosing not to participate in that. We are a premium brand. We have built a business over 25 years with a great deal of competitive advantages. You can see that there. We have amazing partners in stores. We have stores that look distinctive. We have an end-to-end supply chain that, frankly, I would love to have in the U.S. And then we are steeped in coffee and the tradition of coffee in end to end as well as for the knowledge that we have in store. So we bring that to life very well in our business in China.
At the same time, what you are seeing is the intense competition, particularly in the tea segment and it overlaps into coffee in the mass area, is one where you are seeing some of the shakeout happen in terms of the impact on people and how they can really sustain that kind of intensity. For us, our focus is on the premium end, and we're continuing to see that, right now, the headroom we have in China is large.
I mean we're still at 13 cups per capita. Japan's at 280 and the U.S. is at 380. We know that, over time, as the Chinese consumer stops spending, what you're going to realize is that we have a business that is healthy, that has a P&L and a store operating margin level that is strong, and we're going to see that grow as the consumer gets more and more exposed to coffee. So that is what I mean by the overall competitive environment in China.
In terms of your question about the beverage pipeline, I think that's been largely around North America. One of the things we're seeing here is we're core in coffee, and we're tremendously excited about the innovations that we're bringing with whole bean coffee and some of the coffee-forward innovations that we are seeing in our stores. But additionally, as we look at the occasional customers, they are looking for variety. And what we are doing is we're finding ways to open up new platforms of growth.
And last time, I mentioned that there were 3 platforms. And these are foundational -- additional new introductions that we will make over time. The first one was textures. So we started with pearls with our Summer 1 program, which starts next week. We then have a handcrafted energy platform that's coming in later on in this quarter. Additionally, plant-based is an area where we've traditionally been really well known for. So we have designed platforms and these are platforms around which you can expect to see systematic innovations that come in not just this time around, but also, you will see further more that come in around these platforms. That's how we're thinking about R&D. It's around platforms, both in beverage as well as in food.
Operator: Our next question comes from Sharon Zackfia with William Blair.
Sharon Zackfia: I guess I'm trying to think through the sequencing of how we got here today. And it seems like in October and early November at the analyst meeting, demand was not a problem in the U.S., and I hear you saying that you have a lot of unmet demand. But can you kind of help us do a hindsight on how these issues have come to a crux so quickly, just 4 or 5 months hence since those kind of very ambitious goals that were given?
Laxman Narasimhan: Thank you, Sharon. I think that if I look at the headwinds that we see in the market, in particular with the consumer and the pressures that they face, I think that they were sharper and more accelerated than what we expected. I think in hindsight, if I look at the situation in China, while long-term growth potential is sort of picking, we're committed to the long term in China. The recovery has been choppy. But I think what we've seen, particularly since that period is we've seen more intense price competition than what we expected. None of that takes away for the long term, but it's clear that what we had this quarter was tough.
Operator: And our next question comes from Peter Saleh with BTIG.
Peter Saleh: Great. I did want to ask about the Siren System. This was the focal point of the Investor Day a couple of years ago, and it seemed like it was put on the back burner for a little while, but now it seems like you're talking more bullish about this system going forward. So can you just give us an update? I think last we heard, it was going to be rolled out to less than 10% of the stores this year. What is the strategy now? And how does this help solve some of the issues you have? It sounds like some of the issues that you have are more in the supply chain and not necessarily within the four walls of the stores.
Laxman Narasimhan: Peter, just to respond to your question, first of all, the Siren System was never put on the back burner. In fact, we're on track to having the Siren System installed in less than 10% of the stores, much as we committed. So it's on track.
What we've added in here, though, is the underlying processes to ensure that we can reduce the wait time in the store, inside the four walls of the store. And that's what those processes are intended to do in the U.S. And so that's what the acceleration of the processes are that we have been testing. What we provide is a base on which we will continue to implement the overall Siren Systems that we showcased to you in the September Analyst Day when you were here with us and we talked to it.
Operator: Our next question comes from Lauren Silberman with Deutsche Bank.
Lauren Silberman: One quick -- a follow-up and then a question. First, can you just talk about the cadence of U.S. comp throughout the quarter? I know you mentioned lavender was extremely successful. It doesn't seem to be showing up in the comp just given the commentary on the exit rate. So just help us understand the performance of new products and whether that's driving incremental customers you're targeting.
And then just a quick one on like loyalty. It looks like active Rewards members declined quarter-over-quarter, which is very rare. Can you just talk about what you're seeing there given the commentary on the strength of the core customer?
Laxman Narasimhan: Do you want to take that one, Rachel?
Rachel Ruggeri: Sure. Yes. Thank you, Lauren. I'll start with the comp and what I spoke about in my prepared remarks about the exit rate. And lavender was quite successful for us. As you heard in Laxman's prepared remarks, what we are encouraged by is that lavender both to what our customers, particularly Gen Z and Millennial customers, are asking about, which is more new more often and a broader offering, so offering, meaning coffee, non-coffee, food, healthier choices. And so we hit squarely with that with lavender by having particularly our most popular offering in lavender was the Iced Lavender Matcha Latte and so that shows that when we innovate well, we exceed our own expectations.
That was later in the quarter. So it did do something for us in terms of driving customers into the afternoon. Largely, we saw that platform resonate well in the afternoon with our customers. The Latte, we'll tend to do more in the morning, but broadly, lavender, a hit in the afternoon. So we see that, that overall offering and how we're trying to address the customer -- more occasional customer with that worked well.
But what I would say is that it was later in the quarter. We've got more opportunities coming going forward. And as a result of that, our exit rate in the quarter still reflected continued headwinds, which we're reflecting in our guidance for the back half of the year. What we're expecting with the plans that we've outlined today will help us counterbalance some of those headwinds, particularly as we see those actions start to take place.
So I think it's important to think about there are consumer headwinds in there. Our plans will counterbalance that. And as we go after some of those challenges, I think the other thing to remember is that we are coming with a position of strength as it relates to the efficiencies around our Triple Shot as well as the growth we have in new stores and the strength we're seeing in our portfolio overall. We have a very strong portfolio, a profitable portfolio that will help us, and our brand is strong. So we look at all of that, and that's how we're thinking about the exit rates of comp as well as what we're seeing for comps in the back half of the year. So hopefully, that provides a little more texture.
Laxman Narasimhan: Brady, on loyalty?
Brady Brewer: Thank you, Lauren. You talked about the year-over-year increase but quarter-over-quarter declines of Starbucks Rewards members. And I think, just to be clear, that is in terms of 90-day frequency, so we still have a very large population of SR members. So it's about frequency of those customers.
So I think consistent with the consumer pullback, the more occasional and very occasional SR members, those ones visited less frequently within the quarter. As a result of that, we saw fewer 90-day actives quarter-over-quarter. That said, the 6% growth year-over-year, we're continuing to grow SR. MOP grew in the quarter, so we still have a very active customer base setting record high for MOP. Delivery grew double digits in the quarter, and we see a very active digital customer.
And I think as Laxman talked about with regard to how we're going to provide SR and traffic in the coming quarters, this is squarely aligned to this challenge. It's reactivating SR members, bringing them back and demonstrating value and driving frequency through the app and through SR. And we have a lot of great programs lined up [indiscernible] there.
Operator: Our next question comes from John Ivankoe with JPMorgan.
John Ivankoe: Two parts if I may. I heard the word misinformation and I think some improving maybe scores around that. So I just wanted to get a sense how much of an opportunity in terms of sales lost that you think correcting this information might actually mean for Starbucks. I don't think you've quantified that, but that would be helpful.
And then secondly, regarding the Toyota Production System. I think I heard you said that it would help about a point. Correct me if I'm wrong, but that seems to be a fairly low number. And just talk about what kind of changes that would happen in the Toyota Production System.
And to us, one of the opportunities would be having food ready when the customer orders it. In other words, using food warming cabinets would be particularly effective for both Mobile Order & Pay and drive-thru. So is that something that may be -- as part of Siren, that can be accelerated before the entire Siren System goes into place?
Laxman Narasimhan: John, thank you for the question. I think on the question about misperception, misperception did have an impact on our business [indiscernible]. We haven't been -- we don't have a quantification for that. But what we do know is that our brand equity, the stores and the investment involved in the brand have certainly helped spending with overall perception of our brand [ we spend every year ].
In terms of the [indiscernible] system, what we're doing first is we're tracking how [ we do with the week ], so how we essentially work with deployment in the store, how we handle what happens at peaks in terms of where people are deployed. How do we essentially [ process ] customers? And what you see is [indiscernible] there. I know we've given you a quantification of 1 percentage point. That is a conservative estimate because when it fully gets deployed and it fits, you would see even bigger improvements that happen.
In regard to your question about the [ hot food, ] that is purely something suggesting and we're looking to accelerate. So it takes [indiscernible] to accelerate that with the work that we are doing.
Operator: And our next question comes from Andrew Charles with Cowen & Company.
Andrew Charles: I know you're committed, of course, to the tenets of the reinvention plan. But in light of the current environment and caution of U.S. and China consumer, can you level set the long-term earnings algorithm introduced November around guidance for 5% same-store sales and 15% plus EPS growth? Does that still apply to 2025 and beyond?
Laxman Narasimhan: Andrew, thank you for your question. Everything we've seen, I know that we had a tough quarter. But everything we see in terms of the opportunities that lie ahead, as you look at the opportunities we have across [indiscernible], the innovation that we [ see ] in terms of the pipeline going forward [indiscernible] beyond. If you look at the productivity opportunities, the store count opportunities [indiscernible], we believe we'll be back [indiscernible]. And we see no change in the long-term outlook that we set earlier in this [ business ].
Operator: And the last question comes from David Tarantino with Baird.
David Tarantino: My question is on the value strategy that you laid out and the need to check traffic or track traffic in a tough environment. But I'm just wondering how you balance that with protecting the long-term health of the brand. Starbucks has always been a very premium brand position and sort of training some of these occasional users to come in on discount might have some detrimental impact. So I'm just wondering how you balance those 2 things and the strategy that you have.
Laxman Narasimhan: Thank you for your question. [indiscernible] and we have no intention of like going across the board and [indiscernible] what we are doing is we are [indiscernible] the fact that as [indiscernible] levels of [indiscernible] our brand overall right now [ that for what I can ] is still very strong [indiscernible]. So we feel very good about that. And this is more about how we [ move ] and how we [ manage ] customers, particularly those that don't [indiscernible] that is what we intend to do.
Rachel Ruggeri: [indiscernible] transactions [indiscernible] everything, the work [indiscernible] in an integrated way around product [indiscernible] as well as what our customers can get in the app to [indiscernible]
Operator: That was our last question. I'll now turn the call over to Laxman Narasimhan for closing remarks.
Laxman Narasimhan: Thank you for joining us. We had a tough quarter, but we have a clear action plan that the management team and I are [indiscernible] thank you for joining us, and we appreciate the time you're taking this afternoon.
Operator: Thank you. This concludes today's conference. All parties may disconnect. Have a good day. |
AMZN | 1 | 2,024 | 2024-04-30 00:00:00 | Operator: Thank you for standing by. Good day, everyone, and welcome to the Amazon.com First Quarter 2024 Financial Results Teleconference. [Operator Instructions] Today's call is being recorded.
And for opening remarks, I will be turning the call over to the Vice President of Investor Relations, Mr. Dave Fildes. Please go ahead.
Dave Fildes: Hello, and welcome to our Q1 2024 financial results conference call. Joining us today to answer your questions is Andy Jassy, our CEO; and Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2023.
Our comments and responses to your questions reflect management's views as of today, April 30, 2024, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings.
During this call, we may discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast, and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.
Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic and geopolitical conditions and customer demand and spending, including the impact of recessionary fears, inflation, interest rates, regional labor market constraints, world events, the rate of growth of the Internet, online commerce, cloud services and new and emerging technologies, and the various factors detailed in our filings with the SEC. Our guidance assumes, among other things, that we don't conclude any additional business acquisitions, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore, our actual results could differ materially from our guidance.
And now I'll turn the call over to Andy.
Andrew Jassy: Thanks, Dave. Today, we're reporting $143.3 billion in revenue, up 13% year-over-year, excluding the impact from foreign exchange rates; $15.3 billion in operating income, up 221% year-over-year or $10.5 billion; and $48.8 billion in trailing 12-month free cash flow adjusted for equipment finance leases, up $53.2 billion year-over-year. We remain focused on driving better experiences for our customers while also delivering efficiency improvements. Our financial results are an encouraging reminder of the progress we're making.
Starting with our stores business, despite having hundreds of millions of items and the broadest selection available, we remain intensely focused on adding even more selection. One way is to continue adding brands we know our customers want. For instance, in the U.S., we recently welcomed Clinique and 2 Gen Z fashion favorites, Parade and Cider, and announced a collaboration with Hardly Ever Worn It in Europe to offer customers pre-owned items from luxury brands.
Another way to drive selection is to make it easier for our third-party sellers to add their products to our store. We've recently launched a new generative AI tool that enables sellers to simply provide a URL to their own website, and we automatically create high-quality product detail pages on Amazon. Already, over 100,000 of our selling partners have used one or more of our gen AI tools. We remain focused on making sure we're offering everyday low prices, which we know is even more important to our customers in this uncertain economic environment.
As our results show, customers are shopping but remain cautious, trading down on price when they can and seeking out deals. In Q1, we helped customers save with shopping events worldwide, including our first big spring sale in Canada and the U.S. We also held spring deal days in Europe and our Ramadan event in Egypt, Saudi Arabia, and the UAE. Delivery speed really matters to customers, and we've continued to get faster while improving our safety performance. In this past Q1, we delivered to Prime members at our fastest speeds ever. In March, across our top 60 largest U.S. metro areas, nearly 60% of Prime members orders arrived the same or next day. And globally, in cities like Toronto, London, and Tokyo, about 3 out of 4 items were delivered the same or next day.
Faster delivery times have another important effect. As we get items to customers this fast, customers choose Amazon to fulfill their shopping needs more frequently, and we can see the results in various areas, including how fast our Everyday Essentials business is growing and the continued increase in Prime member purchase frequency and total spend with us. Over the past year, we've talked about how our regionalization efforts have helped lower our cost to serve. We've continued to inspect our fulfillment network for additional opportunities and are working on several areas where we believe we can lower costs even further while also improving customer experience.
One example of this is our work to increase the consolidation of units into fewer boxes. As we further optimize our network, we've seen an increase in the number of units delivered per box, an important driver for reducing our cost. When we're able to consolidate more units into a box, it results in fewer boxes and deliveries, a better customer experience, reduces our cost to serve, and lowers our carbon impact.
Another prominent example is our efforts to revamp our U.S. inbound fulfillment architecture to allow for better inventory placement closer to our customers. This will be an iterative process throughout the year as we work with sellers and retail partners, and teams are making good progress on their plans.
Advertising performance remained strong, with ad sales up 24% year-over-year, excluding the impact of foreign exchange. The strength in advertising was primarily driven by sponsored products, supported by continued improvements in relevancy and measurement capabilities for advertisers. We still see significant opportunity ahead in our sponsored products as well as areas where we're just getting started like Prime Video ads. Prime Video ads offers brands value as we can better link the impact of streaming TV advertising to business outcomes like product sales or subscription sign-ups, whether the brands sell on Amazon or not. It's very early for streaming TV ads but we're encouraged by the early response.
Moving to AWS. Year-over-year revenue growth accelerated to 17.2% in Q1, up from 13.2% in Q4. It's useful to remember that year-over-year percentages are only relevant relative to the total base from which you start. And given our much larger infrastructure cloud computing base, at this growth rate, we see more absolute dollar growth again quarter-over-quarter in AWS than we can see elsewhere.
We're seeing a few trends right now. First, companies have largely completed the lion's share of their cost optimization and turned their attention to newer initiatives. Before the pandemic, companies were marching to modernize their infrastructure, moving from on-premises infrastructure to the cloud to save money, innovated at a more rapid rate, and to drive more developer productivity. The pandemic and uncertain economy that followed distracted from that momentum, but it's picking up again. Companies are pursuing this relatively low-hanging fruit in modernizing their infrastructure.
And with the broadest functionality by a fair bit, deepest partner ecosystem and strong security and operational performance, AWS continues to be their strong partner of choice. Our AWS customers are also quite excited about leveraging gen AI to change the customer experiences and businesses. We see considerable momentum on the AI front where we've accumulated a multibillion-dollar revenue run rate already.
You heard me talk about our approach before, and we continue to add capabilities at all 3 layers of the gen AI stack. At the bottom layer, which is for developers and companies building models themselves, we see excitement about our offerings. We have the broadest selection of NVIDIA compute instances around, but demand for our custom silicon, Trainium and Inferentia, is quite high given its favorable price performance benefits relative to available alternatives. Larger quantities of our latest generation Trainium2 is coming in the second half of 2024 and early 2025.
Companies are also starting to talk about the eye-opening results they're getting using SageMaker. Our managed end-to-end service has been a game changer for developers in preparing their data for AI, managing experiments, training models faster, lowering inference latency, and improving developer productivity. Perplexity.ai trains models 40% faster than SageMaker. Workday reduces inference latency by 80% with SageMaker, and NatWest reduces its time to value for AI from 12 to 18 months to under 7 months using SageMaker. This change is how challenging it is to build your own models, and we see an increasing number of model builders standardizing on SageMaker.
The middle layer of the stack is for developers and companies who prefer not to build models from scratch but rather seek to leverage an existing large language model, or LLM, customize it with their own data and have the easiest and best features available to deploy secure high-quality, low-latency, cost-effective production gen AI apps. This is why we built Amazon Bedrock, which not only has the broadest selection of LLMs available to customers but also unusually compelling model evaluation, retrieval augmented generation, or RAG, to expand model's knowledge base, guardrails to safeguard what questions applications will answer, agents to complete multistep tasks, and fine-tuning to keep teaching and refining models.
Bedrock already has tens of thousands of customers, including adidas, New York Stock Exchange, Pfizer, Ryanair and Toyota. In the last few months, Bedrock's added Anthropic's Claude 3 models, the best-performing models in the planet right now; Meta's Llama 3 models; Mistral's various models, Cohere's new models and new first-party Amazon Titan models. A week ago, Bedrock launched a series of other features, but perhaps most importantly, Custom Model Import. Custom Model Import is a sneaky big launch as it satisfies a customer request we've heard frequently and that nobody has yet met.
As increasingly more customers are using SageMaker to build their models, they're wanting to take advantage of all the Bedrock features I mentioned earlier that make it so much easier to build high-quality production-grade gen AI apps. Bedrock Custom Model Import makes it simple to import models from SageMaker or elsewhere into Bedrock before deploying their applications. Customers are excited about this, and as more companies find they're employing a mix of custom-built models along with leveraging existing LLMs, the prospect of these 2 linchpin services in SageMaker and Bedrock working well together is quite appealing.
The top of the stack are the gen AI applications being built. And today, we announced the general availability of Amazon Q, the most capable generative AI-powered assistant for software development and leveraging company's internal data. On the software development side, Q doesn't just generate code. It also tests code, debugs coding conflicts, and transforms code from one form to another. Today, developers can save months using Q to move from older versions of Java to newer, more secure and capable ones. In the near future, Q will help developers transform their .NET code as well, helping them move from Windows to Linux.
Q also has a unique capability called Agents, which can autonomously perform a range of tasks, everything from implementing features, documenting, and refactoring code to performing software upgrades. Developers can simply ask Amazon Q to implement an application feature such as asking it to create an add to favorites feature in a social sharing app, and the agent will analyze their existing application code and generate a step-by-step implementation plan, including code changes across multiple files and suggested new functions. Developers can collaborate with the agent to review and iterate on the plan, and then the agent implements it, connecting multiple steps together and applying updates across multiple files, code blocks and test suites. It's quite handy.
On the internal data side, most companies have large troves of internally relevant data that resides in wikis, Internet pages, Salesforce, storage repositories like Amazon S3 and a bevy of other data stores and SaaS apps that are hard to access. It makes answering straightforward questions about company policies, products, business results, code, people, and many other topics hard and frustrating. Q makes this much simpler. You can point Q at all of your enterprise data repositories and it will search all this data, summarize logically, analyze trends, engage in dialogue with customers about this data.
We also introduced today a powerful new capability called Q Apps, which lets employees describe a natural language what apps they want to build on top of this internal data and Q Apps will quickly generate that app. This is going to make it so much easier for internal teams to build useful apps from their own data.
Q is not only the most functionally capable AI-powered assistant for software development and data but also setting the standard for performance. Q has the highest-known score and acceptance rate for code suggestions, outperforms all other publicly benchmarkable competitors and catching security vulnerabilities, and leads all software development assistants on connecting multiple steps together and applying automatic actions. Customers are gravitating to Q, and we already see companies like Brightcove, British Telecom, Datadog, GitLab, GoDaddy, National Australia Bank, NCS, Netsmart, Slam, Smartsheet, Sun Life, Tata Consultancy Services, Toyota, and Wiz using Q, and we've only been in beta until today.
I'd also caution folks not to overlook the security and operational performance elements of these gen AI services. It's less sexy but critically important. Most companies care deeply about the privacy of the data in their AI applications and the reliability of their training and production apps. If you've been paying attention to what's been happening in the last year or so, you can see there are big differences between providers on these dimensions. AWS has a meaningful edge, which is adding to the number of companies moving their AI focus to AWS.
We expect the combination of AWS' reaccelerating growth and high demand for gen AI to meaningfully increase year-over-year capital expenditures in 2024, which given the way the AWS business model works is a positive sign of the future growth. The more demand AWS has, the more we have to procure new data centers, power and hardware. And as a reminder, we spend most of the capital upfront. But as you've seen over the last several years, we make that up in operating margin and free cash flow down the road as demand steadies out. And we don't spend the capital without very clear signals that we can monetize it this way.
We remain very bullish on AWS. We're at $100 billion-plus annualized revenue run rate, yet 85% or more of the global IT spend remains on-premises. And this is before you even calculate gen AI, most of which will be created over the next 10 to 20 years from scratch and on the cloud. There is a very large opportunity in front of us. We also continue to make strong progress on our newer investments. Our emerging international stores are growing and moving towards profitability. Our third-party logistics business offering services like Buy with Prime, Amazon shipping and multichannel fulfillment continues to grow well.
We just launched a Prime delivery grocery benefit that lets customers receive free unlimited grocery delivery for just $9.99 a month, which is great value and customers are responding accordingly. Later this year in Manhattan, we're launching a new smaller Whole Foods market concept called Whole Foods Market Daily Shops. Prime Video continues to produce compelling content, with Fallout being our latest big hit on the heels of a very successful Road House movie, with strong customer engagement in our original and partner content.
Our health services business is growing robustly as customers are loving our pharmacy customer experience, and we've launched same-day delivery of prescription medications to customers in 8 cities, including Los Angeles and New York City, with plans to expand to more than a dozen cities by the end of the year, with customers now getting first fill medications 75% faster year-over-year nationwide. And Kuiper is getting closer to having its production satellites in space and entering our commercial beta.
There's a lot of invention happening across our business, and I'm super grateful to all our employees for their hard work and ingenuity. I'll close by sharing that I'm enthusiastic about how we started this year. We have a lot of opportunity in front of us in every one of our businesses to make our customers' lives better and easier.
With that, I'll turn it over to Brian for a financial update.
Brian Olsavsky: Thanks, Andy. Starting with our top line financial results. Worldwide revenue was $143.3 billion, representing a 13% increase year-over-year, excluding the impact of foreign exchange and near the top end of our guidance range. I'd like to highlight a couple of points to help you interpret our growth rates. First, we saw an impact from leap year in Q1, which added approximately 120 basis points to the year-over-year quarterly revenue growth rate.
Second, while I typically talk about growth rates, excluding the impact of year-over-year changes in foreign exchange, we did see an unfavorable impact from global currencies weakening against the U.S. dollar, more than we had planned in Q1. This led to a $700 million or 50 basis point headwind to revenue relative to what we guided. Excluding this FX headwind, we would have exceeded the top end of our guidance range. Worldwide operating income was $15.3 billion, which was our highest quarterly income ever, and it was $3.3 billion above the high end of our guidance range.
This was driven by strong operational performance across all 3 reportable segments and better-than-expected operating leverage, including lower cost to serve. The impact on operating income from our Q1 FX rate headwind was negligible. I'll speak more to our profitability trends in a moment. In the North America segment, first quarter revenue was $86.3 billion, an increase of 12% year-over-year. In the international segment, revenue was $31.9 billion, an increase of 11% year-over-year, excluding the impact of foreign exchange.
We remain focused on the inputs that matter most to our customers: selection, price, and convenience. During the quarter, around the world, we helped customers save with our shopping events. We added selection, including premium and luxury brands, and we delivered our fastest speeds ever for Prime members. Third-party sellers continue to be an important part of our offering. Third-party seller services revenue increased 16% year-over-year, excluding the impact of foreign exchange. We saw strong 3P unit growth, coupled with increased adoption of our optional services, such as fulfillment and global logistics. For the quarter, third-party seller unit mix was 61%, up 200 basis points year-over-year.
Shifting to profitability, North America segment operating income was $5 billion, an increase of $4.1 billion year-over-year. Operating margin was 5.8%, up 460 basis points year-over-year. We saw improvements in our cost to serve, including continued benefit from our work to regionalize our operations, savings from more consolidated customer shipments, and improved leverage driven by strong unit growth and lower transportation rates. In our international segment, operating income was $903 million, an improvement of $2.2 billion year-over-year. Operating margin was 2.8%, up 710 basis points year-over-year. This is primarily driven by our established countries as we improve cost efficiencies through network design enhancements and improved volume leverage. Additionally, we saw good progress in our emerging countries as they expand their customer offerings and make strides on their respective journeys to profitability.
Looking ahead, we see several opportunities to further lower cost to serve and improved profitability in our worldwide stores business while still investing to improve the customer experience. Within our fulfillment network, we are focused on investing in our inbound network, streamlining and standardizing process paths, and adding robotics and automation. These improvement opportunities will take time. However, we have a solid plan in place and we like the path we're on. Advertising remains an important contributor to profitability in North America and international segments. We see many opportunities to grow our offerings, both in the areas that are driving growth today like sponsored products and in areas that are newer, like streaming TV ads.
Moving to AWS. Revenue was $25 billion, an increase of 17% year-over-year, and AWS is now a $100 billion annualized revenue run rate business. Excluding the impact from leap year, AWS revenue increased approximately 16% year-over-year. During the first quarter, we saw growth in both generative AI and non-generative AI workloads across a diverse group of customers and across industries as companies are shifting their focus towards driving innovation and bringing new workloads to the cloud.
Additionally, we continue to see the impact of cost optimizations diminish. While there always be a level of ongoing optimization, we think the majority of the recent cycle is behind us, and we're likely closer to a steady state of these optimization efforts. AWS operating income was $9.4 billion, an increase of $4.3 billion year-over-year. As a reminder, these results include the impact from the change in the estimated useful life of our servers, which primarily benefits the AWS segment. We made progress in managing our infrastructure and fixed costs while still growing at a healthy rate, which has resulted in improved leverage.
As we've said in the past, over time, we expect the AWS operating margins to fluctuate, driven in part by the level of investments we are making in the business. We remain focused on driving efficiencies across the business, which enables us to invest to support the strong growth we're seeing in AWS, including generative AI, which brings us to capital investments. As a reminder, we define these as the combination of CapEx plus equipment finance leases. In 2023, overall capital investments were $48.4 billion. As I mentioned, we're seeing strong AWS demand in both generative AI and our non-generative AI workloads, with customers signing up for longer deals and making bigger commitments. It's still relatively early days in generative AI and more broadly, the cloud space, and we see sizable opportunity for growth. We anticipate our overall capital expenditures to meaningfully increase year-over-year in 2024, primarily driven by higher infrastructure CapEx to support growth in AWS, including generative AI.
Turning to our revenue guidance for Q2. Net sales are expected to be between $144 billion and $149 billion or to grow between 7% and 11% compared with the second quarter of 2023. We saw an unfavorable impact from year-over-year changes in foreign exchange in our Q1 results, and we expect that headwind to grow in the second quarter. Our Q2 net sales guidance anticipates an unfavorable foreign exchange impact of approximately 60 basis points. As part of our guidance considerations, we also continue to keep an eye on consumer spending and macro level trends, specifically in Europe where it appears to be a bit weaker relative to the U.S. Operating income is expected to be between $10 billion and $14 billion in Q2. This estimate includes the impact of our seasonal step-up in stock-based compensation expense, driven by the timing of our annual compensation cycle.
I want to thank our customers, our partners, and our teammates around the world for a very strong start to the year, and we're excited to build on this momentum. We'll remain focused on streamlining and prioritizing projects in a way that allows us to continue inventing for customers in a cost-effective way. With that, let's move on to your questions.
Operator: [Operator Instructions] Our first question comes from the line of Doug Anmuth with JPMorgan.
Douglas Anmuth: Probably for both Andy and Brian. Historically, Amazon has shifted between periods of heavy investment and then margin expansion back into heavier investment, but you now have a much bigger base of gross profit and overall operating income. As you think about gen AI and capital intensity or grocery or Kuiper or health care, is there anything from an investment perspective that could materially impact profitability going forward in your view?
Brian Olsavsky: Doug, yes, we have historically always mentioned that. You have seen like a pendulum shift sometimes between profitability and investment. I think we're at the stage now where we're doing both at the same time continually, so we are more apt to talk about the specific investments that we're making and how that might impact our short-term outlook. So if you look at the progress we've made on operating income and free cash flow over really the last 18 months, a lot of it's driven by improvements in our stores business, lower cost to serve. We've talked about regionalization efforts and how that's moving into inbound areas now.
Advertising has been growing strong and AWS has been strong. And you saw AWS margins increased 800 basis points sequentially off Q4. A lot of that's driven by cost controls and expanding revenue on the top line and lower cost structure throughout the company. We do see, though, on the CapEx side that we will be meaningfully stepping up our CapEx and the majority of that will be in our -- to support AWS infrastructure and specifically generative AI efforts. So I would expect that, that will increase -- it will increase depreciation, definitely in that segment.
On the -- well, we're talking about CapEx. Right now, in Q1, we had $14 billion of CapEx. We expect that to be the low quarter for the year. As Andy said earlier, we are seeing strong demand signals from our customers and longer deals and larger commitments, many with generative AI components. So those signals are giving us confidence in our expansion of capital in this area.
And as he also mentioned, we've done this for 18 years. We invest capital and resources upfront. We create capacity very carefully for our customers. And then we see the revenue, operating income and free cash flow benefit for years to come after that, with strong returns on invested capital. So a little bit of a long-winded answer to your question. But yes, we have -- the main issue that we'll see in the near term is additional CapEx and we've talked about that.
And we continue to see strong CapEx performance in our stores business. Most of that will be related to modest capital or capacity increases, in addition to our same-day fulfillment network and some Amazon Logistics upgrades to the fleet. But for the most part, what you'll see is really going to be on the AWS side.
Andrew Jassy: Yes, I just would add briefly, just to summarize. I understand where the question is coming from, Doug. And I think we're in a position to do both is the short answer. I think there's actually an opportunity in our existing large businesses in the stores business along with advertising and AWS. There's a lot of growth in front of us. And I think we're investing in a meaningful way. But I think we also -- we've been pretty consistent about don't believe that we're at the end of what we can do in terms of improving our cost structure on the store side.
Yes, I think there are really unbelievable growth opportunities in front of us. And I think what people sometimes forget on the AWS side, it's a $100 billion revenue run rate business, that we're still 85-plus percent of the global IT spend is on premises. And if you believe that equation is going to flip, which we do, it means we have a lot of growth in front of us, and that's before the generative AI opportunity, which I don't know if any of us have seen a possibility like this in technology in a really long time, for sure, since the cloud, perhaps since the Internet.
And unlike in the cloud where so much -- there's a lot of work to be done to move from on-premises to the cloud, people do it and they get value out of it, which is why they modernize their infrastructure. But it's work. All of this generative AI set of workloads, which will transform every experience they're going to be built from scratch on the cloud largely. And so it's just tremendous opportunities there along with some of the other areas that we're investing that are really early stage. So I think it's both for us.
Operator: And our next question comes from the line of Ross Sandler with Barclays.
Ross Sandler: Somewhat related question on CapEx intensity in AWS. So I think the CEO of Anthropic has said that I think the next generation of models cost in the neighborhood of $1 billion to train. This would be like Claude 4, I guess, high end. And then the generation after that might be as much as $10 billion to train. So is this something that you feel like the industry will do on top of AWS? Do you feel like Olympus and some of the stuff you're doing in-house needs to kind of stay at the state-of-the-art, or can others do that? And then how much did all this training have an impact on the acceleration that you saw in 1Q for AWS revenue?
Andrew Jassy: Well, Ross, I would tell you that we have seen kind of 3, I'll call it, macro trends that I think are contributing to AWS' performance, at least in the last quarter. I think first of all, I think the lion's share of cost optimization is behind us. So I think companies will be smart and have learned a lot over the last number of months in how they run their infrastructure in the cloud. But I think the lion's share of the cost optimization is behind us. And I think people have moved to newer initiatives that I would, at a macro level, describe as modernizing their infrastructure and then trying to drive value at a generative AI.
On the former, I think we were on this march before the pandemic, where most companies were trying to figure out how to move from on-premises to the cloud because it's more cost-effective and it's faster to innovate and they get real developer productivity. And then when the pandemic hit and people were in survival mode and the uncertain economy, you let people save costs wherever they could, and they got distracted on that. But they're back to pursuing and figuring it out because it's low-hanging fruit for them, and we see very significant growth in that space.
And at the same time, we're seeing very significant momentum in people trying to figure out how to run their generative AI on top of AWS. I mentioned we have a multibillion-dollar revenue run rate that we see in AI already, and it's still relatively early days. And I think that there's -- at a high level, there's a few things that we're seeing that's driving that growth. I think first of all, there are so many companies that are still building their models. And these range from the largest foundational model builders like Anthropic, you mentioned, to every 12 to 18 months or building new models.
And those models consume an incredible amount of data with a lot of tokens, and they're significant to actually go train. And a lot of those are being built on top of AWS, and I expect an increasing amount of those to be built on AWS over time because our operational performance and security and as well as our chips, both what we offer from NVIDIA. But if you take Anthropic, as an example, they're training their future models on our custom silicon on Trainium. And so I think we'll have a real opportunity for a lot of those models to run on top of AWS.
I think the thing that people sometimes don't realize is that while we're in the stage that so many companies are spending money training models, once you get those models into production, which not that many companies have, but when you think about how many generative AI applications will be out there over time, most will end up being in production when you see the significant run rates. You spend much more in inference than you do in training because you train only periodically, but you're spinning out predictions and inferences all the time.
And so we also see quite a few companies that are building their generative AI applications to do inference on top of AWS. And a lot of it has to do with the services. And the primary example we see there is how many companies, tens of thousands of companies, already are building on top of Amazon Bedrock, which has the largest selection of large language models around and a set of features that make it so much easier to build a high-quality, cost-effective low latency, production-grade generative AI applications.
So we see both training and inference being really big drivers on top of AWS. And then you layer on top of that the fact that so many companies, their models and these generative AI applications are going to have their most sensitive assets and data. And it's going to matter a lot to them what kind of security they get around those applications. And yes, if you just pay attention to what's been happening over the last year or 2, not all the providers have the same track record. And we have a meaningful edge on the AWS side so that as companies are now getting into the phase of seriously experimenting and then actually deploying these applications to production, people want to run their generative AI on top of AWS.
Operator: And the next question comes from the line of Brian Nowak with Morgan Stanley.
Brian Nowak: I have 2. The first one is on cost to serve. I appreciate all the color in the shareholder letter and even tonight on cost to serve. Andy, maybe could you just help us quantify a little more how to think about some of your North Star cost to serve goals over the next couple of years? And what could that mean for potential accompanying reasonable ranges of outcomes for North America retail margins through all of that?
And then the second one, if cost to serve does improve, I think it should lead to significant incremental cash flow even with more CapEx. So just remind us again how you sort of think through the philosophy of returning capital to shareholders in addition to continuing to invest for the long run?
Brian Olsavsky: Brian, this is Brian. I will start with your second question. So as far as dividends or buybacks or any other capital structure moves, we don't have anything to share with you on that today. But I'll reacquaint you with our general philosophy. So our first priority is to invest in -- to support the growth opportunities and long-term investments within our businesses. And generally, we still have many opportunities to put that capital to use that would generate meaningful returns, especially as you heard in generative AI.
So we're very -- we have a great deal of passion on that and conviction on that as well. We are reaching a different stage of free cash flow. As you mentioned, we had negative free cash flow for 2 years, '21 and '22, immediately after the pandemic as we had doubled the size of our operations network and had a lot of other expenses. That was followed by 2023 when we had our largest -- our highest free cash flow ever. And those trends have carried into Q1. So we feel good about the free cash flow. We are, again, still anticipating higher CapEx this year.
The other thing that we're doing with cash flow right now is we're repaying some of the debt that we had taken on during that negative free cash flow period. We have reached a high watermark at the end of Q1 last year. And since then and then through this year, we'll pay that down over $25 billion. So that's our first priority as well as 2024 capital expenditures. But otherwise, nothing to share on that front.
I'll tee up, Andy, on the stores profitability because I know there's always generally the comment about how high can operating margins go and how do they compare to historic trends. And I think the same still holds. We look back to before the pandemic, and we say, first, we can achieve those operating margins even without the impact of advertising. And we're not quite there yet. But we're not limiting ourselves to that. We're looking for ways to, again, turn over every rock, look at every process and everything that we do on the logistics side and see how can we get our cost structure down and how can we get speed up and selection up. So it is working on a lot of fronts there, but cost is certainly front and center as we meet and improve customer experience.
Operator: And the next question comes from the line of Youssef Squali with Truist Securities.
Youssef Squali: Andy, on logistics, in September, you launched Amazon supply chain. Can you just help us understand the opportunity you see there? Where are you in that journey to build logistics as a service on a global basis? And does that require a step function increase in CapEx?
Andrew Jassy: Yes. Thanks for the question, Youssef. I think that it's interesting what's happening with our -- the business we're building in third-party logistics. And it really kind of, in some ways, mirrors some of the other businesses we've gotten involved in, AWS being an example of it, even though it's -- they're very different businesses in that we realized that we had our own internal need to build a bunch of these capabilities.
And we figured that there were probably others who had those same needs and we decided to build services out of them. So as our business has grown, it turns out to be pretty hard work to actually import items from overseas, get them through customs and through the border and then ship them from that point to various facilities. And then it turns out that you don't want to store those facilities in fulfillment centers because that space is really scarce. So you'd like to have them in upstream storage facilities that are very inexpensive. And then you'd like to have a way to be able to know when your more scarce supply in the fulfillment centers needs replenishment and be able to do it automatically from those upstream storage facilities.
And so all of those were capabilities that we had to build for ourselves to be able to operate our stores business in the way that we wanted to and that our sellers wanted to. And so we built that capability for ourselves first and then we opened up those services as individual services to our sellers. And so we help sellers, we have a service that allows them to get items through the border and through customs. We have a service that allows them to ship from customs to various facilities, whether they're our own or their separate ones.
We allow them to store items in our upstream low-cost warehouses that they can either automatically replenish into our fulfillment centers where we ship or they can move to other facilities that they have. We have a service that lets them -- where we'll ship either to our end customers if they're selling on Amazon or to their end customers. We obviously have Buy with Prime, where we enable our Prime customers to be able to buy from our third-party Buy with Prime sellers websites, which increases their conversion 25% versus what they would do on their own, and it's a great benefit for our Prime customers.
And then I would say that supply chain with Amazon is really an abstraction on top of those individual building block services I just mentioned that makes it easier for customers to have the whole end-to-end supply chain integrated. That collective set of businesses is growing very significantly. It's already what I would consider a reasonable sized business. And I think it's just really early days. It is not something that we anticipate being a giant capital expense driver for us.
We have to build a lot of those capabilities anyway to handle our stores business, and we think we can -- it will be a modest increase on top of that to accommodate third-party sellers. But are third-party sellers find high value in us being able to manage those components for them versus having to do it themselves and they save money in the process.
Operator: And our next question comes from the line of Justin Post with Bank of America.
Justin Post: I thought I'd ask a couple of growth drivers that you mentioned. First, grocery, it seems like you're still changing the threshold for free delivery or the subscription prices. Just can you say at all how much that's contributing to your gross right now and do you think you're over the hump? Or are you optimistic this can be a really big category for you? And then maybe a little bit extra on Prime Video ramp, how that ramp went versus your expectations? And do you think that could be a meaningful contributor to ad revenues going forward?
Andrew Jassy: Yes. I'll take them in opposite order just on Prime Video ads. Very early days, just launched a few months ago. It's off to a really good start. I think advertisers are excited about being able to expand their ability to advertise with us in video beyond Twitch and Freevee to Prime Video shows and movies. I think they also find that the relevancy and the measurability of that type of advertising and Prime Video ads is unique for them. So it's off to a very good start, it's early days, but we're optimistic there.
On grocery, I would tell you that we continue to be optimistic about what we're doing in grocery. We have a very large grocery business. It's kind of got a few different components. And we have a very, very significant nonperishables grocery business much the same way that the mass merchandisers entered this business 30 or 40 years ago. These are consumables and canned goods and pet food and health care and beauty products. That continues to grow at a very rapid rate.
And we have an organic grocery business in Whole Foods Market, which is the pioneer in that space. And that business continues to grow very nicely. We're introducing a new smaller format in the fall in Manhattan and the Whole Foods Market Daily Shops idea. We've worked very hard on the profitability trajectory over the last 18 months and like the way that, that has taken shape. And then if you want to have -- do you want to serve as many grocery missions as we aim to serve. You have to have a perishables business and a mass physical presence. And that's what we've been working on with Amazon Fresh.
We've launched our V2 format in physical stores over the last few months, primarily in Chicago and Southern California. We like the early results a lot. They're really meaningfully better in almost every dimension. It's still early, and there's some things to work through, but we like what we're seeing there. And then we have to decide the best way to roll those out over time.
And as you mentioned, Justin, we just launched a Prime benefit for grocery, which is all-you-can-eat delivery for $9.99 a month, which if you order once from Whole Foods a month, it pays for itself, or once from Amazon Fresh for orders under $40, it pays for itself. It's a very valuable offering for our Prime members, and it's off to a great start. So we have a lot -- in my opinion, we have lots of ways that we can continue to help customers satisfy their grocery needs. And we have some building blocks that I think might also change how people split up their grocery orders over time. But I continue to be optimistic that, that's going to continue to grow for us.
Operator: And our final question will come from the line of Ron Josey with Citi.
Ronald Josey: Maybe, Andy, I wanted to ask on international profitability, just after 1Q's 2.8% margin. Talk just about where we are in terms of international getting or to consistent profitability. We're following a similar trajectory as North America in terms of benefiting from regionalization shift, and we saw what average distance of each package traveled actually came down by 25 kilometers and whatnot. And if you could provide any insights on maybe how inbound fulfillment architecture might add to just continued benefits on faster shipping, same-day, next day, et cetera.
Brian Olsavsky: Thank you, Ron. I'm going to start with this one on international profitability. So yes, in the quarter, our operating income was $902 million. And if you've watched that, we've seen a steady progression in operating income in our international segment, it's up $2.2 billion year-over-year. So we like the trend there. It breaks down into a few areas. I would say the established countries of Europe, Japan, as well as the U.K. are following a lot of the same trajectory as in the United States. They are profitable in their own right. They are adding selection, they're adding new features like grocery there, adding to their Prime benefits, and a lot of the work that we do in the United States carries over there.
The second group is the emerging countries. And of course, we've launched 10 new countries in the last 7 years. Each of those has its own particular trajectory on profitability. The first thing we see there is having a good customer experience, having people sign up for Prime. A lot of times, our Prime Video benefits help with that. Then work on our cost structure as we get scale, add advertising and other things. And eventually, what we see is a breakeven -- countries breakeven and then they make positive income and free cash flow and are more of a contribution to the -- positive contribution to the international segment. So we're seeing both the emerging and the established improving, and we like the trajectory. And I think you'll see more of as we move forward.
Andrew Jassy: Yes. I would add a few things. I mean, I'm again quite bullish on our international stores business. It's already a very large business. We've added a number of countries that are on the right trajectory, as Brian just indicated, and it's going to be a big, profitable business for us. And I really like the direction it's headed.
I'll take also just the second part of your question just really around continuing to take -- to work on cost structure. I'd say, first of all, on the regionalization side, which we've talked a lot about the last year, it may sound a little boring to talk about because we talked about it a lot of times. But I'd just tell you that we're not done there. A lot of the work that we've done, we still have opportunities to refine, to get more value out of that. And a lot of what we learned on the regionalization side in the U.S. was in part inspired from what we saw in Europe, which, in many ways, is set up as a regional network because of the nature of how close those countries are to one another.
And I would say we have also learned lessons from what we've done in the U.S. that we're going to be able to apply to our international operations as well. I think we see additional opportunities in all sorts of places. A good example of which is just how and where we inbound items to. The architecture we've had set up has largely had people inbounding to a couple of places. And then we took -- we spent a lot of effort and time and expense in breaking those down and shipping them to lots of other places.
And we believe we're going to be much more efficient in how we use the inbound network and how we partner with our sellers. Part of what we did with our change in seller fees, we lowered the outbound fees in a meaningful way, but then we added an incentive for our sellers to inbound into locations that allow us to be more cost following and allow both our sellers and us to enjoy in those cost savings when we're able to do so. And we're seeing very optimistic signs there, too.
I think we're still early with respect to how we can continue to optimize the number of units per box, which has all sorts of good benefits. And then I'd just also say that it's been really interesting to watch the same-day facilities evolution in our fulfillment network. And I think a lot of people have made the assumption over the last few years that faster speeds are going to mean higher cost, and that is not the case if you build the infrastructure with the right building blocks the way we have over the last couple of years.
And our same-day facilities are our least expensive facilities in the network. We still have a fraction of the number of those that we will have in the U.S. that we'll have in other parts of the world, which will, again, both change our cost structure while increasing speed. So I don't think we're at the limits of what we can do. It's not going to all happen in 1 year. We're going to be working hard at this and inventing at this for several years, but I think we have a lot of upside in front of us.
Dave Fildes: Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website for at least 3 months. We appreciate your interest in Amazon and look forward to speaking with you again next quarter.
Operator: And ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
CHTR | 1 | 2,024 | 2024-04-26 00:00:00 | Operator: Hello, and welcome to Charter Communications First Quarter Investor Call. [Operator Instructions] Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time.
I will now turn the call over to Stefan Anninger.
Stefan Anninger: Thanks, operator, and welcome, everyone. The presentation that accompanies this call can be found on our website, ir.charter.com.
I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings which we encourage you to read carefully. Various remarks that we make on this call concerning expectations, predictions, plans and prospects, constitute forward-looking statements which are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only, and Charter undertakes no obligation to revise or update such statements.
On today's call, we have Chris Winfrey, our President and CEO; and Jessica Fischer, our CFO. With that, let's turn the call over to Chris.
Christopher Winfrey: Thanks, Stefan. During the first quarter, we lost 72,000 Internet customers. Despite lower Internet sales, we added nearly 500,000 Spectrum Mobile lines and close to 2.3 million lines year-over-year. We now have more than 8.2 million total mobile lines. With still low mobile penetration of Internet customers and passings, we have a long runway for customer and financial growth with the nation's fastest mobile service at incredible value.
Revenue was relatively flat in the quarter while adjusted EBITDA grew by 2.8%. And during the first quarter, our Internet customer growth remained challenged by a low-move and generally low-activity environment coupled with continued elevated competition at least in the short term and a small impact from fewer low-income connects due to discontinued ACP availability. Churn remains at historically low levels.
Telephone Internet continues to compete for gross additions and has expanded its addressable market within our footprint. And we remain confident in our ability to return to healthy long-term growth. Our Internet product is faster and it's more reliable. Our pricing is lower when similarly bundled with mobile. And the cell phone companies will face capacity challenges as customer bandwidth grows.
In the first quarter, wireline overbuild activity continued at a similar pace. And given the value of our converged products, we resisted chasing some less rational promotional offers from overbuilders.
As we move forward with our key strategic initiatives, we believe that our differentiated converged connectivity products with superior speeds, that save customers money, and a video product with increasing value and utility to customers, provide us with significant competitive advantages and a platform to grow customers, penetration, EBITDA and free cash flow over time.
In Internet, data usage continues to grow and demand for faster speeds will grow with it. During the first quarter, Internet customers who do not buy traditional video from us use nearly 800 gigabytes per month. And we now offer 300-meg, 500-meg and 1-gig symmetrical speeds in our first high split market.
Later this year, we'll begin launching the next wave of markets with distributed access architecture technology. When completed, we'll be able -- we'll be capable of offering 5 by 1 gigabit per second speeds in these markets with even better network performance. The next phase of markets will be upgraded to 10 by 1 gigabit per second speed and the ability to offer fiber on demand.
And ultimately, we'll see lower contact rates and truck rolls across these upgraded markets, achieving both lower cost and a superior product. We expect to complete our network evolution initiative in 2026, all at an incremental cost to just over -- or just $100 per passing, excluding the benefit of operating and capital savings that result from the project.
Our mobile offering also continues to evolve and improve. Earlier this month, we began offering Anytime Upgrade to customers within our Unlimited Plus offering. Anytime Upgrade allows new and existing Unlimited Plus customers to upgrade their phones whenever they want, eliminating traditional wait times, upgrade fees and condition requirements. We are the first mobile provider to include this level of freedom within a rate plan. And we also recently launched a new repair-and-replacement plan for just $5 per month. Anytime Upgrade, part of Unlimited Plus, and our repair-and-replacement plan, are each profitable.
Spectrum One continues to perform well beyond its first anniversary and offers the fastest connectivity with differentiated features like mobile speed boost and seamless connectivity to the Spectrum Mobile network across Android and iOS devices.
We still have a lot of room to grow our mobile business. Today, less than 8% of our total passings take our converged offering of Internet and mobile. We remain underpenetrated despite having a differentiated and superior offering with market-leading pricing at promotion and retail. And from a dollars perspective, we captured less than 30% share of residential mobile and Internet dollars spent in our footprint today. Mobile will be a meaningful driver of EBITDA and cash flow going forward with what is still an untapped ability to drive overall customer relationship growth.
Finally, turning to the evolution of our video product. We now offer a unique modern user experience with Xumo, which offers both linear and direct-to-consumer content on one device, combined with packaging and pricing options that offer choice, value and utility across FAST, SVOD, direct-to-consumer apps and linear video services.
In January, Disney+ became available to all Spectrum TV Select customers nationwide at no additional cost, with ESPN+ launched to Select Plus customers in March. ViX, a Spanish language DTC product, and regional sports DTC products, will also be available to customers at no extra cost within their respective packages.
We expect our hybrid DTC-linear model to be fully deployed next year. And we'll be able to deliver value for our customers and programming partners through fully bundled hybrid services, genre-based packages, selling DTC a la carte and potentially bundled DTC services to our broadband customers.
In late January, we launched our Spectrum TV Stream package, a 90-channel non-sports general entertainment package priced at $40 per month. TV Stream provides a compelling content offering at an attractive price from programmers like Paramount, Warner Bros. Discovery, Disney, Fox and A&E.
And so while the video business is clearly under pressure, we believe that flexible and attractively priced packaging options across all forms of video, channels really, integrated within a modern user interface in a more frictionless environment can recreate value in the ecosystem for our customers, programmers and distributors.
So when we step back, we clearly recognized some short-term market challenges, and we've embraced the opportunity to become an even better operator, leaving no stone unturned in our go-to-market and our efficiency initiatives. And in the meantime, we're growing a unique converged product at a rapid pace which can grow EBITDA through a competitive investment cycle. In long term, our network and customer demand products, pricing and packaging capabilities, our service infrastructure and the associated investments we're making today position Charter for sustainable growth and value creation.
And with that, I'll turn the call over to Jessica.
Jessica Fischer: Thanks, Chris. Let's turn to customer results on Slide 5. Including residential and SMB, we lost 72,000 Internet customers in the first quarter, and video customers declined by 405,000. In mobile, we added 486,000 mobile lines. And wireline voice customers declined by 279,000. Our mobile product continued to perform well. And although we saw lower mobile gross adds year-over-year tied to lower gross Internet additions, we also saw lower overall mobile churn rate year-over-year and sequentially.
Customers who signed up for our Spectrum One product in the first quarter of 2023 reached their 12-month anniversary this past quarter. Similar to last quarter, those promotional roll-offs did not drive incremental Internet churn. In fact, our Internet churn rate also declined year-over-year. So as we always expected, Spectrum One lines are performing well, and our converged offering drives higher mobile sales and longer customer lifetimes.
Turning to rural. We ended the quarter with 493,000 subsidized rural passings. And we grew those passings by 324,000 over the last 12 months and 73,000 in the first quarter. It's a bit of a slowdown from Q4, as we noted it would be on our last call, given winter construction seasonality. Penetration growth continues to exceed our expectations, and customer growth in our subsidized rural footprint increased with 35,000 net customer additions in the quarter. We continue to expect to activate approximately 450,000 new subsidized rural passings in 2024, about 50% more than in 2023.
We also continue to expect our RDOF build to be completed by the end of 2026, 2 years ahead of schedule. The RDOF and ARPA program rules have been successful in driving large-scale private capital builds. With respect to BEAD, most of the state's rules are still working through the NTIA review process. We expect some states will have a regulatory environment conducive to private investment while others will not. And we'll be disciplined in our investment approach with the continued expectation that some opportunities with appropriate ROIs will be available.
Before turning to our financial results, I wanted to make a few comments regarding the Affordable Connectivity Program. An ACP renewal now appears unlikely for the program's 23 million recipients nationwide and for our 5.0 million Internet customers receiving a subsidy. We will do everything we can to preserve our relationship with the ACP subsidy recipients, and we expect to keep the vast majority of them as customers. We have a number of ways to assist those that may lose their ACP subsidy, including our Spectrum Internet Assist program and Internet 100 product. We're also offering all of our ACP customers a free mobile line for 1 year.
The success of our Spectrum One offering has shown that we can create long-term converged connectivity customers by saving consumers hundreds or even thousands of dollars on their mobile bill. And even after the initial promotional period ends, we will still be able to save these customers the equivalent or more than the $30 ACP subsidy benefit that they are currently receiving.
The majority of ACP recipients in our customer base were Internet customers before the start of the ACP program. And the vast majority of our ACP customers also pay something out of pocket for their Internet service. Ultimately, we will lose some customers, and our Internet ARPU and bad debt expense may have onetime pressure, but we expect the impact to Charter to be mostly limited to the second and third quarters of this year. And we will provide transparency for those impacts in our quarterly reporting.
Moving to the first quarter financial results, starting on Slide 6. Over the last year, residential customers declined by 0.7%, driven by video-only customer churn. Residential revenue per customer relationship declined 0.1% over-year, given a higher mix of non-video customers and growth of lower-priced video packages within our base, mostly offset by promotional rate step-ups, rate adjustments and the growth of Spectrum Mobile. As Slide 6 shows, in total, residential revenue declined by 0.4% year-over-year.
Turning to commercial. SMB revenue declined by 0.3% year-over-year, reflecting lower monthly SMB revenue per SMB customer primarily due to a higher mix of lower-priced video packages and a lower number of voice lines per SMB customer. These factors were slightly offset by SMB customer growth of 0.2% year-over-year.
Enterprise revenue grew 3.8% year-over-year driven by enterprise PSU growth of 6.9% year-over-year. Excluding all wholesale revenue, enterprise revenue grew by 5.5%.
First quarter advertising revenue grew by 10% year-over-year given political revenue growth. And core ad revenue was essentially flat year-over-year.
Other revenue grew by 2.4% year-over-year primarily driven by higher mobile device sales. And in total, consolidated first quarter revenue was up 0.2% year-over-year and down 0.1% year-over-year when excluding advertising.
Moving to operating expenses and adjusted EBITDA on Slide 7. In the first quarter, total operating expenses declined by 1.5% year-over-year. Programming costs declined by 8.2% year-over-year due to the decline in video customers of 8% year-over-year and a higher mix of lighter video packages. These factors were partly offset by higher programming rates. And first quarter 2024 programming costs include around $30 million of favorable adjustments versus $50 million of favorable adjustments in the prior year period.
Other cost of revenue increased by 9.8% primarily driven by mobile service direct costs and higher mobile device sales. Cost to serve customers were essentially flat year-over-year with additional activity to support the growth of Spectrum Mobile and higher bad debt expense, mostly offset by lower service transactions per customers, including productivity from 10-year investments. Sales and marketing costs declined by 2.7% primarily driven by lower labor costs, partly tied to lower connect volume. Finally, other expense grew by 0.5%.
Adjusted EBITDA grew by 2.8% year-over-year in the quarter. And when excluding advertising, EBITDA grew by 2.2% year-over-year. Looking ahead, our goal is to deliver solid EBITDA growth, and we believe we can do that even as we make significant investments in the business, face a challenging competitive environment and reach the likely end of the ACP program.
Our residential revenue will be supported by Internet ARPU growth and our growing mobile customer base. In addition, mobile's contribution to EBITDA continues to improve as the business scales. We've also lapped the significant investments that we made in our employee base, so the related EBITDA drag should be mostly behind us.
And finally, we continue to carefully manage our expenses across the business. And while we're not going to do anything that would impact our sales or service capabilities, this quarter's cost to service customers and sales and marketing expense results demonstrate our ability to drive efficiencies into the business.
In the second quarter, we will face some tough expense comparisons, particularly in other expense as well as ACP headwinds. So while our second quarter EBITDA growth will be muted, our expense management process is clearly working. And financial growth in the back half of the year should accelerate given our expense management initiatives, Spectrum One promotional roll-off and political advertising revenue.
Turning to net income on Slide 8. We generated $1.1 billion of net income attributable to Charter shareholders in the first quarter, up from $1 billion last year, driven by higher adjusted EBITDA and a gain on the sale of towers, partly offset by higher income tax and interest expenses.
Turning to Slide 9. Capital expenditures totaled $2.8 billion in the first quarter, about $325 million above last year's first quarter spend. Line extensions totaled $1 billion, $69 million higher than last year driven by our subsidized rural construction initiative and increased residential and commercial greenfield and market fill-in opportunities.
First quarter capital expenditures, excluding line extensions, totaled $1.8 billion compared to $1.6 billion in the first quarter of 2023 driven by higher spend on upgrade, rebuild, primarily network evolution, and higher CPE spend due to purchases of Xumo Stream boxes. For the full year 2024, we continue to expect capital expenditures to total between $12.2 billion and $12.4 billion, including line extension spend of approximately $4.5 billion and network evolution spend of approximately $1.6 billion.
Turning to free cash flow on Slide 10. The cash flow in the first quarter totaled $358 million, a decrease of approximately $300 million compared to last year. The decline was primarily driven by an increase in capital expenditures and a onetime settlement payment in the first quarter of 2024, partly offset by a less unfavorable change in working capital year-over-year and higher adjusted EBITDA.
We finished the quarter with $97.8 billion in debt principal. Our current run rate annualized cash interest is $5.2 billion. Given our long-dated and 85% fixed rate debt structure, our sensitivity to higher rates is relatively low. If we refinanced all of our debt due in 2025 and 2026 at current rates, the impact to our run rate interest expense would be less than $140 million.
As of the end of the first quarter, our ratio of net debt to last 12-month adjusted EBITDA was 4.41x, which is lower sequentially and year-over-year. We expect to continue that trend, moving closer to the middle of our 4 to 4.5x target leverage range through the end of this year.
We remain fully committed to maintaining our split-rated debt structure, including access to the investment-grade market given the significant benefits it offers to all of our providers of capital. And we continue to be confident in the long-term trajectory of the business. We believe that our levered equity strategy, including share buybacks, combined with the investments that we are making in the business, will drive value going forward. During the quarter, we repurchased 1.7 million Charter shares and Charter Holdings common units totaling $567 million at an average price of $339 per share.
With the continued temporary impact from cell phone Internet competition and the potential headwind from the end of ACP, we will continue to face short-term customer growth headwinds. Despite these short-term challenges, we are competing well. We have a very attractively structured balance sheet, and we're focused on driving healthy EBITDA growth in 2024 through a short-term competitive and investment cycle. So we're well positioned today and for continued future growth.
With that, I'll turn it over to the operator for Q&A.
Operator: [Operator Instructions] Our first question will come from John Hodulik from UBS.
John Hodulik: If I could follow up on the ACP comments, first of all, just any additional color you guys can provide over the -- on the subscriber and ARPU impacts to that program winding down in the second and third quarter. And it sounds like given the cost-cutting opportunities and the commentary, you still believe you can grow EBITDA for the year. That's number one.
And then number two, I thought the commentary about the churn on the video side from the Disney renewal was interesting. Chris, is that a trend that you expect to continue, especially as you sort of roll over your existing or you go through more renewals and add more D2C services to your lineup?
Christopher Winfrey: Sure. Let me try to tackle those, and Jessica may want to chime in here as well. The first one is on ACP and what we estimate. John, the non-renewal of ACP, there's 23 million customers have it today. It's unfortunate. But it's certainly going to have a negative Internet customer growth impact for everyone, including us. And that's going to happen in what's already a seasonal Q2 and probably the third quarter as we work through likely non-pay activity. And so really, as you think about the extent of those losses, it's going to depend on a few things.
One, first, being the stickiness of our retention offers. That includes us doing a free mobile line as well as for all ACP customers. That allows customers to save as much, if not more money on a monthly basis than the subsidy we already offered by ACP. In some cases, it can be much closer to EBB or maybe even more.
And we do have a Spectrum Internet Assist. We have Internet 100. So we have products that we can move people to as needed. And so the second thing I would say is it's going to depend on how well we really execute on those retention tactics that matters. And then thirdly, the way that we manage what's going to be likely an elevated non-pay environment and really managing that to the best of our ability for the benefit of customers.
In terms of specifics, this is an event that's unprecedented. In almost 30 years of cable, I haven't seen something like this before. So the short-term impact, it's difficult to predict. But in the end, I'm really confident we're going to manage through it successfully. It will be a onetime event, both on subscribers and maybe initial suppression of ARPU, but it's not going to impact our long-term growth potential.
Jessica Fischer: Yes. As you think about EBITDA across the year, as we pointed out and I would just highlight it, there are some pressures on EBITDA in Q2 because of the comps to last year as well as likely, if there is non-pay impact, there could be some bad debt pressure inside of Q2 as well. So I would expect our EBITDA growth to be more pressured in Q2.
But we see the ability for it to accelerate across the rest of the year when you consider the roll-off of Spectrum Mobile, political advertising and our continued expense initiatives in the business as well. And so because of that, in all of the scenarios that we've looked at, we continue to expect EBITDA growth in the year.
Christopher Winfrey: Yes. And so EBITDA, we're very confident on that. Giving a hard estimate on subscriber impact, for all the reasons I mentioned, is difficult. But we're going to outline that quarter by quarter. We'll have the ability to isolate. We'll provide that transparency for people along so they can see what's the underlying growth rate.
Your other question, John, I want to make sure I understand, was on video churn. We rolled out -- at the beginning of the quarter, we rolled out the Disney+ to all Spectrum Select customers and above and to Select Plus customers, which is our more sports-oriented package on top. We rolled out ESPN+ in March. Very early on, good take-up on that product along the way. But there was nothing that was a rotation of our subscriber base inside there. So there was not a negative contributing factor to adding those in.
I would highlight, in an environment where video these days really is coming in as an attach rate to Internet, we have lower Internet sales opportunities that has an impact on video. So the video churn rate stays relatively consistent. But the combination of having both lower selling opportunities for Internet and therefore lower attach rates for video, combined with the fact that we did do a programming cost increase pass-through inside of Q1 contributed to the video loss inside the quarter.
I do think that as we add more bundling of these DTCs in a hybrid linear model over time, I think we have the ability to stem a lot of the churn and actually add back to both the gross addition side coming from potentially new calls coming in, but also higher attach rate to Internet primarily as we provide more value into the package, which offsets the significant programming cost increases that we've been forced to pass through. Does that answer where you're trying to get to?
John Hodulik: Yes, that's perfect.
Operator: The next question comes from Benjamin Swinburne with Morgan Stanley.
Benjamin Swinburne: Just maybe unpacking the EBITDA outlook a little bit more. Jessica, last quarter, you gave us some helpful guidance on a few expense line items for the year. I think programming, cost to service and marketing come to mind. I don't know if you had any updates on any of those given some of the moving pieces. I just wanted to check on that.
And then secondly, for either of you or both of you, just on broadband competition. Could you spend a minute just talking about sort of how you see your product competing right now with fixed wireless, which is sort of everywhere or in a lot of markets, and then the wireline overbuild piece? Because fixed wireless net adds at the industry level this quarter, or cell phone Internet just to stay on brand here, were down year-on-year and a bit lighter than at least we were expecting. So it does seem like that product is starting to mature here. But you also called out wireline overbuild sort of pricing at a discount in the market as well. So I'd love to hear your updated thoughts on sort of the competitive framework you're thinking about this year.
Jessica Fischer: So Ben, on the line item expense guidance that we gave earlier in the year, I don't have an update to any of those specific items. But what I would tell you is that, because of some of the work that we're doing around expenses across the business, I think it's possible that we come in lower than what we guided to, to begin with. I don't have a revision, but I think it's possible we come in on the low side.
Benjamin Swinburne: Okay. Even with the bad debt comment you made earlier?
Jessica Fischer: So that's a fair call out. The exact amount of the bad debt related to ACP is hard to predict because it's a matter of what the mix is between customers that go non-pay and customers that sort of contact you in some other way. So that's fair call out.
On items other than that, I think the possibility is that we do better.
Christopher Winfrey: You've got a lower transaction environment, plus all the expense management activity that we're doing, and that will have significant impact to cost to serve as well as sales and marketing as well.
And the broadband competition, maybe just take a step back and talk a little bit more detail about the operating environment and competitive and the results in that context.
The first thing I think is important to just keep in mind is that our churn, it continues to be at or below historic lows, so very good. And bear with me, but we actually performed a little better in the first quarter in competitive switching versus last year. Which then somebody said, "Well, wait a second, how does that work?"
And the real issue has been selling opportunities for broadband were actually much lower in the marketplace year-over-year, and that's driven by continued lower year-over-year move and household formation rates. There is some reversion to pre-pandemic mobile-only levels the past 2 quarters.
And at the same time, as you mentioned, there's still some cell phone Internet expansion, and that's competing what is for a much lower opportunity set. So if you add to that, then just a bit of impact from the removal of ACP connects that started in early February, that's really what drove us to the loss of roughly 70,000 Internet.
Ben, as you know, in this environment, small shifts in gross adds in particular, or even churn, which hasn't been the case, it just really has an outsized impact on net adds. And so that's going to definitely, as I mentioned before, it's going to be the case in the seasonal Q2, also with the end of ACP, all of which is temporary in nature.
I think the bigger question is what are we doing? And as I mentioned, we still know, and I think everybody agrees, we have the best products. And we have it at the best all-in price, particularly when you're combining broadband and mobile, which is, in a lot of cases, what we're competing against. Our network evolution to symmetrical and multi-gig wireline and wireless capabilities, and we're doing that at a low cost of $100 per passing. And then as I mentioned, we have the expansion of that best-in-class network and converged products to homes with no broadband today.
So in essence, what we're doing is we're still very competitive saving customers lots of money with fastest products. And we do that with a 100% in-house onshore service structure. And when you put that together with what I mentioned in the prepared remarks is continued increasing customer demand for data, it means we're very well positioned to return to sustainable growth over time.
And the key for us really is, in the meantime, we're heads down on execution. It doesn't mean that we don't have short-term opportunities. We're leaving no stone unturned on go-to-market. We have great assets and ability to package and price in I think ways that are new and innovative.
And what we're trying to do in the meantime as well, you mentioned on wireline overbuild in particular, still be very disciplined around the pricing because we know the value of our products. And so we saw a few overbuilders go a little bit downstream during the quarter. And we've resisted the temptation to go there just because we know the value of our both wireline and wireless services and the value that we can bring to customers long term.
Operator: The next question comes from Jonathan Chaplin at New Street.
Jonathan Chaplin: I guess the first one for Jessica, just on the change in your leverage target navigating towards the midpoint of the range. Would love to just get some more context on the thinking behind that. You sort of mentioned earlier in the script that the risk of higher rates isn't a material concern. And so this navigating down in the leverage range just reflect lower confidence in the cash -- the sort of the cash generation in the business given the competitive environment?
Jessica Fischer: Yes. So Jonathan, I would say our confidence in the business hasn't changed. We remain comfortable with our 4 to 4.5x range based on the outlook that we have. But I think being sort of at the height of the investment cycle, we thought that creating a little bit of headroom was appropriate.
We constantly reevaluate our position. We'll continue to do that. But we continue to believe in the long-term trajectory of the business. We think the investments that we're making will deliver strong returns. And we know that maintaining the levered equity strategy, including sort of buybacks and leverage levels overall, is important to continuing to drive value.
Christopher Winfrey: I would just add on -- just to add, Jessica said it, 0 lack of confidence. We have good, strong free cash flow today, have even growing free cash flow, and much more so as we get through these onetime investments. It's really -- as Jessica has already said, it's about making sure that we ensure the investment-grade structure we have. And that's important to us, it's important to our debt holders, and it's important to our equity holders as well.
Jonathan Chaplin: And Chris, just a follow-up on that. Were the rating agencies sort of asking you to bring leverage lower in the range? And are there things that you could look -- that we could look for in the business that would make you feel comfortable to go back to the high end of the range over the course of the next few quarters?
Jessica Fischer: Jonathan, we're in regular contact with all 3 of the ratings agencies. Certainly, I think that there has been some additional conversation across debt holders and the rating agencies, given the higher CapEx that we have in the business and the sort of short-term pressure that, that puts on free cash flow.
And given sort of the tone of the broader market, you might have seen S&P issued a tearsheet at the end of last week that addressed ACP and the competitive environment. And I think their concerns are similar to those of equity holders, though they noted in there that they don't expect our ratings to change even though they might adjust their triggers somewhat. And even if our corporate family ratings were to change, they didn't expect any impact to the investment-grade rating.
So we constantly communicate with them. I think that given where we are, it made sense for us to create a little bit of headroom. As I said, we constantly reevaluate. It's certainly possible that we could move back up in the range at some point in time, particularly as you think about sort of free cash flow growth coming back as the investments winds down.
Christopher Winfrey: And so I'd put that one to being responsive, and at the same time, given the current stock price, we want to do as much as we can within that responsiveness.
Jessica Fischer: Yes.
Operator: The next question comes from Craig Moffett at MoffettNathanson.
Craig Moffett: Chris, I want to -- maybe 2 questions. One broader sort of more strategic question and then just one clarification from Jessica. On the first one, you said something to me a while back that I've been thinking about, about the way you think about convergence. And you characterized the Spectrum One offer not really as an offer but sort of as a new product category.
I wonder if you could just talk about that a little bit and particularly in the context of AT&T talking quite frequently about their converged offering in the portion of their footprint where they have it. T-Mobile now with their Lumos deal yesterday, obviously sort of searching around for a converged offering. How much of the market is actually going in that direction?
And then, Jessica, just one minor clarification. Could you just let us know how much is left of wholesale in the business services market? So that we can understand when we might start to see the overall growth rate start to look more like the non-wholesale part of your business?
Christopher Winfrey: So Craig, I'll start on the first one on convergence. And I think the best way to do this is I spend a lot of time internally talking about it as well, is if I asked you 15 years ago, what's the speed of your Internet connection? You would have connected to the back of the computer in your kitchen, and that would have been it. And 10 years ago, it might have been, here it is on WiFi on my couch or out on the terrace.
And today, if you're pulling out of the driveway and driving out and I say, "Who's your Internet provider right now?" You'd say, "I don't know, I don't care. It just has to work and it has to be fast." And if that's people's definition increasingly of what's broadband connectivity, then we're the only provider in our footprint that can provide that uniform, ubiquitous broadband Internet in a seamless connectivity way.
And so we have the Internet. We have the WiFi. Our 5G cellular is a backup service when Internet and WiFi isn't available. And over -- last we reported, it was 87% of our traffic was going over our WiFi and increasingly with CBRS.
So 5G, interestingly, it's the backup radio. It's the slowest portion of our network. And when you put that all together in a way that I think we're uniquely capable of doing, we have the ability to offer something in the marketplace.
Now the challenge is that's not the way that it's been sold. It's not the way that customers think about it explicitly today in terms of how they purchase service. So there's an education challenge that's there in the way that we package, price and market that along the way. We'll have a meaningful impact.
Another way of thinking about it is that mobile today, and in fact I would argue, always has been, is just an extension of an Internet connection. And is it really a product? Is mobile a product? Or is it just an extension? Because even in 15 years ago, it's really a wireline service going to a tower, and that was just extending the broadband connection. And today, we're doing that from WiFi inside the home, out on strand. And we have the ability to provide that service in a ubiquitous way that is competitive.
And so Spectrum One, the idea is how do you educate the market and try to get the purchase habits to change in a different way. And over time, is mobile really a product? And testing and pushing the limits in the market, I think we have something here that's a competitive advantage, and it just may take a little bit of time to fully flesh its way out.
But we are that service provider today, not only to ourselves, but we're actually providing that backhaul service to foreign cellular devices on our WiFi routers today. And we are the backhaul and the backbone of almost all cellular traffic. So it just puts a unique opportunity for us to capitalize on that in the future.
Jessica Fischer: Craig, on the other side, wholesale is a little less than 20% of overall enterprise revenues.
Christopher Winfrey: And the piece of that, the piece that's pulling that is really cell tower backhaul...
Jessica Fischer: Yes, and that's really a little less than half of that piece.
Christopher Winfrey: Right. So the traditional wholesale is relatively steady, and it's the cell tower backhaul that's in systemic decline, if you will.
Operator: The next question comes from Bryan Kraft with Deutsche Bank.
Bryan Kraft: I had 2 if I could. First, Jessica, related to free cash flow. I was wondering if you could size for us the onetime payment in the first quarter that impacted free cash flow. And also if you could help us understand how you're thinking about working capital usage this year.
And then, Chris, just on network neutrality. I was wondering if you could share your thoughts on the SEC's recent reinstituting of net neutrality rules. Any concerns with the rules? Do they impact the way you're running the business in any way, whether it's on the home broadband or on mobile side?
Jessica Fischer: Yes. So Bryan, the onetime payment that impacted free cash flow on the order of $150 million to $180 million, in that range. And then from a working capital perspective, Q1 is always for us a negative working capital quarter. And I fully expect that we'll sort of make back to close to flat over the course of the year the negative working capital that we had. Excluding working capital, excluding the mobile device or the mobile side in the first quarter. Obviously, mobile continues to be a drag on working capital because of the device sales, and so you should expect that piece to continue.
Christopher Winfrey: Bryan, on the net neutrality, I'd start from the get go. We don't -- the key concern isn't net neutrality. The concern is the Title II regime. We've -- we don't block. We don't do paid prioritization. We don't throttle, and we don't even have data caps. We believe that customers should have unlimited usage of the service that they're paying for.
The question has really been around Title II and what that brings, things around forbearance on rate regulation, the additional unintended consequences of where that can lead to on regulation for a product that, without regulation, is that type of regulation has been very successful to delivering tremendous value for consumers over a couple of decades now.
I would say that where we're at in the Title II debate with the FCC, there's 0 surprise. It's exactly where everybody thought we would be, and we're going to continue to go through that process. Unfortunately, it seems like over many years as this kind of works its way probably back to a court at this stage. And then hopefully, over time, we can get a standard set by Congress that puts this to bed once and for all. That's always been the hope. But I don't think Title II is the right way to regulate the things that we're already doing well.
Operator: The next question comes from Michael Rollins at Citi.
Michael Rollins: Two questions. First, with respect to the residential broadband ARPU performance, can you unpack the benefit in the quarter from the Spectrum One promotions rolling off? And how the potential benefit of this in terms of size can move through the year as more customers start getting back to maybe the normal course rate levels?
And then just secondly, in the press release for quite some time now, you noted customers, and I hope I'm framing this right, that are broadband subscribers where there may have been some suspension of collections for other Charter services. And I'm curious what happens to those customers if ACP is discontinued? And do those disclosures provide any insight on how to quantify potential customer risk or churn risk if this program is discontinued?
Jessica Fischer: Yes. So starting on the first one on the Internet ARPU. The Spectrum One allocation was 70 basis points of drag year-over-year on our net ARPU growth in the quarter. So the GAAP Internet ARPU increased by 1.7%. It would have been 2.4% excluding the mobile allocation for free lines. Generally, I would expect that the gap in those 2 growth rates should narrow over the course of the year because the base of free lines becomes more stable given promotional roll-off.
However, I talked about that we are offering all of our ACP customers a free mobile line for a year. And depending on the level of success of that program, if we did see a reacceleration in the number of free lines, the gap between those 2 things could widen again.
Talking about what you see inside of the footnote and the aging. So we have had a process over time where we save customers into ACP. So if there was a customer who took multiple lines of business, say they were an Internet and video customer, and they were paying us. And then went into a non-pay status but they were eligible for ACP.
Christopher Winfrey: Or in it, in most cases.
Jessica Fischer: Or already in ACP. What we would do would be to downgrade the customer to an Internet-only product that was fully covered by the ACP subsidy, which enabled them to continue their Internet service. But then they would no longer have whatever the additional services were that were on their accounts. We have held those balances, though they're fully reserved. So they're sitting in receivables, but they're also sort of fully written off already in the bad debt reserve process.
But you're correct that numerically inside of the footnote, then you can see the base of customers who at some point in the past went into a non-pay process but have had their bill fully subsidized by ACP for some period of time.
Christopher Winfrey: And if you think about it just from a customer perspective and how we were trying to be responsive to the government request, we wanted to make sure that these customers entering into collection cycle on video or phone didn't somehow suppress their ability to continue to receive the ACP benefit and continue to receive connectivity. And it's -- that's a classic example of the base of customers that we're going to work through, as I talked about from a collection cycle. And do the right thing for those customers to do everything we can to make sure that they stay connected to Internet over time. But there's challenges there.
Michael Rollins: And are you choosing to implement the ACP wind-down at the end of April? Or are you planning to go through mid-May with your customers?
Christopher Winfrey: We'll go through the month of May with a partial ACP in accordance with what the government outlined. It's going to be a partial credit of $14, and we've agreed to make it $15 just to round it and make it clear to -- and fair to customers. So that's what we'll do inside of May.
Operator: The next question comes from Vijay Jayant with Evercore.
Vijay Jayant: Chris, given your focus on improving the video consumer proposition, I think you have a pretty substantial programming contract coming up very shortly. And what [ you sort of saw ] with the Disney agreement. Can you just talk about, is there a big [ opportunity ] there to sort of resize your programming costs associated with that sort of portfolio of channels?
And second, I saw that your buyback authorization is somewhere around the $260 million. Is that something that's going to be re-upped?
Christopher Winfrey: So on the first question, the connection was a little off, and so we're going to sell you a Spectrum Mobile after this call here.
But the -- so I'm going to want to take the liberty of answering the question I think you asked. Look, we don't get into detail on individual programming renewals, and we've been generally very successful at getting renewals throughout the years. That's always our goal.
Our goal, though, is to really make sure that, first and foremost, that we really change the model so that we, once again, create value for customers. That starts with not asking them to pay twice for the same product, which is the debate that we've had historically and where we set a new model.
But it also means approaching the marketplace in all of our deal renewals and saying, "Look, we've got to fight for the customer." And if they have a path to get a product that's equivalent or in some cases, even better for a lower price, we should just be selling that product, and that's the way that we should go to market.
And we can have that ability to do traditional linear hybrid. We can sell DTCs. We can sell them in a bundle. We have 25,000 in-house sales representatives in sales and retention. And so we have a workforce that's very capable of being a distribution engine for linear hybrid, DTC. And we have a large base of broadband customers, none surpassing us, that we can use that's unique. And we want to do that in a way that creates value for consumers.
I think as we've approached the marketplace in what is a different way, it creates consternation because it's something very different. But our goal here is really to create a video ecosystem that works for customers and providing utility and value. Again, utility through Xumo and value through our ability to package in different ways that meets the customers' needs at a fair price. And ultimately, while it may be painful along the way, actually creates value again for programmers and distributors and recreates a video ecosystem that works for everybody.
And so we're not approaching this from a way of just trying to save money. We're just trying to actually create value for customers by either adding more product so that the price they pay is worth it or saving them money because they wanted to package anyway. And we can do that in a way in a lower churn environment for the benefit of programmers, and that just takes a little bit to get through.
But our goals here are really to recreate a video ecosystem that works for everybody. Today, it doesn't. It's been broken, and it's been broken for a while. And I think that we had the first time in maybe 2 decades where we can do something where we have a product that we're proud to put on our Internet bill at some point soon.
And that really is, when we talked about it last year, is the balance of, on one hand, our bundled customers churn less. And so a high-quality video product has always been an asset. But when the rate continues to go up and the value goes down and it's being sold around customers and ask them to pay twice, then it becomes a liability on the Internet broadband bill. And then I think we need to rethink the way that what we're selling for video and how it actually creates value for customers or not.
So that's where we've been. And I'm confident we're going to continue to make progress in this space.
Jessica Fischer: On the buyback authorization side. I'm going to make sure we answer that question. The authorization as of the end of the quarter, as you pointed out, is a little bit lower than what you would typically see. There are multiple mechanisms by which that gets renewed, and we have increased the buyback authorization since that point in time. And just because of the readthrough to that, I want to be really clear that we expect to be able to maintain our buybacks over the course of the year even as we delever. So you should not read that through as any sort of sign about the direction of the program.
Stefan Anninger: Operator, we'll take our last question, please.
Operator: The last question will come from Steven Cahall with Wells Fargo.
Steven Cahall: So Chris, earlier, you said you're confident in returning to long-term growth, and you spoke a lot about the overbuilding activity that you're seeing. I think the challenge many of us have is when we pencil that out and kind of think about penetration of fiber and then we look at your passings growth and think about penetration as well, it's just tough to see when things return to growth on the subscriber side, maybe ex rural. So I was wondering if you could just give us any thinking as to your color and timing when we might start to see subscriber growth reaccelerate to a positive level.
And then Jessica, just picking up on Bryan's question. You talked about maybe mobile being a bit of drag in working capital this year. So as you start to do the ACP lines for mobile, could that accelerate the drag for mobile working capital on handsets? Or do you not expect the customers to necessarily be acquiring new handsets?
Christopher Winfrey: So I'm not going to provide a detailed timeline for the timing to reaccelerate, just because I want to be conservative and recognize that it's a very fluid space. I mean, clearly, we have ACP going on right now, which is going to be a onetime hit. You have cell phone Internet where they will reach capacity, and the timing of that isn't entirely clear. And then there's fiber upgrades, which have been announced and are pretty far along from what was actually announced.
So I think if you put that all together, though, and flip it and say, well, get past ACP, and the pace of fiber upgrades is relatively stable, and I think over time should actually start to decline. Cell phone Internet will run out of capacity, and you're already starting to see some signs of some of that paring back, all of which bodes well.
And then you combine that with the fact that when you look at our -- the quality of our Internet product, in 100% of the market, particularly and even more so in those that don't have a gig overlap, which is about half. And then you combine that with the unique ability to provide a very attractively priced mobile product that's actually the fastest mobile product in the business simply because it largely rides on our gigabit wireless infrastructure, we have a structural advantage for now and many years to come, not only just on quality, but the ability to save customers hundreds and even thousands of dollars.
And so I sit back and look at that and say, it isn't a question of if. It's just a question of when. And as some of these short-term pressures pare back, that's when you'll start to see it turn.
Honestly, we haven't been the best at predicting the exact timing of that. And so I said last quarter, we owned that. And so I want to be careful that I'm not overextending ourselves here either. But I think it's more important just to take a step back and look at what is the product we have, what's the network capabilities we have. It's only getting better.
If you then tack on to that the rural passings, that you mentioned ex rural, so I did that ex rural. But if you add on to that the subsidized rural passings where it's just math in terms of the penetration, the net additions that we're going to get on the back of that investment, I still think the future's very, very bright for Charter.
Jessica Fischer: On the mobile working capital side, so you point out, without a doubt, the drag on working capital is driven by the number of phones or other mobile devices that you sell subject to EIP notes. And so if we were to end up with additional devices because of having additional mobile customers as a result of our work on ACP or if we end up with some additional devices because of the Anytime Upgrade program, which is also possible, there could be some acceleration in that drag.
What I would tell you on the other side of that is, as we've been building our mobile business, we haven't taken advantage of some of the financing options that are available for us related to having those EIP notes as part of our overall asset stack. And it hasn't yet made sense for a wide variety of reasons, including just sort of building the scale for a program like that to make sense.
So I think it's also possible that we could offset some of that drag in working capital by working through some of those financing mechanisms. And certainly, as we've been building, I think we're reaching a size at which that becomes a more viable option.
Christopher Winfrey: Good. Well, thank you, everyone, for joining the call. And look forward to talking to you again on the next one.
Stefan Anninger: Thanks, operator. |
MSFT | 3 | 2,024 | 2024-04-25 22:05:24 | Operator: Greetings and welcome to the Microsoft Fiscal Year 2024 Third Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Brett Iversen, Vice President of Investor Relations.
Brett Iversen: Good afternoon and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's third quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission, in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call and in the Risk Factors section of our Form 10-K, Forms 10-Q and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.
Satya Nadella: Thank you, Brett. It was a record third quarter, powered by the continued strength of the Microsoft Cloud, which surpassed $35 billion in revenue, up 23%. Microsoft Copilot and Copilot stack, spanning everyday productivity, business process, and developer services, to models, data, and infrastructure, are orchestrating a new era of AI transformation, driving better business outcomes across every role and industry. Now, I’ll highlight examples, walking up the stack, starting with AI infrastructure. Azure again took share, as customers use our platforms and tools to build their own AI solutions. We offer the most diverse selection of AI accelerators, including the latest from NVIDIA, AMD, as well as our own first-party silicon. Our AI innovation continues to build on our strategic partnership with OpenAI. More than 65% of the Fortune 500 now use Azure OpenAI Service. We also continue to innovate and partner broadly to bring customers the best selection of frontier models and open source models, LLMs and SLMs. With Phi-3, which we announced earlier this week, we offer the most capable and cost-effective SLM available. It’s already being trialed by companies like CallMiner, LTIMindtree, PwC, and TCS. Our Models as a Service offering makes it easy for developers to use LLMs and SLMs without having to manage any underlying infrastructure. Hundreds of paid customers, from Accenture and EY, to Schneider Electric, are using it to take advantage of API access to third-party models, including as of this quarter the latest from Cohere, Meta, and Mistral. And, as part of a partnership announced last week, G42 will run its AI applications and services on our cloud. All-up, the number of Azure AI customers continues to grow and average spend continues to increase. We also saw an acceleration of revenue from migrations to Azure. Azure Arc continues to help customers like DICK'S Sporting Goods and World Bank streamline their cloud migrations. Arc now has 33,000 customers, up over 2X year-over-year. And, we are the hyperscale platform of choice for SAP and Oracle workloads, with Conduent and Medline moving their on-premises Oracle estates to Azure, and Kyndryl and L'Oreal migrating their SAP workloads to Azure. Overall, we are seeing an acceleration in the number of large Azure deals from leaders across industries, including billion dollar plus multi-year commitments announced this month from Cloud Software Group and The Coca-Cola Company. The number of $100 million plus Azure deals increased over 80% year-over-year, while the number of $10 million plus deals more than doubled. Now, on to data and analytics. Our Microsoft Intelligent Data Platform provides customers with the broadest capabilities spanning databases, analytics, business intelligence, governance, and AI. Over half of our Azure AI customers also use our data and analytics tools. Customers are building intelligent applications running on Azure, PostgreSQL and Cosmos DB with deep integrations with Azure AI. TomTom is a great example. They’ve used Cosmos DB along with Azure Open AI service to build their own immersive in-car infotainment system. We are also encouraged by our momentum with our next-generation analytics platform, Microsoft Fabric. Fabric now has over 11,000 paid customers, including leaders in every industry from ABB, EDP, Energy Transfer to Equinor, Foot Locker, ITOCHU and Lumen, and we are seeing increased usage intensity. Fabric is seamlessly integrated with Azure AI Studio, meaning customers can run models against enterprise data that’s consolidated in Fabric’s multi-cloud data lake, OneLake. And Power BI, which is also natively integrated with Fabric provides business users with AI-powered insights. We now have over 350,000 paid customers. Now on to developers. GitHub Copilot is bending the productivity curve for developers. We now have 1.8 million paid subscribers with growth accelerating to over 35% quarter-over-quarter and continues to see increased adoption from businesses in every industry, including Itau, Lufthansa Systems, Nokia, Pinterest and Volvo cars. CoPilot is driving growth across the broader GitHub platform, too. AT&T, Citi Group and Honeywell all increased their overall GitHub usage after seeing productivity and code quality increases with CoPilot. All up more than 90% of the Fortune 100 are now GitHub customers and revenue accelerated over 45% year-over-year. Anyone can be a developer with new AI-powered features across our low-code, no-code tools, which makes it easier to build an app, automate workflow or create a Copilot using natural language. 30,000 organizations, across every industry have used Copilot Studio to customize Copilot for Microsoft 365 or build their own, up 175% quarter-over-quarter. Cineplex, for example, built a Copilot for customer service agents, reducing query handling time from as much as 15 minutes to 30 seconds. All up over 330,000 organizations, including over half of Fortune 100 have used AI-powered capabilities in Power Platform, and Power Apps now has over 25 million monthly active users, up over 40% year-over-year. Now on to future of work, we are seeing AI democratize expertise across the workforce. What inventory turns are to efficiency of supply chains, knowledge turns, the creation and diffusion and knowledge are to productivity of an organization. And Copilot for Microsoft 365 is helping increase knowledge turns, thus having a cascading effect changing work, work artifacts and workflows and driving better decision-making, collaboration and efficiency. This quarter, we made Copilot available to organizations of all types and sizes from enterprises to small businesses, nearly 60% of the Fortune 500 now use Copilot and we have seen accelerated adoption across industries and geographies with companies like Amgen, BP, Cognizant, Koch Industries, Moody’s, Novo Nordisk, NVIDIA, and Tech Mahindra purchasing over 10,000 seats. We’re also seeing increased usage intensity from early adopters, including a nearly 50% increase in the number of Copilot-assisted interactions per user in Teams, bridging group activity with business process workflows and enterprise knowledge. And we’re not stopping there. We’re accelerating our innovation, adding over 150 Copilot capabilities since the start of the year. With Copilot and Dynamics 365, we are helping businesses transform every role in business function as we take share with our AI-powered apps across all categories. This quarter, we made our Copilot for Service and Copilot for Sales broadly available, helping customer service agents and sellers at companies like Land O’Lakes, Northern Trust, Rockwell Automation and Toyota Group generate role-specific insights and recommendations from across Dynamics 365 and Microsoft 365, as well as third-party platforms like Salesforce, ServiceNow, and Zendesk. And with our Copilot for Finance, we are drawing context from dynamics, as well as ERP systems like SAP to reduce labor-intensive processes like collections and contract and invoice capture for companies like Dentsu and IDC. ISVs are also building their own co-pilot integrations. For example, new integrations between Adobe Experience Cloud and Copilot will help marketeers access campaign insights in the flow of their work. When it comes to devices, Copilot in Windows is now available on nearly 225 million Windows 10 and Windows 11 PCs, up 2x quarter-over-quarter. With Copilot, we have an opportunity to create an entirely new category of devices, purpose-built for this new generation of AI. All of our largest OEM partners have announced AI PCs in recent months. And this quarter, we introduced new surface devices, which includes integrated NPUs to power on-device AI experiences like auto framing and live captions. And there is much more to come in just a few weeks, we’ll hold a special event to talk about our AI vision across Windows and devices. When it comes to Teams, we once again saw year-over-year usage growth. We’re rolling out a new version, which is up to two times faster while using 50% less memory to all customers. We surpassed 1 million Teams Rooms for the first time as we continue to make hybrid meetings better with new AI-powered features like automatic camera switching and speaker recognition. And Teams Phone continues to be the market leader in cloud calling now with over 20 million PSTN users, up nearly 30% year-over-year. All of this innovation is driving growth across Microsoft 365 companies across the private and public sector, including Amadeus, BlackRock, Chevron, Ecolab, Kimberly-Clark. All chose our premium E5 offerings this quarter for advanced security, compliance, voice and analytics. Now on to industry and cross-industry clouds. We are also bringing AI-powered transformation to every industry. In health care, DAX Copilot is being used by more than 200 health care organizations, including Providence, Stanford Health Care and WellSpan Health. And in manufacturing, this week at Hannover Messe, customers like BMW, Siemens and Volvo Penta shared how they're using our cloud and AI solutions to transform factory operations. Now on to security. Security underpins every layer of the tech stack, and it's our number one priority. We launched our Secure Future Initiative last fall for this reason, bringing together every part of the company to advance cybersecurity protection, and we are doubling down on this very important work, putting security above all else, before all other features and investments. We are focused on making continuous progress across the six pillars of this initiative as we protect tenants and isolate production systems, protect identities and secrets, protect networks, protect engineering systems, monitor and detect threats, and accelerate responses and remediation. We remain committed to sharing our learnings, tools and innovation with customers. A great example is Copilot for Security, which we made generally available earlier this month, bringing together LLMs with domain-specific skills informed by our threat intelligence and 78 trillion daily security signals to provide security teams with actionable insights. Now let me talk about our consumer businesses starting with LinkedIn. We continue to combine our unique data with this new generation of AI to transform the way members learn, sell and get hired. Features like LinkedIn AI-assisted messages are seeing a 40% higher acceptance rate and accepted over 10% faster by job seekers, saving hirers time and making it easier to connect them to candidates. Our AI-powered collaborative articles, which has reached over 12 million contributions are helping increase engagement on the platform, which reached a new record this quarter. New AI features are also helping accelerate LinkedIn Premium growth with revenue up 29% year-over-year. And we are also seeing strength across our other businesses with hiring taking share for the seventh consecutive quarter. Now on to search, advertising and news. We once again took share across Bing and Edge as we continue to apply this new generation of AI to transform how people search and browse. Bing reached over 140 million daily active users, and we are particularly encouraged by our momentum in mobile. Our free Copilot apps on iOS and Android saw a surge in downloads after our Super Bowl ad and are among the highest rated in this category. We also rolled out Copilot to our ad platform this quarter, helping marketeers use AI to generate recommendations for product images, headlines and descriptions. Now on to gaming. We are committed to meeting players where they are by bringing great games to more people on more devices. We set third quarter records for game streaming hours, console usage and monthly active devices. And last month, we added our first Activision Blizzard title Diablo IV to our Game Pass service. Subscribers played over 10 million hours within the first 10 days, making it one of our biggest first-party Game Pass launches ever. We were also encouraged by ongoing success of Call of Duty: Modern Warfare 3, which is attracting new gamers and retaining franchise loyalists. Finally, we are expanding our games to new platforms, bringing four of our fan favorite titles to Nintendo Switch and Sony PlayStation for the first time. In fact, earlier this month, we had seven games among the top 25 on the PlayStation store more than any other publisher. In closing, I'm energized about our opportunity ahead as we innovate to help people and businesses thrive in this new era. With that, let me turn it over to Amy.
Amy Hood: Thank you, Satya, and good afternoon, everyone. Our third quarter revenue was $61.9 billion, up 17%; and earnings per share was $2.94, up 20%. Results exceeded expectations, and we delivered another quarter of double-digit top and bottom line growth with continued share gains across many of our businesses. In our commercial business, bookings increased 29% and 31% in constant currency, significantly ahead of expectations, driven by Azure commitments with an increase in average deal size and deal length as well as strong execution across our core annuity sales motions. In Microsoft 365, suite strength contributed to ARPU expansion for our Office Commercial business, although new business growth continued to moderate for stand-alone products sold outside the Microsoft 365 suite. Commercial remaining performance obligation increased 20% and 21% in constant currency to $235 billion. Roughly 45% will be recognized in revenue in the next 12 months, up 20% year-over-year. The remaining portion recognized beyond the next 12 months increased 21%. And this quarter, our annuity mix increased to 97%. In our consumer business, PC market demand was slightly better than we expected, benefiting Windows OEM, while advertising spend landed relatively in line with our expectations. In gaming, we also saw better-than-expected performance of Activision titles, benefiting Xbox content and services. At a company level, Activision contributed a net impact of approximately 4 points to revenue growth, was a 2-point drag on operating income growth and had a negative $0.04 impact to earnings per share. A reminder, that this net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first party and also includes $935 million from purchase accounting adjustments, integration and transaction-related costs. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment level revenue, COGS and operating expense growth. Microsoft Cloud revenue was $35.1 billion and grew 23%, ahead of expectations. Microsoft Cloud gross margin percentage decreased slightly year-over-year to 72%, a bit better than expected. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage increased slightly, driven by improvement in Azure and Office 365, even with the impact of scaling our AI infrastructure, partially offset by sales mix shift to Azure. Company gross margin dollars increased 18% and gross margin percentage increased slightly year-over-year to 70%. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point even with the impact from the purchase accounting adjustments, integration and transaction-related costs from the Activision acquisition. Growth was driven by the improvement in Azure and Office 365 just mentioned as well as sales mix shift to higher-margin businesses. Operating expenses increased 10% with 9 points from the Activision acquisition. At a total company level, head count at the end of March was 1% lower than a year ago. Operating income increased 23% and operating margins increased roughly 2 points year-over-year to 45%, excluding the impact of the change in accounting estimate, operating margins increased roughly 3 points, driven by the higher gross margin noted earlier and improved operating leverage through continued cost discipline. Now to our segment results. Revenue from Productivity and Business Processes was $19.6 billion and grew 12% and 11% in constant currency, in line with expectations. Office Commercial revenue grew 13% and 12% in constant currency. Office 365 commercial revenue increased 15%, in line with expectations, driven by healthy renewal execution, ARPU growth from continued E5 momentum and early Copilot for Microsoft 365 progress. Paid Office 365 commercial seats grew 8% year-over-year with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, although growth continued to moderate in SMB. Office Commercial Licensing declined 20% and 18% in constant currency, with continued customer shift to cloud offerings. Office Consumer revenue increased 4%, slightly below expectations. Microsoft 365 subscriptions grew 14% to $80.8 million. LinkedIn revenue increased 10% and 9% in constant currency, ahead of expectations, driven by slightly better-than-expected performance in our premium subscriptions and Talent Solutions businesses. However, in Talent Solutions, bookings growth continues to be impacted by the weaker hiring environment in key verticals. Dynamics revenue grew 19% and 17% in constant currency, ahead of expectations. Growth was driven by Dynamics 365, which grew 23% and 22% in constant currency with continued growth across all workloads and better-than-expected new business, although bookings growth remains moderated. Segment gross margin dollars increased 11%, and gross margin percentage decreased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased slightly driven by improvement in Office 365. Operating expenses increased 1% and operating income increased 17% and 16% in constant currency. Next, the Intelligent Cloud segment. Revenue was $26.7 billion, increasing 21%, ahead of expectations with better-than-expected results across all businesses. Overall, Server products and cloud services revenue grew 24%. Azure and other cloud services revenue grew 31% ahead of expectations, while our AI services contributed 7 points of growth as expected. In the non-AI portion of our consumption business, we saw greater-than-expected demand broadly across industries and customer segments as well as some benefit from a greater-than-expected mix of contracts with higher in-period recognition. In our per-user business, the Enterprise Mobility and Security installed base grew 10% to over 274 million seats, with continued impact from the growth trends in new stand-alone business noted earlier. In our on-premises server business, revenue increased 6%, ahead of expectations, driven by better-than-expected renewal strength, particularly for contracts with higher in-period revenue recognition. Enterprise and partner services revenue decreased 9% on a strong prior year comparable for enterprise support services. Segment gross margin dollars increased 20% and gross margin percentage decreased slightly year-over-year. Excluding the impact of the change in accounting estimate [indiscernible] percentage increased slightly, primarily driven by the improvement in Azure noted earlier, even with the impact of scaling our AI infrastructure, partially offset by sales mix shift to Azure. Operating expenses increased 1% and operating income grew 32%. Now to More Personal Computing. Revenue was $15.6 billion, increasing 17% with 15 points of net impact from the Activision acquisition. Results were above expectations, driven by better-than-expected performance in gaming and Windows OEM. Windows OEM revenue increased 11% year-over-year, ahead of expectations, primarily driven by the slightly better PC market noted earlier as well as mix shift to higher monetizing markets. Windows commercial products and cloud services revenue increased 13% and 12% in constant currency, below expectations with impact from the growth trends in new stand-alone business noted earlier as well as lower in-period revenue recognition from a mix of contracts. Devices revenue decreased 17% and 16% in constant currency as we remain focused on our higher-margin premium products. Overall, Surface demand was slightly lower than expected. Search and News advertising revenue ex TAC increased 12% ahead of expectations with continued volume growth and increased engagement on Bing and Edge. And in gaming. Revenue increased 51% and 50% in constant currency with 55 points of net impact from the Activision acquisition. Results were ahead of expectations, primarily driven by Call of Duty. Xbox content and services revenue increased 62% and 61% in constant currency with 61 points of net impact from the Activision acquisition. Xbox hardware revenue decreased 31% and 30% in constant currency. Segment gross margin dollars increased 27% and 26% in constant currency, with 13 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 4 points year-over-year, primarily driven by sales mix shift to higher-margin businesses. Operating expenses increased 41% with 43 points from the Activision acquisition. Operating income increased 16% and 15% in constant currency. Now back to total company results. Capital expenditures, including finance leases, were $14 billion to support our cloud demand, inclusive of the need to scale our AI infrastructure. Cash paid for PP&E was $11 billion. Cash flow from operations was $31.9 billion, up 31%, driven by strong cloud billings and collections. Free cash flow was $21 billion, up 18% year-over-year, reflecting higher capital expenditures to support our cloud and AI offerings. This quarter, other income and expense was negative $854 million, lower than anticipated, driven by losses on investments accounted for under the equity method. Our effective tax rate was approximately 18%. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases. Now moving to our Q4 outlook, which unless specifically noted otherwise, is on a U.S. dollar basis. First, FX. Based on current rates, which reflect the recent strengthening of the U.S. dollar, we now expect FX to decrease total revenue and segment level revenue growth by less than 1 point. When compared to our January guide for Q4, FX, this is a decrease to total revenue of roughly $700 million. We expect FX to decrease COGS growth by approximately 1 point and operating expense growth by less than 1 point. In commercial bookings, we expect solid growth on a relatively flat expiry base driven by continued strong commercial sales execution. As a reminder, larger, long-term Azure contracts, which are more unpredictable in their timing, can drive increased quarterly volatility in our bookings growth rate. Microsoft Cloud gross margin percentage should decrease roughly 2 points year-over-year. Excluding the impact from the change in accounting estimate, Q4 cloud gross margin percentage will be down slightly as improvement in Azure, inclusive of scaling our AI infrastructure will be offset by sales mix shift to Azure. We expect capital expenditures to increase materially on a sequential basis driven by cloud and AI infrastructure investments. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-outs and the timing of finance leases. We continue to bring capacity online as we scale our AI investments with growing demand. Currently, near-term AI demand is a bit higher than our available capacity. Next, to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 9% and 11% in constant currency or US$19.9 billion to US$20.2 billion. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth primarily through E5. We expect Office 365 revenue growth to be approximately 14% in constant currency. We continue to progress with adoption of CoPilot for Microsoft 365 and remain excited for the long-term growth opportunity. In our on-premises business, we expect revenue to decline in the mid to high teens. In Office Consumer, we expect revenue growth in the low to mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the mid to high single digits driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the low to mid-teens, driven by Dynamics 365. For both LinkedIn and Dynamics, the continued bookings growth moderation noted earlier is a headwind to Q4 revenue growth. For Intelligent Cloud, we expect revenue to grow between 19% and 20% in constant currency or US$28.4 billion to US$28.7 billion. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and in-period revenue recognition depending on the mix of contracts. In Azure, we expect Q4 revenue growth to be 30% to 31% in constant currency or similar to our stronger-than-expected Q3 results. Growth will be driven by our Azure Consumption business and continued contribution from AI with some impact from the AI capacity availability noted earlier. Our per-user business should see benefit from Microsoft 365 suite momentum. Though we expect continued moderation in seat growth rates given the size of the installed base. In our on-premises server business, we expect revenue growth in the low to mid-single digits with continued hybrid demand, including licenses running in multi-cloud environments. And in Enterprise and Partner Services revenue should decline in the mid- to high single digits on a high prior year comparable for enterprise support services. In More Personal Computing, we expect revenue to grow between 10% and 13% in constant currency or US$15.2 billion to US$15.6 billion. Windows OEM revenue growth should be in the low to mid-single digits as PC market unit volumes continue at pre-pandemic levels. In Windows Commercial Products and Cloud Services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the mid-single digits. As a reminder, our quarterly revenue growth can have variability primarily from in-period revenue recognition depending on the mix of contracts. In Devices, revenue should decline in the mid-teens as we continue to focus on our higher-margin premium products. Search and news advertising ex TAC revenue growth should be in the low to mid-teens, driven by continued volume strength. This will be higher than overall search and news advertising revenue growth, which we expect to be relatively flat. And in Gaming, we expect revenue growth in the low to mid-40s, including approximately 50 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the high 50s driven by approximately 60 points of net impact from the Activision acquisition. Hardware revenue will decline again year-over-year. Now back to company guidance. We expect COGS between US$19.6 billion to US$19.8 billion, including approximately $700 million from purchase accounting, integration and transaction-related costs from the Activision acquisition. We expect operating expense of US$17.15 billion to US$17.25 billion, including approximately $300 million from purchase accounting, integration and transaction-related costs from the Activision acquisition. Therefore, we now expect full year FY2024 operating margins to be up over 2 points year-over-year, even with our cloud and AI investments, the impact from the Activision acquisition and the headwind from the change in useful lives last year. This operating margin expansion reflects the hard work across every team to drive efficiencies and maintain disciplined cost management, knowing we will continue to grow our cloud and AI investments next year. Other income and expense should be roughly negative $850 million as interest income will be more than offset by interest expense and losses on investments accounted for under the equity method. As a reminder, we are required to recognize gains or losses on our equity investments which can increase quarterly volatility. We expect our Q4 effective tax rate to be approximately 18%. Now I’d like to share some closing thoughts as we look to the next fiscal year. We continue to focus on building businesses that create meaningful value for our customers and therefore, significant growth opportunities for years to come. In FY2025, that focus on execution should again lead to double-digit revenue and operating income growth to scale to meet the growing demand signal for our cloud and AI products, we expect FY2025 capital expenditures to be higher than FY2024. These expenditures over the course of the next year are dependent on demand signals and adoption of our services. So we will manage that signal through the year. We will also continue to prioritize operating leverage. And therefore, we expect FY2025 operating margins to be down only about 1 point year-over-year, even with our significant cloud and AI investments, as well as a full year of impact from the Activision acquisition. We are leading the AI platform wave and are committed to bringing that value to our global customers as we enter the final quarter of our fiscal year. With that, let’s go to Q&A, Brett.
Brett Iversen: Thanks, Amy. We’ll now move over to Q&A. Out of respect for others on the call, we request that participants please only ask one question. Operator, can you please repeat your instructions?
Operator: [Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.
Keith Weiss: Thank you, guys for taking the question and congratulations on a fantastic quarter. A lot of excitement in the marketplace around generative AI and the potential of these technologies, but there’s also a lot of investment going on behind them. It looks like Microsoft is on track to ramp CapEx over 50% year-on-year this year to over $50 billion. And there’s media speculation of more spending ahead with some reports talking about like $100 billion data center. So obviously, investments are coming well ahead of the revenue contribution. But what I was hoping for is that you could give us some color on how use as the management team, try to quantify the potential opportunities that underlie these investments because they are getting very big. And maybe if you could give us some hint on whether there's any truth to the potential of like $100 billion data center out there? Thank you so much.
Satya Nadella: Thank you, Keith for the question, let me start and then Amy, you can add. At a high level, the way we, as a management team, talk about it is there are two sides to this, right? There is training and their inference. Given that we want to be a leader in this big generational shift and paradigm shift in technology, that's on the training side. We want to be able to allocate the capital required to essentially be training these large foundation models and stay on the leadership position there. And we've done that successfully all the way today, and you've seen it flow through our P&L, and you can continue to see that going forward. Then Amy referenced what we also do on the inference side, which is, one, we first innovate and build products. And of course, we have an infrastructure business that's also dependent on a lot of ISVs building products that run on our infrastructure. And it's all going to be demand driven. In other words, we track – we're closely what's happening with inference demand, and that's something that we will manage, as Amy said in her remarks very, very closely. So we feel – and obviously, we've been doing this, quite frankly, Keith, for now multiple years. So this is not the quarter. I realize in the news, it's a lot more in the quarter nowadays. But if you look at it, we have been doing what is essentially capital allocation to be a leader in AI for multiple years now, and we plan to sort of essentially keep taking that forward.
Amy Hood: And Keith, I do think it's important to really think about our planning cycles and we do talk about spending sequentially higher. And we look forward to being able to continue to build out the infrastructure needed to meet the demand. Another thing that you’ve really asked in the beginning was the opportunity and the size of that. And I think in some ways, it's important to think about every business process that can be impacted and the opportunity that's represented by every business process. And so when you think of it that way, I think the opportunity is significant. The opportunity to power that next wave of “cloud infrastructure” is important. It's important because we've been the leader for this decade of the cloud transition, and it's important for us to confidently invest to do that in the second wave, building on our success in the first. And I think that's really the best way to think about how we'll spend is the same way we approached it for a decade. Watch the signal, invest to be a leader in the technical foundation and then execute consistently to add value to customers. The opportunity is represented by the amount of value we add and I look forward to being able to continue to deliver that.
Keith Weiss: Excellent. Thank you so much.
Brett Iversen: Thanks, Keith. Operator, next question please.
Operator: The next question comes from the line of Brent Thill with Jefferies. Please proceed.
Brent Thill: Satya, how would you characterize the demand environment? On one hand, you have bookings in Azure both accelerating year-over-year in the quarter, but we're seeing a lot of future concern hesitation from other vendors we all cover. So, I think everyone love to get your sense of budget health for customers this year.
Satya Nadella: Great question, Brent. There are a couple of things I’d say. On the Azure side, which I think is what you specifically asked, we feel very good about the – we are fundamentally a share taker there because if you look at it from our perspective at this point, Azure has become a protocol for pretty much anybody who is doing an AI project. And so that's sort of been a significant help for us in terms of acquiring even new customers. Some of the logos I even referenced in my remarks, our new Azure customers. So, that's one. The second thing that we're also seeing is AI just doesn't sit on its own. So, AI projects obviously start with calls to AI models, but they also use a vector database. In fact, Azure Search, which is really used by even ChatGPT is one of the fastest-growing services for us. We have Fabric integration to Azure AI. And so, Cosmos DB integration. So, the data tier, the dev tools is another place where we are seeing great traction. So, we are seeing adjacent services in Azure that get attached to AI. And lastly, I would say, migrations to Azure as well. So, this is not just all an AI story. We are also looking at customers, I mean, this is something that we have talked about in the past, which is there's always an optimization cycle, but there's also – as people optimize, they spend money on new project starts, which will grow and then they'll optimize. So, it's a continuous side of it. So, these are the three trends that are playing out on Azure in terms of what at least we see on demand side.
Brent Thill: Thank you.
Brett Iversen: Thanks, Brent. Operator, next question please.
Operator: And the next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.
Mark Moerdler: Thank you very much for taking my question and congratulates on the quarter and the guidance. I want to follow up on the AI, obviously. We’re seeing companies shifting their IT spending to invest in and learn about AI rather than receiving additional budgets for AI. At some point, for AI to be transformative, as everyone expects, it needs to be accretive to spending. Satya, when do you believe AI will hit the maturity level, will be net increase to IT or outside of IT spending? And what would be the leading indicators of that maturation? And Amy, am I characterizing this correctly as it relates to Azure? Some projects are being delayed so that, that spending could be shifted from core Azure toward Azure AI? Thank you.
Satya Nadella: Yes. Great set of questions, Mark. Let me just start by saying, a good place to start is to watch what’s happening in terms of standard issues for software teams, right? I mean if you think about it, they bought tools in the past. Now, you basically buy tools plus Copilot, right? So, you could even say that this is characterized as perhaps shift of what is OpEx dollars into effectively tool spend because it gives operating leverage to all of the OpEx dollars you’re spending today, right? That’s really a good example of, I think, what’s going to happen across the board. We see that in customer service. We see that in sales. We see that in marketing. Anywhere, there’s operations. That’s why I described it as knowledge turns. You can even think of it as lean for knowledge work, right, because it just reduces waste, increases speed, and customer value. And so, one of the interesting rate limiters here is culture change inside of organizations. When I say culture change that means process change. And Amy referenced this even in her answer to the first question because at the end of the day companies will have to take a process, simplify the process, automate the process, and apply these solutions. And so that requires not just technology, but in fact, companies to go do the hard work of culturally changing how they adopt technology to drive that operating leverage. And this is where we are going to see firm-level performance differences. So, one of the things we see is any customer who is working closely with us deploying it internally at Microsoft we see it, right. We’re also taking our own medicine to apply this across every process. And we know that this is not just about technology, it’s about being able to have the methodology that goes with it. And so, we see it in software development. We see it in customer service. We’re seeing it even in the horizontal use of Copilot today where every day people are discovering new workflows that they can optimize. And so, that’s like the PC when it became standard issue in early 1990s. That’s the closest analogy I can come up with. And so, yes, it will take time for it to percolate through the economy, but this is faster diffusion, faster rate of adoption than anything we have seen in the past, as evidenced even by Copilot, right. It’s faster than any suite we have sold in the past, but it is going to require workflow and process change.
Amy Hood: And Mark, maybe to answer your question on, are we seeing project starts transition from maybe the – something that was core consumption to an AI project? In our results, that’s not what we saw. We saw more what Satya was speaking to earlier, which is, you see maybe growth in migrations again. You’re seeing work in the data space, again, and you’re seeing AI project starts. And I think that’s why maybe you see our growth be different, of course, than you see IT budget spend. It’s because it’s a share, I think, improvement plus also really focusing on what Satya said, it’s about spending maybe in other areas that we don’t traditionally think of as being in the IT budget spend under a CIO. It’s spend being done by the Head of Customer Service, it’s spend being done by the Head of Marketing. And I do think that will be important as we think about the opportunity ahead.
Mark Moerdler: Incredibly helpful. Thank you both.
Brett Iversen: Thanks, Mark. Operator, next question please.
Operator: The next question comes from the line of Karl Keirstead with UBS. Please proceed.
Karl Keirstead: Thank you. And Satya and Amy, congrats on these outstanding Azure results. I’d love to hone in a little bit on the seven-point lift to Azure growth from AI, outstanding number, but it’s leveling off a little bit from six points in December. I’m wondering if you could unpack that a little bit. To what extent did the capacity issues that you Amy highlighted on the call, impact that number? Is there any seasonality? I wouldn’t think so or any other factor that can swing around that number that you’d advise us to keep in mind? Thanks so much.
Amy Hood: Thanks, Karl. There’s not a seasonality to the numbers. So, you’re absolutely right to start there, and it’s a good question. The way to think about it is a bit more by – it is how much capacity we have in play and how much capacity that we have to sell on the inferencing side, in particular. And so, that is partially why you see the capital investment in the shape that is, is because right this minute, we do have demand that exceeds our supply by a bit. So, it is fair to say that, that could have been an impact on the number for the quarter and it does impact a little bit the number in Q4.
Karl Keirstead: Okay. Helpful. Thank you.
Brett Iversen: Thanks, Karl. Operator, next question please.
Operator: And the next question comes from the line of Raimo Lenschow with Barclays. Please proceed.
Raimo Lenschow: Thank you. I have more conceptual question for Satya. If you think about Copilots and what you're doing there, you're kind of impacting a lot of this in businesses and the opportunities seem very broad-based. How do you think this will play out in the industry between you guys offering certain Copilots versus like the rest of the industry following and everyone seems to have a Copilot now and seems to be talking about it. How does that impact what do you want to do, your partner strategy going forward? Thank you.
Satya Nadella: Yes, it's a great question. So the way we see it play out is, if you think about it, the way Office was used broadly for knowledge work was in the context of business processes, right? So it's not like – when people do knowledge work, they're not doing knowledge work, they're doing knowledge work and support of making progress in the context of sales enablement, customer service, revenue ops, supply chain or what have you, right? So that's the first thing to note. And they do it inside of e-mail. They do it inside of Teams. They do it inside of Excel, PowerPoint, Word and what have you. Now we have the ability to essentially bridge the work and the work artifacts inside of these knowledge worker tools with the workflow and the business process and the business process data. So when we think about our Copilot, our Copilot has that ability to integrate, whether it's with ServiceNow, it has the ability to integrate with SAP with Salesforce, with obviously Dynamics. That's what we are seeing. In fact, you'll hear us talk a lot about it at our developer conference, which is the extensibility and Copilot Studio is really off to the races in terms of the product that most people are excited because one of the things in the enterprise if you want to ground your Copilot with enterprise data, which is in all of these SaaS applications and Copilot Studio is the tool to use it, to make that happen. And so that's what we are seeing, which is we are building a Copilot, which also happens to be an orchestrator of all in other Copilots, which to us appear as extensions. And net-net, what happens is some of these knowledge worker tools that people have used all the time, right? Because when you think about Teams, when you're having a meeting, you're not doing a random meeting, the meeting is in the context of some business process. It could be a supply chain meeting where you're trying to understand which suppliers to bet on or what terms to do. And so now you can access all that data right in the Team's context. So that's I think what's exciting for us, having built all these horizontal tools, which I would say we're under underappreciated for the amount of work. How people use those tools to make progress on business process, but we now get to bridge that between the business applications and knowledge worker tools, tomorrow horizontally.
Raimo Lenschow: Okay. Perfect. Thank you.
Brett Iversen: Thanks Raimo. Operator, next question please.
Operator: And the next question comes from the line of Michael Turrin with Wells Fargo. Please proceed.
Michael Turrin: Hey. Great. Appreciate you taking the question. I wanted to go back to Azure. You've been hinting at stabilization there for the past couple of quarters, but still very good to see the balance. Maybe you can expand on just what the commercial bookings number, appreciating the variability there does in terms of visibility. And any characterization you can give us around what you're seeing in areas like cost optimization and core workload growth coming back is just helpful context for us in unpacking the numbers. Thank you.
Amy Hood: Thanks, Michael. I may take those a bit in reverse. It's a little easier to address them. When you think about – we've been talking about sort of stabilization and what you saw this quarter, if you break down the Azure number as you saw, which I think I talked a little bit about with Karl was 7 points of contribution from AI, and you could call them the difference '24 from our core really Azure business. And within that, the activity we saw and the consumption side was really this balance that we were quite used to and have seen throughout the cloud transition. We saw new workload starts and we saw optimizations. And then those optimizations create new budget, and you apply it. And that cycle which is actually quite normal. We saw it again this quarter in a balanced way. And I think when we talk about stabilization or even what we saw between Q2 and Q3, which is a bit of acceleration in that core, was a lot of the newer project starts relating back to not just AI starts, but lots of other workflows. The companies are still going from on-prem to cloud, Satya mentioned migrations. And some of that, which I know isn't as exciting as talking about all the AI projects. This is still really foundational work to allow companies to take advantage of the cost savings and the total TCO is still really good. And so I think that balance is really what you saw this quarter, and I do feel like there wasn't really a big difference, Michael, across industries or across geos. So I would say it was actually pretty consistent is the other maybe texture that I could give you to that question. And so then when you're saying do we keep sort of pointing to stabilization, I really do look sort of workload to workload. What are we seeing? Where it starts? And this one actually felt quite balanced and optimization looks like they normally would, which by the way, is super important. It's something we encourage customers to do. You want to run your workloads as efficiently as you possibly can. It's critical to customers being able to grow and get value out of that. So I sometimes think we – you all may ask the question more as a negative. And for us, it's just about a healthy cycle at the customer account level.
Michael Turrin: Consistent core cloud growth is still pretty exciting to us as well. Thank you.
Amy Hood: Thank you.
Brett Iversen: Thanks, Michael. Operator, next question please?
Operator: The next question comes from the line of Kirk Materne with Evercore ISI. Please proceed.
Kirk Materne: Yes. Thanks for taking the question. I'll add my congrats in the quarter. Hey Satya, I was wondering if you could chime in on a discussion that comes up a lot with investors, which is, is there a sort of data quality problem in the market in terms of being able to take advantage of all these new GenAI capabilities? And I was just curious, if you could comment on, do you see companies making inroads on sort of addressing that? And do you see that as sort of an inhibitor to AI growth at all at this point? Thanks.
Satya Nadella: Yes, it's a great question because there are two sets of things in order to make sense for successful deployment of these new AI capabilities. I mean if you sort of say this, what is this AI, it does two things, right? There's a new user experience, there is a natural language interface and second thing is it's the reasoning engine. And the reasoning engine requires good data, and it's good requires, good data for grounding, right? So people talk about something called retrieval augmented generation. And in that context, having good grounding data that then help with the reasoning, I think, is helpful. And then, of course, people are also looking to sort of fine-tune or RLHF or essentially take the large model and ground it further. So all of these tools are now available, the sophistication of how to people can deploy these models across various business processes where there is data and where there is tuning of these models is also getting more widespread, even at system integrators and other developers are there to help enterprises. So all that's maturing. So we feel good. And this is what I think on the commercial side, these are some of the harder problems to solve broad consumer, right? I mean I think this is a couple of orders of magnitude of improvements in, I'll call it, our models before we can sort of have more sophisticated open-ended consumer scenarios. Whereas in the enterprise, these are all things we can go tackle. Again, I point to get up, if you think about how it's got an entire system, right? It's just not an AI model. It's the, AI – the user experience, scaffolding, the editor, the chat, then interpreter and the debugger work along with the continuations of the model to help essentially create these reasoning traces, which help the entire thing work. And effectively, what we are doing with Copilot, Copilot Studio and connectors to all these business systems, think of it as we are creating GitHub Copilot like scenarios for every business system. That's what I think is going to have both what Amy referenced is business value and better grounding. But you're absolutely right in saying a lot of work we're doing with Fabric or Cosmos or PostgreSQL is about preparing that data so that it can be integrated with these AI projects.
Kirk Materne: Thank you.
Brett Iversen: Thanks, Kirk. Operator, we have time for one last question.
Operator: Our last question will come from the line of Alex Zukin with Wolfe Research. Please proceed.
Alex Zukin: Hey guys. Thanks for taking the question. I wanted to ask the AI question but from a Microsoft 365 Copilot perspective. I think you talked a little bit about starting to see some of those impacts positively in the quarter on the office business. I wanted to ask more broadly around that capacity constraint that you alluded to in your prepared remarks, Amy. And kind of how does the easing – how tied are we like as you invest for that CapEx and bring more of the capacity online. How much does that unlock or unlock the ability to deliver both a higher Azure AI number as well as a higher Microsoft 365 Copilot number.
Amy Hood: Thanks for the question. It's a good opportunity to clarify. And I would not say that there is a capacity constraint on the Copilots. It's a real priority for us to make sure we optimize the allocation of our capacity to make sure that those per user businesses are able to continue to grow. And so think about that as our priority one. And so then what that does mean is capacity constraints when we have them, you'll tend to see them on the Azure infrastructure side, the consumption side of the business is a better way of thinking about it
Alex Zukin: Perfect. Thank you.
Brett Iversen: Thanks, Alex. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today, and we look forward to speaking with all of you soon.
Satya Nadella: Thank you all.
Amy Hood: Thank you.
Operator: This concludes today's conference. You may now disconnect your lines at this time. Enjoy the rest of your day. |
CMCSA | 1 | 2,024 | 2024-04-25 00:00:00 | Operator: Good morning, ladies and gentlemen, and welcome to Comcast's First Quarter Earnings Conference Call. [Operator Instructions] Please note this conference call is being recorded. I'll now turn the call over to Executive Vice President, Investor Relations, Ms. Marci Ryvicker. Please go ahead, Ms. Ryvicker.
Marci Ryvicker: Thank you, operator, and welcome, everyone. Joining us on today's call are Brian Roberts, Mike Cavanagh, Jason Armstrong and Dave Watson. I will now refer you to Slide 2 of the presentation accompanying this call, which can also be found on our Investor Relations website and which contains our safe harbor disclaimer.
This conference call may include forward-looking statements subject to certain risks and uncertainties. In addition, during this call, we will refer to certain non-GAAP financial measures. Please see our 8-K and trending schedule issued earlier this morning, for the reconciliations of these non-GAAP financial measures to GAAP. With that, I'll turn the call over to Mike.
Michael Cavanagh: Thanks, Marci, and good morning, everyone. Across the company, our team is managing extremely well in a highly competitive and evolving marketplace. We have a clear vision for how we are going to compete now and into the future, combined with a sharp focus on execution. Equally important, our disciplined capital allocation strategy, coupled with our strong balance sheet, puts us in an enviable position relative to our peers to invest organically and aggressively in our 6 scaled and diverse growth businesses namely: Residential Broadband, Wireless, Business Services, Theme Parks, Studios and Streaming. These businesses comprise more than 55% of the company's total revenue today, and that proportion will only grow over time.
In the first quarter, these businesses generated a high single-digit increase in revenue on a trailing 12-month basis. And when combined with our substantial share repurchase activity, enabled us to deliver double-digit adjusted EPS growth as well as significant growth in free cash flow per share. In fact, since 2018, we grew adjusted EPS over 50% and free cash flow per share nearly 25%.
Now for some of the highlights of the first quarter, I'll start with Broadband. The broadband market remains extremely competitive, particularly within the market for more price-conscious consumers. We continue to be intensely focused on segmentation, providing customers with options that meet both their lifestyle and budget. Importantly, we are striking the right balance between ARPU and subscribers, which is clearly reflected in our first quarter results, where despite modest subscriber losses, ARPU grew over 4%, driving mid-single-digit growth in residential broadband revenue to over $6.5 billion.
We continue to see extremely encouraging broadband consumption trends across our base of 32 million customers. Usage on our network rose double digits year-over-year with broadband-only households consuming over 700 gigabytes of data each month, and our broadband customers continue to value faster speeds. Today, over 70% of our residential subscribers receive speeds of 500 megabits per second or higher and around 1/3 are getting a gig or more.
We believe that consumers' expectations for their broadband experience in terms of speed, reliability, security and performance will only increase over time. It is extremely important to us that our network upgrades stay well ahead of this demand, our deployment of mid splits doubled year-over-year and now reach 40% of the footprint. The investments we are making to increase capacity and incorporate multi-gigabit symmetrical speeds everywhere we offer service put us in a great position to capitalize on these very favorable consumer trends. And when combined with our rapid footprint expansion, set us up to gain market share and return to broadband subscriber growth over time.
Turning to wireless. We increased our domestic customer lines by 21% year-over-year to nearly $7 million, yet with wireless penetration of our residential broadband customer base still only 11%, we have plenty of room to grow. We continue to see the benefit of bundling broadband and mobile, which decreases churn and improves customer lifetime value. Our customers also benefit by being connected to our WiFi network, which is the largest in the nation. In fact, 90% of all Xfinity Mobile traffic is delivered over WiFi, not cellular, and we are constantly adding new features to further differentiate the experience. The most recent example is our introduction of WiFi Boost, which enables any Xfinity Mobile customer to experience speeds of up to 1 gig whenever they connect to our 23 million hotspots at no additional cost.
Across our Connectivity & Platforms business, we're focused on profitably serving each segment of the market from our premium and traditional customers who want fully featured products to more price-driven consumers. With regard to the latter, we are introducing NOW, a new brand and product portfolio targeting the prepaid market that delivers high-quality, low-cost Internet, mobile and streaming TV products with simple all-in pricing.
NOW Internet and mobile will be particularly helpful to those Americans impacted by the end of ACP, bringing them another option for affordable, reliable connectivity and supplementing our Internet Essentials program, which we offer to eligible households as part of our long-standing commitment to help close the digital divide in America.
Turning to Content & Experiences. Let's start with parks. We continue to see strong underlying demand in both Hollywood and Japan, where healthy attendance and per cap levels were once again driven by the success of Super Nintendo World. Building on our momentum, later this year, we're opening our newest Nintendo-themed land, Donkey Kong Country, which will increase the size of Super Nintendo World in Japan by 70%.
Switching gears to Orlando. We started to feel some pressure on attendance levels late in the first quarter, which tends to occur in tandem with the ebbs and flows of new attractions in the market. Right now, we happen to be lapping the multiyear surge in attendance from our opening of new attractions in prior periods, but we remain confident about our longer-term growth opportunities, especially as we look ahead to next year with the opening of Epic Universe. With 3 new hotels and 5 immersive worlds featuring more than 50 attractions, entertainment, dining and shopping experiences, it will be the most technologically advanced park in the world. Together with our 3 current gates in Orlando, Epic will enable us to offer a full week's vacation experience to even more guests.
Moving to Studios. We're incredibly proud of our film team and our recent ranking as the #1 global studio by worldwide box office and winner of Academy Awards, including Best Picture for Christopher Nolan's Oppenheimer. On the back of our fantastic performance in 2023, the power of our studios continued this quarter with the theatrical release of Kung Fu Panda 4, which has grossed over $480 million in worldwide box office to date. And we have an exciting slate still ahead. For the third year in a row, we'll release more movies than any other major studio with The Fall Guy, an action thriller starring Ryan Gosling and Emily Blunt coming this May; Despicable Me 4, Illumination's newest installment of this highest grossing animated franchise as well as our adaptation of Twisters, both debuting in July; and Wicked, one of the most highly anticipated movies of 2024 coming in November.
Finally in media. We are successfully managing the segment as one business across linear and streaming, by providing the tens of millions of traditional pay TV subscribers as well as streamers with choice in how they engage with us, we continue to generate significant audience for our programming. Big events like the Olympics, Sunday Night Football, Big Ten; top entertainment shows like Saturday Night Live and Law & Order, with strong consumer demand for our content, we're well positioned to evolve with the changing market.
Our exclusively streamed NFL Wild Card game was a big success this past quarter. We added and then retained even more new Peacock subscribers than we expected. Overall, people are staying with us to engage in a broad range of content, spending 90% of their time on the platform viewing nonsports programming. This includes scripted shows like Ted and reality shows like The Traitors, both of which ranked within Nielsen's streaming top 10. And our award-winning collection of films like Oppenheimer, which premiered exclusively on Peacock in February and was the most watched film across all streaming in its first 7 days on the platform.
Clearly, Peacock has been on a great trajectory since our launch 4 years ago, where 34 million paid subscribers having grown 12 million year-over-year and at a $10 ARPU. Looking ahead, our content offering provides such a great value proposition that we should have some real pricing power over time.
Of course, sports also play an important role in our media business, and that's especially true this year. Following the Kentucky Derby in May, we'll have the Paris Olympics for 17 nights this summer. With more programming hours on the NBC Broadcast Network than any previous Olympics and over 5,000 hours of live coverage on Peacock, the games are on track to generate the most advertising revenue in history with $1.2 billion in ad sales commitments.
Right after the Olympics, we have the return of football with Big Ten, Sunday Night Football and the NFL's first-ever Friday night opening game from São Paulo, streaming exclusively on Peacock.
So wrapping up, I'm really proud of the work that our teams across the company are doing. Together, we're executing at the highest level and positioning ourselves for growth in a challenging and dynamic marketplace. So Jason, over to you.
Jason Armstrong: Thanks, Mike, and good morning, everyone. I'll start with our consolidated results on Slide 4. Total revenue increased 1% to $30.1 billion. And within this, our 6 major growth drivers generated nearly $17 billion in revenue, well over half of total company revenue and once again have shown steady and consistent growth at a high single-digit rate over the past 12 months.
While EBITDA was in line with prior year's level at $9.4 billion, we generated a high level of free cash flow this quarter at $4.5 billion, and we returned $3.6 billion of capital to shareholders, including $2.4 billion in share repurchases. And over the last 12 months, we have reduced our share count by nearly 6%, contributing to our adjusted EPS growth in the quarter of 14%.
Now let's go through our business results, starting on Slide 5 with Connectivity & Platforms. Note that our largest foreign exchange exposure is to the British pound, which was up 4% year-over-year. So as usual, in order to highlight the underlying performance of the Connectivity & Platforms business, I will refer to year-over-year growth on a constant currency basis.
Revenue for total Connectivity & Platforms was flat at $20.3 billion, reflecting strong growth in connectivity revenues, offset mainly by declines in video revenue. Residential Connectivity revenue grew 7%, driven by 4% growth in domestic broadband, 13% growth in domestic wireless and 19% growth in international connectivity, while Business Services Connectivity revenue grew 5%.
In domestic broadband, our revenue growth was driven by very strong ARPU, which increased 4.2% and came in a bit above our historical range. Our team is doing an excellent job of customer segmentation while balancing rate and volume. And we are encouraged by the positive consumer behavior trends we see in our base of 32 million customers.
Bandwidth requirements and engagement are increasing at a rapid clip while the vast majority of our customers are now on speeds of 500 megabits or higher, and adopting advanced tier as a service like xFi complete at a higher rate. But as Mike mentioned, it continues to be a very competitive environment. And we lost 65,000 subscribers in the first quarter, following a loss of 34,000 subscribers in the fourth quarter of 2023.
As we sit here right now, we do not see this trend improving in the near term. We expect churn could be elevated given the end of ACP, which is only fully funded through April and partially funded through May. We remain in constant communication with our ACP customers and we'll continue to be diligent in helping this customer segment stay connected through various options. Whether that's our successful Internet Essentials program or our new prepaid NOW offerings, as Mike described.
In addition, I want to remind you that the second quarter also tends to experience seasonal headwinds. While it's a competitive market, especially for the price-driven segment, we will continue to compete aggressively, yet in a financially balanced way and expect to drive healthy broadband revenue growth through growth in ARPU, which we expect to remain well within our historical range of 3% to 4% growth even as we manage through the ACP transition.
Turning to domestic wireless. Revenue growth of 13% was due to higher service revenue, driven by a 21% year-over-year increase in our customer lines, ending the quarter at $6.9 million in total, including the 289,000 lines we just added in the quarter. We are consistently in the marketplace testing new offers, including some recent pricing plans targeted at multiline customers, the new NOW Mobile product as well as our Buy 1, Get 1 line offer.
We continue to see significant opportunity in wireless to increase the penetration of our domestic residential broadband customer base, which currently sits at 11% and to sell additional lines per account. International connectivity revenue reflects strong growth in broadband revenue, driven by solid ARPU growth as well as growth in wireless due to additional customer lines and also higher ARPU.
For business services connectivity, we generated 5% revenue growth driven by higher ARPU in small business and broader growth in both customers and additional solutions for mid-market and enterprise. The SMB market has gotten more competitive but will aggressively defend our position. And similar to this quarter, we'll grow revenue by increasing ARPU, driven by higher adoption of additional products like Mobile, Security Edge, Connection Pro and WiFi Pro and through targeted rate opportunities.
Meanwhile, our momentum continues to build in mid-market and enterprise as our expanding capabilities in managed services, wide area networking and cybersecurity have led to increasing customer wins and the expansion of existing relationships.
The strong growth in our Connectivity businesses was offset by a decline in video and other revenue. The decline in our video revenue was driven by continued customer losses and slower domestic ARPU growth versus last year, and the lower Other revenue reflects continued customer losses in wireline voice. As I mentioned earlier, Connectivity & Platforms total EBITDA increased 1.3% with margin of 50 basis points, reflecting a decline in overall expenses driven by the mix shift to our high-margin connectivity businesses, combined with a continued focus on expense management.
While margins for our domestic legacy cable business improved even more, our international business was impacted by a reclassification of some expense from capitalized software to operating expenses, creating a tough comparison to last year. We will see a similar trend until we start to lap this change at the end of this year.
I'll note that absent this change, EBITDA growth in the first quarter would have been about 1 point higher, and our margin improvement would have been about 50 basis points higher. While this change increased our operating expenses this quarter, there was an offsetting decline in Connectivity & Platforms capital, resulting in a neutral impact on net cash flow, which was up 5% this quarter.
Breaking out our Connectivity & Platforms EBITDA results further. Residential EBITDA grew 1.1% with margins improving 60 basis points to 38.3%. And Business Services EBITDA growth was lower than our typical mid-single-digit level at 2.6% with margins declining 160 basis points to 56.7%. These results include significant investments in the enterprise space, including in sales and fulfillment that we are making to drive future revenue growth. Business Services generates well over $5 billion in annual EBITDA, which is margin accretive, and we expect it to continue to be a material contributor to overall connectivity and platforms growth this year and over the longer term.
Now let's turn to Content & Experiences on Slide 6. Overall, revenue increased 1% to $10.4 billion and EBITDA decreased 7% to $1.5 billion. Let's take a closer look at the details. Starting with Theme Parks. Revenue increased 2%, while EBITDA decreased 4% for the quarter. These results reflect the negative impact of currency as the Japanese yen is at a 34-year low against the dollar.
Adjusting the results to exclude the impact of foreign currency, Parks' revenue would have increased 5% and EBITDA would have been flat compared to last year's first quarter. We had strong underlying growth at our park in Osaka, which continues to benefit from demand for Super Nintendo World. We're also seeing growth in Hollywood despite lapping the opening of Super Nintendo World in that park during the quarter.
Beijing results were relatively flat in what is typically a seasonally light quarter, and Orlando results were below last year, but still roughly in line with pre-pandemic levels. We are seeing some pullback from the unprecedented attendance we realized immediately after the pandemic, which we believe is driven by the timing of new attraction openings and some increased competition from other entertainment venues, notably cruises.
At Media, which includes our TV Networks and Peacock, revenue increased 4% as Peacock's strong growth of 54% more than offset a low single-digit decline at our linear networks. Distribution revenue growth of 7% was driven by Peacock with subscription revenue growth of 68%, powered by the 55% year-over-year increase in our paid subscriber base to 34 million including 3 million net adds in the first quarter.
We are really pleased with Peacock's trajectory. We started the year with an incredibly successful NFL Wild Card game, which resulted in a nice lift to paid subs. But even more important was how our broad content offering enabled strong consumer acquisition, retention and engagement. We've had success across a broad range of content during the quarter, including films moving into our Pay-One window like Oppenheimer, the most watched Pay-One film in Peacock's history; and The Holdovers, as well as successful originals, including Apples Never Fall, Ted and the second season of The Traitors.
Looking ahead, we'll continue to be focused on retention, particularly in the second quarter as we look forward to the second half of the year, we will have a substantial amount of acquisition-oriented content lined up. This is consistent with Peacock's historical trends, and this year is expected to be driven by the Olympics this summer and the NFL and Big Ten returning in the fall, in addition to the steady stream of films landing in our Pay-One window as well as upcoming originals.
Finally, domestic advertising revenue was flat in the quarter, reflecting a stable overall market with strong advertising growth at Peacock, offset by lower advertising revenue at our linear networks. Media EBITDA decreased 6%, reflecting the revenue pressure on our linear networks, partially offset by continued year-over-year improvement in Peacock EBITDA losses even with the addition of the wildcard rights costs. And we expect to see, on average, even better year-over-year improvement for Peacock in the coming quarters.
At Studios, the revenue decline of 7% reflects lower content licensing, which was impacted by the timing of deliverables related to our film licensing business, which was partially offset by a modest increase in theatrical revenue, driven by the strong performance of Kung Fu Panda 4 at the box office this quarter. Studio's EBITDA declined 12%, reflecting the difficult comparison to last year's film slate, including the highly successful carryover title, Puss in Boots: The Last Wish and the timing of licensing deals at film.
Now I'll wrap up with free cash flow and capital allocation on Slide 7. As I mentioned previously, we generated $4.5 billion in free cash flow this quarter, and we achieved this even with the significant investments we continue to make to support our growth drivers. Specifically, our $3.3 billion in total capital spending this quarter incorporates our efforts in expanding our footprint and further strengthening our domestic broadband network, scaling our streaming business and supporting the continued build of our Epic Universe Theme Park ahead of its 2025 opening. And working capital was a $940 million drag for the quarter, a significant improvement over last year, a lot of which is timing related.
Turning to return on capital. For the quarter, we returned a total of $3.6 billion to shareholders, an increase of 13% year-over-year. This includes share repurchases of $2.4 billion and dividend payments of $1.2 billion. Putting it all together in the last 12 months, we've returned over $16 billion in capital to shareholders between share repurchases and dividends, reducing our share count by nearly 6%.
At the same time, we invested nearly $17 billion back into our businesses in the form of capital and working capital, carefully and consistently balancing reinvesting in our businesses for growth, returning significant capital to shareholders and doing so with a very strong balance sheet, which facilitates this consistency through a variety of operating environments.
Now let me turn it over to Marci for Q&A.
Marci Ryvicker: Thanks, Jason. Operator, let's open up the call for Q&A, please.
Operator: [Operator Instructions] Our first question today is coming from Ben Swinburne from Morgan Stanley.
Benjamin Swinburne: Two questions maybe for Dave on the Cable side. Could you talk maybe bigger picture about customer segmentation, particularly some of the new efforts around prepaid and the NOW brand as well as some of the speed boost you've done, and just how you think about that impacting the business over time? And then if you're willing to give us a little more on how you are able to deliver ARPU growth within the historical range through the CP transition, just given, obviously, the subsidies going away.
And then I think for Jason. We expect EBITDA growth this year, free cash flow growth this year. You guys had a nice free cash flow, first quarter. I guess, I would have expected buybacks to grow as well year-on-year. And as you point out on that last slide, trailing 12 months, $11.5 billion, $2.5 billion in the first quarter. So it looks like it's slowing a bit. So just wondering if you could comment or if there's anything that's changed on sort of the capital allocation leverage math that we should be thinking about with Comcast this year?
David Watson: Ben, Dave. So let me start with segmentation and a little bit more context on NOW. So stepping back, our segmentation strategy is really key. It starts with the beginning point always for us is premium and traditional broadband customers. We've focused there and invested in terms of better network, better products around providing a better service for the premium segment.
We have consistently competed for all segments. And as we break it down, we've focused where we think the main point is where broadband is going. And broadband is going is the engagement. And so our focus is to continue to deliver multi-gig symmetrical and build towards that point. And do this for a variety of Internet options. And the proof is in the footing in terms of segmentation in that 70% of our HSD-only customers receive speeds of 500 megabits per second or higher and 1/3 of our customers -- resi customers receive gig plus. So it never has been one-size-fits-all.
[ There is ] start there and the focus of premium. But there is currently a lot of activity at the low end of the market. And we've not been as competitive in this space. We've had great products and several options, but we -- in the prepaid area, in particular, we believe there is an opportunity to improve our effectiveness there.
And so thus NOW. And NOW, there are 3 components of NOW. One is prepaid broadband, which, by the way we've had prepaid broadband for some time. We've just approved upon the value proposition there. So it's a NEW prepaid broadband update. And second, we have prepaid NOW mobile, which is new and then we feel that it's positioned for an alternative to fixed wireless and just a lot of activity there. The focus there is there are no credit checks. It's easy.
It's no contract and on an everyday price point. So not a lot of movement in terms of just a competitive value-based price point. At the time we're doing NOW, obviously, it's a good alternative to ACP and where that goes. So early to talk about any progress but we're real pleased with the positioning of the NOW product for the income-constrained segment of the market. We've had NOW TV for some time and traction there. So it's a stand-alone product suite. I feel very good about that.
On ARPU, this is a strength that we've had. We've been balancing ARPU growth, along with share volume for a very long time. So we feel good about this quarter, came in very strong at 4.2% and a bit above the historical 3% to 4% range. It's a very competitive marketplace, to say the least, and we're just striking the right balance, we think, in volume and rate. And our approach is reasonable rate increase. The teams have managed this well leading to rate yield results that exceeded our expectations a bit.
But also it goes back to the first point. We're segmenting the marketplace and tailoring product approaches that meet each specific segment. So it starts with the high end that I've talked about and very focused there and the results that I've talked about. So that's the starting point. But when you look at our long-standing approach to pricing and packaging, we're going to compete for every segment. And it's really focused, though, where the market is going and making sure that in the long run as the overall usage goes up.
And to me, that is the main point. You have double-digit increases in terms of overall broadband consumption. You have lots of customers, a lot of interest in our high end of our portfolio and strength in a ubiquitous, reliable, great network that can stand up for every segment, but power through every application that is there. So I think for us, pleased with ARPU. And I think we can muscle through this ACP thing and feel good about the guidance that we've been giving at 3% to 4% historical range.
Brian Roberts: This is Brian. I just want to just underscore that last point that Dave was making. As you look with a longer lens, which I -- hopefully, the company tries to do, there's -- and we -- just even yesterday, we're looking at our technology road map internally and seeing some demonstrations of innovation. It's inspiring and exciting to think about what broadband will actually help you do in the next 5, 10 years as a consumer and as a business. And it's kind of in some levels, unimaginable. A lot of discussion about AI but so much happening in the entertainment sector, sports sector and also in the health care sector, and then things we're not even talking about.
And so our strategy is pretty simple. But having NOW, this NOW strategy to help consumers with are super easy-on, it's all there in a prepaid market. But the main strategy has always been to have the superior product in the market with fantastic service and constant innovation and do it in a capital way where our investment is consistent and within the guidelines that we've previously talked about.
All that's happening, and we're making great inroads on that. And if I had to pick one number this quarter that excites me, it was a double-digit growth of bits per home, which is showing that usage for whatever it is, gaming, multi streams, whatever. And then the actual high definition becoming even higher definition over time with the quality of the picture. So hopefully, all that's useful, and we're pretty pleased with how the team is executing. Jason?
Jason Armstrong: Yes. Great. Thanks. So just to round that out, Ben, just you think your question specifically on ARPU and how do you go through the ACP cycle and have confidence in ARPU growth. I think all these points are relevant and valid. Number one, we continue to see usage grow at a rapid rate. So the value that the consumer is getting is higher. That's a tailwind in general for ARPU growth. I think number two is segmentation that Dave's talked about. We see a lot of competition in a certain segment of our base, the value-conscious segment of our base. The segmentation allows you to keep that from seeping into other segments of the base. And the team has done a nice job executing there.
Final thing I'd point out is as we said, ACP customers have got about 1.4 million in our base that we'll need to manage through. This is very similar, though, to -- if you think about how this business is wired, Dave and his team, it's promotional roll-offs. This is something we're dealing with every single quarter, how do you navigate a base of customers that's on promotion and roll them into new rate plans and keep them as customers? So this is very much what the Cable business is wired to do.
On buyback spend, I would go back and over the last few years. We've had a very consistent capital allocation strategy starting with reinvesting in our business, layered into protecting the balance sheet. We really like our current credit rating and have committed to metrics that are associated with the credit rating as you've seen. And as you point out, very strong free cash flow last year and expectation for similar this year. As you mentioned, allows for substantial share repurchase activity. So since we restarted the buyback in 2021, we bought back over 15% of our share count. If you look at the last year, we bought back over 6% of our share count. So both very strong metrics.
I would point out the tail end of last year, we were pretty clear in the third quarter that we were going to accelerate the buyback, anticipating minimum floor Hulu proceeds, which came in at the very end of last year. And that's in advance of more full proceeds for full value this year, but we did get a minimum floor payment last year and hence, accelerated the buyback in 3Q and 4Q to $3.5 billion.
Michael Cavanagh: And Ben, I'll just come in on the back of the question about any changes in how we think about capital allocation. I think Jason and team are carrying on a phenomenal tradition. I've been here now close to 10 years. And I think the idea of taking our well-generated capital across our businesses, and first and foremost, investing them back in the business with a very long-term view of what the future can be, where there's expected return. Whether that's the Parks business, whether that's the broadband network, whether that's streaming, whether it's just broad innovation.
I think it's in our DNA at this place to try to figure out ways to invest wisely for the future, while at the same time, maintaining a very strong balance sheet and we like the way the balance sheet is set up. When you go through these long arcs of change across industries with disruption, it allows you to sleep better at night knowing the strength of balance sheet we have and allows us to continue making those earlier investments. And then so to do those 2 things together with the very substantial interest on the part of the management team and the facts that we've done it to just get lots of capital return to shareholders. Not many companies are inclined to manage those 3 priorities as much as we are. And I can commit that that's where our head is as we look forward to the next 10 years ahead.
Operator: Your next question is coming from Craig Moffett from MoffettNathanson.
Craig Moffett: Two questions about broadband, if I could. First, you talked about how your broadband business -- or sorry, your wireless business is helping broadband churn. I wonder if you could just talk a little bit more about that. How you -- first, can you put some numbers around the churn reduction that you see when a customer bundles broadband and wireless together?
But more importantly, how do you think about wireless? Is it a stand-alone business to you? Or is it really in service of broadband churn? And then I wonder if you could -- maybe I was just -- I missed it. But Jason, I think you mentioned the margins for this domestic Cable-only business. But I think I may have missed the number. I wonder if you could just repeat that for us.
David Watson: Craig, Dave. Let me start with wireless and then hand it over to Jason and folks. But let me -- wireless is an absolute integral part of our overall strategy. And specifically to your question, we've always thought the main value for us, wireless is connected with broadband. And that it adds -- it surrounds broadband with value. I think we don't give specifics on exactly the churn benefits, but we do see it. And whether it's acquisition-oriented, connected to broadband; whether it's base management upgrading; whether it's retention, wireless plays a role in all of them.
So it's a key growth opportunity. But it's also -- it's a product where our marginal economics are strong. So it's good to have that, but it's -- the way we go to market, it's connected to broadband and it's connected to packaging. So it's performing well. We like our consistency in the marketplace and love the fact that we have a good runway ahead only about 11% penetrated, now 7 million lines. And so I really like the opportunity in front of us. And for us, we've constantly been evolving our approach towards wireless and how we connect it with broadband and how we use it.
So we have, for example, new pricing plans. Our new mobile plants that are really targeting multiline customers excited about that. The new mobile product and segmentation. We've already talked about that in the prepaid area. And for that segment, we've had a Buy 1, Get 1 program for the base. So almost every single segment. And then just announced, the WiFi boost for our mobile customers being able to open up the public. The WiFis, hotspots and open it up as fast as devices can go and leveraging WiFi complement to mobile. So I think we've demonstrated that we're in this business, we love this business, and it's -- but it is definitely the core part of our strategy is how it impacts broadband over the long run. Jason?
Jason Armstrong: Craig, so on margins, we said overall connectivity and platforms margins were up 50 basis points and said domestic was an even greater increase. The domestic was up 70 basis year-over-year, sort of continuing the formula of a mix shift in our business to higher-margin businesses. Our connectivity businesses are growing faster than our nongrowth video businesses. So that's a margin favorable trade-off for us as we said historically and then operating efficiencies in the business. I think we gave a stat last call that I'd reiterate, we've taken 50% of our truck rolls out of the system in the last 6 years. We've taken 40% of customer interactions out of the system in the last 6 years. So lot of good progress on expense efficiency. But Craig, the domestic margin's up 70 basis points.
Operator: Next question is coming from Jessica Reif Ehrlich from Bank of America Securities.
Jessica Reif Cohen: I have a question on NBCU and also on Comcast Cable. On the Theme Parks, which is clearly one of your growth pillars, can you give us the investment levels you expect over the next 5 years? Obviously, Epic will be in there, so it will be a little elevated. But you have other new parks and you're also investing in the existing parks. And how different is the return on invested capital for Theme Parks versus your other businesses? And then one more on NBCU, are there other areas that NBCU should or you're thinking about investing in like video games?
And then on Cable, on Comcast Cable. Just a question on your programming expense or programming contracts. Presumably, you have MSMs, I think you've always had them. How should we think about the impact on Comcast Cable programming expenses as some major programming contracts come up with other distributors?
Michael Cavanagh: Jessica, it's Mike. So on parks, as we've said, this is a year in 2024, where CapEx in parks and at NBCUniversal overall will sustain at the level it was in '23. So it remain elevated. In '25, when we open Epic, it will begin to step down. And then after that, it will return to a more normal level with adjustments for the Hollywood Hard Nights and the Kids park in Frisco, Texas that we've talked about. But those, as we've said, are not of the same size and scale as a large park like Epic but we do have a bigger footprint of parks than we did, say, 5 years ago.
So you're right, part of the part of the capital equation for parks is to continue to invest in new attractions within existing parks. So again, once we get to '26, you'll see us easing into a new steady state that does include continued experimentation with some of our alternative concepts. And then certainly, we hope over the longer term to come up with some ideas for bigger deployments of capital, but that's what we have in our plans as we sit here right now. But we love the business.
And to the question of returns, we think the returns are very strong. We take a careful look at that every time we're greenlighting a new park. And I think we like the stability of the long-term nature of the return. It's us and one other great company that are world leaders in that level of park experience. The response to our parks has been phenomenal coming out of COVID. And so we see that being a place, live entertainment at the level we're talking about, being just a strong pillar of the media and entertainment side of the company for a long time ahead.
And then in terms of other areas. I think the success that we've had across parks and experiences are -- lead us to plenty of opportunities to think about gaming and other areas around live entertainment that go around and cross between our businesses. So we experiment with things and we look, and it's our job to see if there are great opportunities to do that, but nothing to report today.
David Watson: Jessica, Dave. Just so on your question on renewals and our point of view. Yes, look, from our view, there's not a single approach towards -- we handle it on a case-by-case basis. When you step back for a second though, we evaluate each one in 3 primary areas. One, the overall cost relative to the content, flexibility that's required in a very fast-changing environment and the overall consumer value. And so -- and we're going to look at this significant transition that has been going on. We'll continue to go on between linear and streaming. And so that is something that we think we can play a unique role in, in terms of win-win opportunities between the content providers and distribution.
And for us, we have a unique platform that is positioned well to be able to do -- handle everything that video can handle, linear channels, on-demand, DVR and streaming. We've been doing streaming packaging on the platform for some period of time. So we can build bridges as these things come up. And -- but our goal consistently has been to find win-win opportunities as we examine each and every specific renewal, but that's how we'll evaluate each one.
Operator: Our next question is coming from John Hodulik from UBS.
John Hodulik: Two, if I could, maybe first for Jason. Just finishing up on ACP. Given the strong start you guys had to the year and the strong ARPU, do you guys think that you can keep domestic cable EBITDA flat to up for the year even with ACP going away? That's first.
And then maybe for Dave, the wireless companies are definitely talking at sort of bigger game on fixed wireless in the business market. I know you guys had some sort of strong comments in the prepared remarks about the business market. But are you starting to see some increasing competition leak in at the low end because of fixed wireless?
Jason Armstrong: Yes, John, let me hit domestic or Cable EBITDA, C&P EBITDA over the course of the year. So I think as you mentioned, it's competitive market. We've got ACP coming our way. At the same time, the balance, I think about broadband specifically. The balance between rate and volume we've seen, obviously, a little bit of pressure on volume. But 4.2% ARPU growth in the quarter, an outlook for -- we continue to stay at 3% or 4% during the year. So we still think there's tailwinds for broadband revenue growth. We had 3.9% this quarter.
We're growing business Services, we're growing Wireless, and we're offsetting video and other revenue declines. But at the total level, that's a margin accretive mix shift. I'd go back to what I've said before on some of the expense initiatives across the company and being very disciplined, taking volumes out of the system and that's providing a tailwind as well. So without giving specific guidance for EBITDA growth, I would give you the components and our confidence in them.
David Watson: John, Dave. So just a follow-on to Jason's point in terms of ACP. Remember, I think a really important point. We've been segmenting the marketplace, and I think we've had the industry-leading platform in terms of Internet Essentials for a very long time so a decade-plus. So we are familiar with the segmentation in this area and we're very familiar in terms of promo roles and bigger moments like this. So I -- because of that, in particular, the ARPU point that's connected to it is we feel pretty good about the historical range of 3% to 4%. So -- but we've had a long-standing approach towards this.
On your question around business services, there's no question, John, that we -- the SMB market has become a bit more competitive and fixed wireless is a part of that. So they are -- you've seen it in the results. We now have 3 fixed wireless competitors that are in it. When you have that much all at once, there's some impact. So we're seeing it in SMB. It's unique to SMB. But our game plan consistently has been to focus on both the share and the overall -- the rate and we have a great slate of products. We have multiple segments within Business Services, mid-market and enterprise that offset a lot of this and great product road maps that have.
But really important point as you feel competitive pressure, I think it's important to keep in mind, uniquely to SMB that reliability and ubiquity of our products and business services is really key here. For businesses, they get 24/7. They're always on. It has to work. I think over time, we will continue to press that point and have -- we're not going to chase things down to zero in terms of discounting. We're going to offer better products and surround those products with features that make sense for business customers. But we will make sure that customers know the reliability and ubiquity of what we do is unique and different than fixed wireless.
Brian Roberts: And just -- Brian. One -- just again, just as we talked about in the residential market, the long-term opportunity where we're only just getting started is that large enterprise and medium-sized business. And as you think about cybersecurity and other data reliability and just consumption behavior of businesses and think of your own businesses and where that might lead to the use of new tools and video and everything else, you want to have the best network. And once again, we have a really exciting team and road map on that front. So again, we're battling the reality in one segment with great opportunity in others and long-term love our situation.
Operator: Our next question is coming from Steven Cahall from Wells Fargo.
Steven Cahall: Maybe first just on broadband trends. I think you've been pursuing a line extension strategy for, at least, 18 months and that will continue. So is it correct to assume that your gross adds on broadband are starting to pick up just as you add more passings in the market? And if that's true, can you give us any color on within the deactivations where they're headed? I think you've always said that you view fiber as the bigger competitive threat. And so does that kind of help us understand what's going on between gross adds and net adds?
And then separately on Peacock. You talked about retaining subs between some of your big marquee sporting events and you've got a lot of great film on Peacock as well. I'm wondering what your tolerance is for original content and original content spend and how we think about originals on Peacock maybe, vis-a-vis, a long-term breakeven goal.
David Watson: Steven, this is Dave. Let me start with footprint and then go to competition views. So let me -- in terms of overall footprint expansion, the vast majority of our new passings each quarter are fill-ins within our existing footprint. The balance of the growth is mostly from our organic edge-outs into adjacent areas. And so with some government subsidized builds representing a much smaller, albeit increasing portion. So it's really the kind of 3 different components of it that we're looking at.
And so it's still early and -- but we are very disciplined. We evaluate the risk adjusted returns of each -- one of these network builds on a case-by-case basis. And generally, though the edge outs as that will increase, they're adjacent, sometimes located in between geographic markets that we currently serve. So looking ahead, we expect these edge out projects to continue to contribute to the future growth in our total passings. And we don't give -- to your question, the specific numbers on this.
I could tell you that we're going to reach very healthy penetration levels in a few years on these edge out projects. So the ramp-ups happen pretty quickly, and we're pleased with the returns though. So pretty disciplined process. We look on the returns. And then as you shift towards the competition, the environment, let me back up and just its overall -- it's a very intense competitive environment that is very consistent the last several years.
And so it's picked up a bit. And when you have, again, 3 fixed wireless competitors coming in pretty much at the same time and you have the fiber level, about half of our footprint now has fiber competition of some form and it's an intense competitive environment. But we have adjusted. We've been going up against fiber competition now for over 15 years. And it is -- we've made adjustments. We've done, I think, very well in going toe-to-toe for the -- exactly as Brian laided out, that our long-term game plan is to focus on a better network, ubiquitous network, better products.
Surround it with the full portfolio of better products and not chase units just for the sake of it. And we've had moments going up against fiber where they've gone way down market. They've become rational. We've had different cycles. And so I think we've made adjustments and we have proven that we more than hold our own in that footprint. What we're seeing now is kind of an intense -- more intense competitive focus around the lower end of the market.
And that's why we're segmenting. That's why we're doing what we're doing, never losing sight though. That we're going to have a better product than anybody in the marketplace. The better network and backing it up with better devices, that can eventually -- as we get to multi-gig symmetrical. And that's the key. Every single application ubiquitously delivered, that's our focus. So it's a tough competitive environment but I think we have a unique differentiated approach.
Michael Cavanagh: And so on Peacock. I mean we're very pleased as we split -- both Jason and I said earlier, with a quarter where we ended at 33.5 million subs, 3.5 years in. We are at a place now where we really are seeing traction in our approach to providing a service for consumers that is a combination of both entertainment and sports and how those 2 go together.
Very much a reflection, as we said from the beginning, of our -- a mirror image of what we see as our strengths at NBCUniversal itself. And so when you look at this quarter in particular, you end up with a start with a Wild Card game that brought in a tremendous number of subs ahead of where we expected it to be. And then retention, that was ahead of where we expected it to be. And so that's obviously great and the power of sports to bring audiences together and will stay committed because of our strength in sports.
But when you really reflect on what then happened in the weeks that followed our viewing was the record highs across all parts of our non-sports portfolio. And in fact in the quarter, we launched our biggest original, Ted, to the greatest success of any of the originals we've ever launched. And Traitors 2, our reality series on Peacock, both of those were in the Nielsen Top 10 streaming in the earlier part of the year.
So I think we see the 2 -- the parts of the portfolio interplaying well with each other. And obviously, the strength of our movie studio, which we talked about earlier with Oppenheimer and Holdovers and now coming up in future quarters, Kung Fu Panda 4. That is another great source of strength into our portfolio. So I think you can expect to see us having a very broad approach to it' sports, it' originals, it' next-day airing of NBC content, it's our library, and it's our Pay-1 movies. All those things going into a service that we think is one of the best values in streaming and a very distinct place over time in the streaming marketplace for consumers.
And when you look ahead from where we started the year, we are now in continue to focus hard on retaining the growth in subs we had. Second quarter will be a little lighter in terms of the cadence of our content. But when you look to the middle of the year, we've got Olympics. Right after that, we've got the return of NFL, Big Ten and our exclusive NFL game in São Paulo, Brazil, along with the tremendous movie slate: Fall Guy, Twisters, Despicable Me 4, in addition to Kung Fu Panda 4.
And so we feel great about what we're doing and the progress we're making, and it's very consistent with the way we've described Peacock as taking advantage of what makes us great at NBCUniversal to begin with, and taking our existing strengths and assets into a digital future. So that's -- and it's one of our 6 big growth drivers, so glad to get a chance to comment on it.
Marci Ryvicker: Thanks, Steve. Operator, we have time for one last question.
Operator: Our final question today is coming from Jonathan Chaplin from New Street.
Jonathan Chaplin: One for Dave and one for Jason. Dave, taking a step back from the sort of the increased competitive intensity you're seeing in the broadband market, I would love your perspectives on how the overall market is trending. As we tally up all the ads from the quarter, it looks like we're sort of trending to somewhere around half of what we normally see for the industry in the first quarter. Everybody's adds are down. And I'm wondering if you've got any thoughts as to what might be driving that?
And then, Jason, on the segmentation strategy. You hit the low end of the market with some offers last year and then pulled back because you're worried about cannibalization. I'm wondering how the NOW -- you've sort of structured NOW differently so you don't end up seeing that cannibalization impact.
David Watson: Jonathan, Dave. Let me start with the broadband in its entirety, the whole market and a viewpoint. So let me begin with the broadband market as a whole is still growing, maybe at a slower pace than it was last year and the year before, but there's still going to be a pretty healthy amount of net adds in 2024 and likely beyond. The right way, though, in addition to that, I think you got it. Everything we've talked about before, the right way we think to look about it is it's holding our own, growing relationships responsibly, but it's also where the market is going and how broadband is being used.
And that -- as we've talked about the utility of the broadband product itself is only going up. So when you look at the health of the entire category, it's the relationships, but it's also the overall usage and consumption. And for us, you can see usage is up double digits. Broadband-only subs using over 700 gigabytes of data a month. Over 70% of our subscriber base is on speed tiers of 50 megs or more, nearly 1/3 of our customers are on 1 gig. Those are great trends for us over the long term and gives us the great confidence as we're investing, continuing to invest in a better network and a better customer experience, as Brian has said.
So when you look at things, I think it's clearly competitive as we've talked about. One other factor that enters into it, in some cases, in certain segments. There are some people that revert back to mobile-only, that can happen. So there's a variety of factors that could enter into it. But overall, as a category and a growth opportunity, quite optimistic about broadband.
Jason Armstrong: Jonathan, let me start on segmentation and Dave probably wants to chime in as well. So on NOW, I think what's interesting and exciting about it is it's a dedicated sort of flanker brand strategy. We've had prepaid offers in the past sort of wedged into our existing portfolio. This is a more dedicated and branded strategy around it.
By the way, the branding around this has worked very well in our U.K. market for Sky. It's actually where the brand name came from. And so we expect this to have some resonance. I would point out the -- if you look at where it's sort of targeted, we've got 100 meg offer for $30. It's inclusive of taxes, fees and equipment. We've got a $45 offering that's 200 megs and inclusive as well, very competitive versus fixed wireless, right? That is in this range, maybe slightly higher without the same reliability and ubiquity that we have.
David Watson: Yes. Just adding on to that, Jonathan. But again, we've been doing prepaid broadband for a while, years. And it's just we needed to refresh it, needed to update it and put it in a more competitive position. The prepaid mobile is new, and NOW TV is relatively new. But it's a segmented approach. And if you think about -- it's all in pricing, it's very simple. It's really easy.
There's no contracts, no credit checks, customers can sign up, pause, cancel online, anytime. It's a very straightforward -- but feature-light product as we keep our focus on the high end in terms of fully featured things. We'll continue to do that. But this just gives us a brand, gives us a product suite to be able to clearly and define segmentation in a way that we can manage through.
Marci Ryvicker: Thanks, Jonathan, and we want to thank everyone on the call for joining us this morning.
Operator: Thank you. That concludes the question-and-answer session and today's conference call. A replay of the call will be available starting at 11:30 a.m. Eastern Time today on Comcast Investor Relations website. Thank you for participating. You may all disconnect. |
GOOGL | 1 | 2,024 | 2024-04-25 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet First Quarter 2024 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's First Quarter 2024 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler, and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations, and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now I'll turn the call over to Sundar.
Sundar Pichai: Thank you, Jim, and hello, everyone. It was a great quarter led by strong performance from Search, YouTube, and Cloud.
Today, I want to share how we are thinking about the business and the opportunity more broadly. Of course, that's heavily focused on AI and Search. Then I'll take you through some highlights from the quarter in Cloud, YouTube and beyond.
Let's discuss our momentum and strategy. Taking a step back, it took Google more than 15 years to reach $100 billion in annual revenue. In just the last 6 years, we have gone from $100 billion to more than $300 billion in annual revenue. Of course, Search continues to power that as you see in our Q1 results. But in addition, we expect YouTube overall and Cloud to exit 2024 at a combined annual run rate of over $100 billion. This shows our track record of investing in and building successful new growing businesses.
Now let's look at how well we are positioned for the next wave of AI innovation and the opportunity ahead. There are 6 points to make: one, research leadership; two, infrastructure leadership; three, innovation in Search; four, our global product footprint; five, velocity in execution; six, monetization paths.
First, our foundation of research leadership. We've been an AI-first company since 2016, pioneering many of the modern breakthroughs that power AI progress for us and for the industry. Last week, we further consolidated teams that build AI models under Google DeepMind. This will help simplify development and establish a single access point for our product teams as they build generative AI applications with these models. The teams are making rapid progress, developing Gemini and other models.
In February, we rolled out Gemini 1.5 Pro, which shows dramatic performance enhancements across a number of dimensions. It includes a breakthrough in long context understanding, achieving the longest context window of any large-scale foundation model yet. Combining this with Gemini's native multimodal understanding across audio, video, text code and more, it's highly capable. We are already seeing developers and enterprise customers enthusiastically embrace Gemini 1.5 and use it for a wide range of things. Beyond Gemini, we have built other useful models, including our Gemma open models as well as image and visual models and others.
Second, infrastructure leadership. We have the best infrastructure for the AI era. Building world-leading infrastructure is in our DNA, starting in our earliest days when we had to design purpose-built hardware to power Search. Our data centers are some of the most high-performing, secure, reliable, and efficient in the world. They've been purpose-built for training cutting-edge AI models and designed to achieve unprecedented improvements in efficiency. We have developed new AI models and algorithms that are more than 100x more efficient than they were 18 months ago.
Our custom TPUs, now in their fifth generation, are powering the next generation of ambitious AI projects. Gemini was trained on and is served using TPUs. We are committed to making the investments required to keep us at the leading edge in technical infrastructure. You can see that from the increases in our capital expenditures. This will fuel growth in Cloud, help us push the frontiers of AI models and enable innovation across our services, especially in Search.
AI innovations in Search are the third and perhaps the most important point I want to make. We have been through technology shifts before, to the web, to mobile, and even to voice technology. Each shift expanded what people can do with Search and led to new growth. We are seeing a similar shift happening now with generative AI. For nearly a year, we've been experimenting with SGE in search labs across a wide range of queries. And now we are starting to bring AI overviews to the main Search results page. We are being measured in how we do this, focusing on areas where gen AI can improve the search experience while also prioritizing traffic to websites and merchants.
We have already served billions of queries with our generative AI features. It's enabling people to access new information, to ask questions in new ways and to ask more complex questions. Most notably, based on our testing, we are encouraged that we are seeing an increase in search usage among people who use the new AI overviews as well as increased user satisfaction with the results. And with Circle to Search, people can now circle what they see on their Android screens, ask a question about an image or object in a video and get an AI overview with Lens.
Fourth, our global product footprint beyond Search. We have 6 products with more than 2 billion monthly users, including 3 billion Android devices. 15 products have 0.5 billion users, and we operate across 100-plus countries. This gives us a lot of opportunities to bring helpful gen AI features and multimodal capabilities to people everywhere and improve their experiences. We have brought many new AI features to Pixel, Photos, Chrome, Messages and more. We are also pleased with the progress we are seeing with Gemini and Gemini Advanced through the Gemini app on Android and the Google app on iOS.
Fifth, improved velocity in execution. We've been really focused on simplifying our structures to help us move faster. In addition to bringing together our model-building teams under Google DeepMind, we recently unified our ML infrastructure and ML developer teams to enable faster decisions, smarter compute allocation, and a better customer experience.
Earlier this year, we brought our Search teams together under one leader. And last week, we took another step, bringing together our platforms and devices teams. The new combined team will focus on delivering high-quality products and experiences, bolstering the Android and Chrome ecosystems, and bringing our best innovations to partners faster.
We also remain focused on long-term efforts to durably reengineer our cost base. You can see the impact of this work reflected in our operating margin improvement. We continue to manage our head count growth and align teams with our highest priority areas. This speeds up decision-making, reduces layers, and enables us to invest in the right areas.
Beyond our teams, we are very focused on our cost structures, procurement and efficiency. And a number of technical breakthroughs are enhancing machine speed and efficiency, including the new family of Gemini models and a new generation of TPUs. For example, since introducing SGE about a year ago, machine costs associated with SGE responses have decreased 80% from when first introduced in Labs driven by hardware, engineering, and technical breakthroughs. We remain committed to all of this work.
Finally, our monetization path. We have clear paths to AI monetization through Ads and Cloud as well as subscriptions. Philipp will talk more about new AI features that are helping advertisers, including bringing Gemini models into Performance Max. Our Cloud business continues to grow as we bring the best of Google AI to enterprise customers and organizations around the world. And Google One now has crossed 100 million paid subscribers, and in Q1, we introduced a new AI premium plan with Gemini Advanced.
Okay, those are the 6 points so now let me turn to quarterly highlights from Cloud and YouTube in a bit more detail. In Cloud, we have announced more than 1,000 new products and features over the past 8 months. At Google Cloud Next, more than 300 customers and partners spoke about their generative AI successes with Google Cloud, including global brands like Bayer, Cintas, Mercedes-Benz, Walmart and many more.
Our differentiation in Cloud begins with our AI hypercomputer, which provides efficient and cost-effective infrastructure to train and serve models. Today, more than 60% of funded gen AI start-ups and nearly 90% of gen AI unicorns are Google Cloud customers. And customers like PayPal and Kakao Brain are choosing our infrastructure. We offer an industry-leading portfolio of NVIDIA GPUs along with our TPUs. This includes TPU v5p, which is now generally available and NVIDIA's latest generation of Blackwell GPUs. We also announced Axion, our new Google design and Arm-based CPU. In benchmark testing, it has performed up to 50% better than comparable x86-based systems.
On top of our infrastructure, we offer more than 130 models, including our own models, open source models and third-party models. We made Gemini 1.5 Pro available to customers as well as Imagine 2.0 at Cloud Next. And we shared that more than 1 million developers are now using our generative AI across tools, including AI Studio and Vertex AI. We spoke about how customers like Bristol-Myers Squibb and Etsy can quickly and easily build agents and connect them to their existing systems. For example, Discover Financial has begun deploying gen AI-driven tools to its nearly 10,000 call center agents to achieve faster resolution times for customers. Customers can also now ground their gen AI with Google Search and their own data from their enterprise databases and applications.
In Workspace, we announced that organizations like Uber, Pepperdine University and PennyMac are using Gemini and Google Workspace, our AI-powered agent that's built right into Gmail, Docs sheets and more. We also announced Google Vids, a new application to create stories in short video format. And we introduced Gemini for Meetings and Messaging and Gemini Security for Workspace.
Customers are choosing Workspace because they have deep trust in our powerful security and privacy features.
Our Cloud business is now widely seen as the leader in cybersecurity. I saw this firsthand when I went to the Munich Security Conference in February. Cybersecurity analysts are using Gemini to help spot threats, summarize intelligence and take action against attacks, helping companies like American Family Insurance aggregate and analyze security data in seconds instead of days.
Turning next to YouTube, which continues to grow and lead in streaming. We announced that on average, viewers are watching over 1 billion hours of YouTube content on TVs daily. AI experiments like Dream Screen will give anyone the ability to make AI-generated backgrounds for YouTube Shorts. And on subscriptions, which are increasingly important for YouTube, we announced that in Q1, YouTube surpassed 100 million Music and Premium subscribers globally, including trialers. And YouTube TV now has more than 8 million paid subscribers.
Finally, in Other Bets, Waymo's fully autonomous service continues to grow ridership in San Francisco and Phoenix with high customer satisfaction, and we started offering paid rides in Los Angeles and testing rider-only trips in Austin.
Overall, it was a great quarter, and there's more to come. IO is in less than 3 weeks, followed by Brandcast and Google Marketing Live.
I want to thank our employees around the world who are at the heart of this progress and who continue to focus on building innovative products, helpful services and new opportunities for businesses and partners around the world. Thank you. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone.
Google Services revenue of $70 billion were up 14% year-on-year. Search and other revenues grew 14% year-on-year led again by solid growth in the retail vertical with particular strength from APAC-based retailers, which began in the second quarter of 2023.
YouTube Ads revenues were up 21% year-on-year driven by growth in both direct response and brand. Network revenues declined 1% year-on-year. In subscriptions, platforms and devices, year-on-year revenues increased 18%, driven again by strong growth in YouTube subscriptions.
Let's now talk about a few highlights from the quarter from a product innovation and advertising performance perspective.
First, it bears repeating that AI innovation across our Ads ecosystem is core to every aspect of our product portfolio, from targeting, bidding, creative, measurement, and across campaign types. We've talked about whole solutions like Smart Bidding use AI to predict future ad conversions and their value in helping businesses stay agile and responsive to rapid shifts in demand and how products like broad match leverage LLMs to match ads to relevant searches and help advertisers respond to what millions of people are searching for. This is foundational.
As advances accelerate in our underlying AI models, our ability to help businesses find users at speed and scale and drive ROI just keeps getting better. We're especially excited about the doors gen AI is opening for creative capabilities, helping deliver on the premise of getting the right ad to the right user in the right moment.
Look at Performance Max. In February, we rolled Gemini into PMax. It's helping curate and generate text and image assets so businesses can meet PMax asset requirements instantly. This is available to all U.S. advertisers and starting to roll out internationally in English, and early results are encouraging. Advertisers using PMax asset generation are 63% more likely to publish a campaign with good or excellent ad strength. And those who improve their PMX ad strength to excellent see 6% more conversions on average.
We're also driving improved results for businesses opting into automatically created assets, which are supercharged with gen AI. Those adopting ACA see, on average, 5% more conversions at a similar cost per conversion in Search and Performance Max campaigns.
And then there's Dimension. Advertisers are loving its ability to engage new and existing customers and drive purchase consideration across our most immersive and visual touch points like YouTube, Shorts, Gmail and Discover.
Hollywood film and TV studio, Lionsgate, partnered with Horizon Media to test what campaign type will deliver the most ticketing page views for its The Hunger Games: Ballad of Songbirds and Snakes film. Over a 3-week test, demand gen was significantly more efficient versus social benchmarks with an 85% more efficient CPC and 96% more efficient cost per page view. Lionsgate has since rolled out demand gen for 2 new titles.
We're also bringing new creative features to demand gen. Earlier this month, we announced new generative image tools to help advertisers create high-quality assets in a few steps with a few simple prompts. This will be a win for up-leveling visual storytelling and testing creative concepts more efficiently.
And then there's obviously Search generative experience, which Sundar talked about. I laid out that innovation and the user experience on Search has historically opened up new opportunities for advertisers. We saw this when we successfully navigated from desktop to mobile. We're continuing to experiment with new ad formats, including search and shopping ads alongside search results in SGE. And we shared in March how folks are finding ads either above or below the SGE results helpful. We're excited to have a solid baseline to keep innovating on and confident in the role SGE, including Ads, will play in delighting users and expanding opportunities to meet user needs.
Which brings me to Search and our strong performance in the first quarter. In Q1, retail was again the top contributor. Our focus remains on driving profitability and growth for retailers, helping them optimize digital performance for both online and off-line as well as innovate across our shopping and merchant experiences.
Highlights include continued upsides for retailers, leading into agile budget and bidding strategies across Search, PMax, or both; take-home goods retailer IKEA, who leaned into Google's store sales measurement to understand its total omnichannel revenue opportunity across search. By measuring 2.3x more revenue and using value-based bidding solutions to bid to its omnichannel customers, IKEA drove a significant increase in omni revenue in Q1 and is now scaling this strategy globally. We also expanded local inventory ads into 23 countries, helping drive shopper confidence and off-line sales. Retailers can convert intent into action by showcasing in-store availability, pricing, pickup options and more all in one ad format.
Moving to YouTube. Last quarter, I went deep into our strategy. It all starts with creation, which drives viewership, which leads to monetization. A few updates to build on Sundar's remarks.
First, creation, which is all about giving creators the tools to create amazing content, grow their audiences and build their businesses. In 2023, more people created content on YouTube than ever before, and the number of channels uploading Shorts year-on-year grew 50%. We also hit a new milestone with 3 million-plus channels in our YouTube Partner Program. We recently shared that YPP has paid out more than any other creator monetization platform, including over $70 billion to creators, artists, and media companies over the last 3 years.
From a viewer's perspective, watch time across YouTube continues to grow, with strength in both Shorts and CTV. According to Nielsen, YouTube has been the leader in U.S. streaming watch time for the last 12-plus months. In the first quarter, Livingroom. benefited from a combination of strong watch time growth, innovation in the user and advertiser experience, and a shift in brand advertising budgets from linear TV to YouTube. Viewers are watching YouTube because they expect to access everything in one place across screens and formats, their favorite creators, live sports, breaking use, educational content, movies, music and more. And advertisers continue to lean in to find audiences they can't find elsewhere.
Which brings me to monetization. We're pleased with our Q1 performance across both our ad-supported and subscription offerings. Sundar covered subscription growth. On the Ads front, direct and brand were both strong this quarter. Shorts monetization continued to improve, with Shorts ads now supported on mobile, tablet, Livingroom. and desktop, and available to both performance and brand advertisers.
In the U.S., the monetization rate of Shorts relative to in-stream viewing has more than doubled in the past 12 months, including a 10-point sequential improvement in the first quarter alone. Just last week, we introduced new ways for brands to get the most out of their Shorts ads with new lineups on YouTube Select, including sports, beauty, fashion and lifestyle, and entertainment. For YouTube advertisers, increasing brand lift is one of the core goals. In Q1, we saw strong traction from the introduction of a pause ads pilot on connected TVs, a new non-interruptive ad format that appears when users pause their organic content. Initial results show that pause ads are driving strong brand lift results and are commanding premium pricing from advertisers.
Before I wrap, two quick highlights on how we're helping our partners transform and accelerate impact with the best across Google.
Number one, to help McDonald's build the restaurant of the future, we're deepening our partnership across cloud and ads. Part of this includes them connecting Google Cloud's latest hardware and data technologies across restaurants globally and starting to apply Gen AI to enhance its customer and employee experiences.
Number two, WPP. At Google Cloud Next, we announced a new collaboration that will redefine marketing through the integration of our Gemini models with WPP Open, WPP's AI-powered marketing operating system, already used by more than 35,000 of its people and adopted by key clients, including The Coca-Cola Company, L'Oreal and Nestle. We're just getting started here and excited about the innovation this partnership will unlock.
With that, a huge thank you to our customers and partners, many of whom we're excited to see at Google Marketing Live and Brandcast in just a few weeks. And a huge thank you, as always, to our incredible teams for their agility and hard work this quarter.
Ruth, you're up.
Ruth Porat: Thank you, Philipp. We are very pleased with our financial results for the first quarter driven, in particular, by strength in Search and Cloud as well as the ongoing efforts to durably reengineer our cost base. My comments will be on year-over-year comparisons for the first quarter unless I state otherwise. I will start with results at the Alphabet level, followed by segment results and conclude with our outlook.
For the first quarter, our consolidated revenues were $80.5 billion, up 15% or up 16% in constant currency. Search remained the largest contributor to revenue growth.
In terms of total expenses, the year-on-year comparisons reflect the impact of the restructuring charges we took in the first quarter of 2023 of $2.6 billion as well as the $716 million in employee severance and related charges in the first quarter of 2024. As you can see in our earnings release, these charges were allocated across the expense lines in other cost of revenues and OpEx based on associated head count.
To help with year-on-year comparisons, we included a table in our earnings release to adjust other cost of revenues, operating expenses, operating income, and operating margin to exclude the impact of severance and related office space charges in the first quarter of 2023 versus 2024.
In terms of expenses, total cost of revenues was $33.7 billion, up 10%. Other cost of revenues was $20.8 billion, up 10% on a reported basis, with the increase driven primarily by content acquisition costs associated with YouTube given the very strong revenue growth in both subscription offerings and ad-supported content. On an adjusted basis, other cost of revenues were up 13% year-on-year.
Operating expenses were $21.4 billion, down 2% on a reported basis, primarily reflecting expense decreases in sales and marketing and G&A, offset by an increase in R&D. The largest single factor in the year-on-year decline in G&A expenses was lower charges related to legal matters.
On an adjusted basis, operating expenses were up 5%, reflecting, first, in R&D, an increase in compensation expense, primarily for Google DeepMind and Cloud; and second, in sales and marketing, a slight increase year-on-year, reflecting increases in compensation expense primarily for Cloud sales.
Operating income was $25.5 billion, up 46% on a reported basis, and our operating margin was 32%. On an adjusted basis, operating income was up 31%, and our operating margin was 33%. Net income was $23.7 billion and EPS was $1.89. We delivered free cash flow of $16.8 billion in the first quarter and $69.1 billion for the trailing 12 months. We ended the quarter with $108 billion in cash and marketable securities.
Turning to segment results. Within Google Services, revenues were $70.4 billion, up 14%. Google Search and other advertising revenues of $46.2 billion in the quarter were up 14% led again by growth in retail. YouTube advertising revenues of $8.1 billion were up 21% driven by both direct response and brand advertising. Network advertising revenues of $7.4 billion were down 1%. Subscriptions, platforms and devices revenues were $8.7 billion, up 18%, primarily reflecting growth in YouTube subscription revenues.
TAC was $12.9 billion, up 10%. Google Services operating income was $27.9 billion, up 28%. And the operating margin was 40%.
Turning to the Google Cloud segment. Revenues were $9.6 billion for the quarter, up 28%, reflecting significant growth in GCP with an increasing contribution from AI and strong Google Workspace growth, primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $900 million and an operating margin of 9%.
As to our Other Bets, for the first quarter, revenues were $495 million, benefiting from a milestone payment in one of the Other Bets. The operating loss was $1 billion.
Turning to our outlook for the business. With respect to Google Services, first, within Advertising, we are very pleased with the momentum of our Ads businesses. Search had broad-based strength across verticals. In YouTube, we had acceleration in revenue growth driven by brand and direct response.
Looking ahead, two points to call out: first, results in our advertising business in Q1 continued to reflect strength in spend from APAC-based retailers, a trend that began in the second quarter of 2023 and continued through Q1, which means we will begin lapping that impact in the second quarter; second, the YouTube acceleration in revenue growth in Q1 reflects, in part, lapping the negative year-on-year growth we experienced in the first quarter of 2023.
Turning to subscriptions, platforms, and devices. We continue to deliver significant growth in our subscriptions business, which drives the majority of revenue growth in this line. The sequential quarterly decline in year-on-year revenue growth for the line in Q1 versus Q4 reflects, in part, the fact that we had only 1 week of Sunday Ticket subscription revenue in Q1 versus 14 weeks in Q4. Looking forward, we will anniversary last year's price increase in YouTube TV starting in May.
With regard to platforms, we are pleased with the performance in Play driven by an increase in buyers.
With respect to Google Cloud, performance in Q1 reflects strong demand for our GCP infrastructure and solutions as well as the contribution from our Workspace productivity tools. The growth we are seeing across Cloud is underpinned by the benefit AI provides for our customers. We continue to invest aggressively while remaining focused on profitable growth.
As we look ahead, two points that will affect sequential year-on-year revenue growth comparisons across Alphabet: first, Q1 results reflect the benefit of leap year, which contributed slightly more than 1 point to our revenue growth rate at the consolidated level in the first quarter; second, at current spot rates, we expect a larger headwind from foreign exchange in Q2 versus Q1.
Turning to margins. Our efforts to durably reengineer our cost base are reflected in a 400 basis point expansion of our Alphabet operating margin year-on-year, excluding the impact of restructuring and severance charges in both periods. You can also see the impact in the quarter-on-quarter decline in head count in Q1, which reflects both actions we have taken over the past few months and a much slower pace of hiring. As we have discussed previously, we are continuing to invest in top engineering and technical talent, particularly in Cloud, Google DeepMind and technical infrastructure.
Looking ahead, we remain focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure. We believe these efforts will enable us to deliver full year 2024 Alphabet operating margin expansion relative to 2023.
With respect to CapEx, our reported CapEx in the first quarter was $12 billion, once again driven overwhelmingly by investment in our technical infrastructure, with the largest component for servers followed by data centers. The significant year-on-year growth in CapEx in recent quarters reflects our confidence in the opportunities offered by AI across our business. Looking ahead, we expect quarterly CapEx throughout the year to be roughly at or above the Q1 level, keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx. With regard to Other Bets, we similarly have work streams underway to enhance overall returns.
Finally, as I trust you saw in the press release, we are very pleased to be adding a quarterly dividend of $0.20 per share to our capital return program as well as a new $70 billion authorization in share repurchases. The core of our capital allocation framework remains the same, beginning with investing aggressively in our business as you have heard us talk about today. Given the extraordinary opportunities ahead, we view the introduction of the dividend as further strengthening our overall capital return program.
Thank you. Sundar, Philipp, and I will now take your questions.
Operator: [Operator Instructions] Our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two. The first one, I wanted to ask about overall search behavior. Philipp, I know you talked in the past about how overall query trends continue to grow. Can I ask you to drill a little bit more into monetizable and commercial query trends? Has there been any changes in sort of your commercial query trends growth. There's just been all these new entrants moving around in e-commerce. That is my first one.
Then the second one for Ruth, when you talked about sort of more efforts to moderate expense growth from here, can you just sort of give us some examples of areas where you still see the potential for more optimization or work streams in place to continue to durably reengineer the OpEx base as we go throughout 2024.
Sundar Pichai: Thanks, Brian. To your first question, look, I think broadly, we've always found that over many years, when things work well on the organic side, monetization follows. So typically, the trends we see carry over well. Overall, I think with generative AI in Search, with our AI overviews, I think we will expand the type of queries we can serve our users. We can answer more complex questions as well as, in general, that all seems to carry over across query categories. Obviously, it's still early, and we are going to be measured and put user experience at the front, but we are positive about what this transition means.
Ruth Porat: And on the second question in terms of the various work streams, as both Sundar and I said, we remain very focused on ongoing efforts to slow the pace of expense growth, what we've been calling durably reengineering our cost base. And I made this point in opening comments, but we are very cognizant of the increasing headwind we have from higher depreciation and expenses associated with the higher CapEx, and so these efforts are ongoing. And they're very much the same that we've talked with you about previously. It starts with product and process prioritization, all of the work around organizational efficiency and structure. These are ongoing.
And so as an example, the work that Sundar talked about, combining devices and services with our platforms and ecosystems, product area is a really good example because unifying the teams not only helps us deliver higher-quality products and experiences, but we think it enables us to move with greater velocity and efficiency.
And then the other work streams we've talked to you about in the past, like all of the work around technical infrastructure, which Sundar alluded to; streamlining operations within the company through the use of AI; what we're doing with procurement with our suppliers and vendors, which he also referenced; the work you've seen on real estate optimization, these are all ongoing work streams, which is why we have them under the umbrella, durably reengineering our cost base, and they are ongoing.
Operator: Our next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: Sundar, you talked about bringing more generative AI features into the main Search page. Can you just talk about what kind of queries or scenarios do you think that that's working best for so far? And just how we should think about the cadence of continuing to adopt more of those features within core search.
And then Ruth, on CapEx spending, the $12 billion in 1Q, can we assume that run rating that and above is reasonable for this year? And I know it's very early, but should we generally expect higher CapEx next year as well?
Sundar Pichai: Thanks, Doug. On SGE in Search, we are seeing early confirmation of our thesis that this will expand the universe of queries where we are able to really provide people with a mix of actual answers linked to sources across the Web and bring a variety of perspectives, all in an innovative way. And we've been rolling out AI overviews in the U.S. and the U.K., trying to mainly tackle queries which are more complex, where we think SGE will clearly improve the experience. We've already served billions of queries and it seems to cut across categories, but we are still continuing our testing. And we are metrics-driven in these areas. But I am optimistic that it clearly improves the user experience. Users are telling us that. And we are seeing it in our metrics, and we'll continue evolving it through the course of this year.
Ruth Porat: And then in terms of CapEx, as I said in opening comments, we do expect the quarterly CapEx throughout the year to be roughly at or above the $12 billion cash CapEx we had here in Q1. As I said, you can always have variability in the reported quarterly CapEx just due to the timing of cash payments, but roughly at or above this level. And it really goes to Sundar's opening comment that we're very committed to making the investments required to keep us at the leading edge in technical infrastructure to support the growth in Cloud, all the innovation in Search that he and Philipp has spoken about and our lead with Gemini.
I will note that nearly all of the CapEx was in our technical infrastructure. We expect that our investment in office facilities will be about less than 10% of the total CapEx in 2024, roughly flat with our CapEx in 2023, but is still there. And then with respect to 2025, as you said, it's premature to comment so nothing to add on that.
Operator: Our next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Maybe just one question of a big picture nature for Sundar. Sundar, if we come back to your earlier comments at the beginning of the call and framing up longer-term initiatives and longer-term narratives, I wanted to know if you could talk a little bit about both the opportunities and the challenges of operating at scale in a time like this where there's a lot of technology innovation going on and how you see the elements of trying to strike a balance towards moving the organization forward while still continuing to both invest for growth as well as balance margins.
Sundar Pichai: Thanks, Eric. Great question. Obviously, I think the AI transition, I think it's a once-in-a-generation kind of an opportunity. We've definitely been gearing up for this for a long time. You can imagine we started building TPUs in 2016, so we've definitely been gearing up for a long time. The real opportunities we see is the scale of research and innovation, which we have built up and are going to continue to deliver. I think for the first time, we can work on AI in a horizontal way and it impacts the entire breadth of the company, be it Search, be it YouTube, be it Cloud, be it Waymo and so on. And we see a rapid pace of innovation in that underlying. So it's a very leveraged way to do it, and I see that as a real opportunity ahead.
In terms of the challenges, I think it's been a mindset shift, which we've been driving across the company to make sure that we are embracing this opportunity but being very efficient in how we are approaching it, making sure we are redirecting our people to the highest priorities across the company, building on our 20 years of experience in driving machine efficiencies year-on-year so that we can put our dollars to work as efficiently as possible. So making sure balancing all of that moving forward in a very bold and responsible way at the same time. Those are the important things to get right from my perspective.
Operator: Our next question comes from Stephen Ju with UBS.
Stephen Ju: Philipp, I think it's approaching the 2-year anniversary for the launch of Ads on YouTube Shorts. And you've given us an update on monetization pickup sequentially. But with that in mind, I think YouTube has launched an array of ad products and automation tools to help advertisers transfer what they're doing to the vertical screen. So how is this translating into buy-in among your advertiser clients?
And secondly, based on what you've seen over the last 2 years, are there any structural reasons that you can cite as to why the monetization cannot match what is already the case on the horizontal screen?
Philipp Schindler: Yes. Look, this is a great question, first of all. I mean, let's start with the fact that YouTube performance was very strong in this quarter. And on Shorts specifically in the U.S., I mentioned how the monetization rate of Shorts relative to in-stream viewing has more than doubled in the last 12 months. I think that's what you were referring to. And yes, we're obviously very happy with this development.
The way to think about it is advertisers really only spend with us when they see a positive ROI. So you can assume that this wouldn't be happening unless it were to work for advertisers in the short term and also in the long term. That's an important part, I think.
Overall, Shorts is a long-term bet for the business. It has really helped us respond to both creator and viewer demand for short-form video. We talked about the strong growth, averaging 70 billion daily views. I mentioned the number of channels uploading has increased 50% year-over-year, so again, very happy with us development. And to your question, structural reasons, whether we can't get to a match here, I have a hard time seeing those at the moment over time.
Operator: Our next question comes from Justin Post with Bank of America.
Justin Post: I'm going to ask another one on CapEx. It seems to be your biggest investment area. Just first, you saw the big uptick the last 2 quarters, but you've been investing in AI for years. Is the uptick because supply is getting easier to get? Or do you see more opportunities with the available supply to really fuel AI? So has the GPUs and everything gotten better that you feel more, investing more? And then thinking about the returns, both for Advertising and Cloud on the CapEx, do you feel like this is a higher cost of doing business? Or do you think this is an opportunity to even get better returns on your capital spend than you've had in the past?
Ruth Porat: So the increase in CapEx, as Sundar said and I said, really reflects the opportunity we continue to see across the company. It starts with all that we're doing in support of the Gemini foundational model but then also, clearly, the work across Cloud, on behalf of Cloud customers, and the growth that we're seeing with GCP and the infrastructure work there, and then, of course, as both Sundar and Philipp talked about the application across Search, YouTube and, more broadly, the services that we're able to offer. So it's the growing application and our focus on ensuring that we have the compute capacity to deliver in support of the services and opportunities we see across Alphabet.
And it really goes to the second part of your question, which is that as we're investing in CapEx and applying it across our various businesses, it opens up more services and products, which bring revenue opportunities. And we're very focused on the monetization opportunity. It does underlie everything that we're doing in Google Services and Google Cloud. And as Sundar noted, we're, at the same time, very focused on the efficiency of all elements of delivering that compute capacity from hardware, software and beyond.
Operator: Our next question comes from Mark Mahaney with Evercore.
Jian Li: This is Jian Li for Mark Mahaney. A couple of questions. One, just maybe an expansion on the Search, query questions on before, more like Search volume, and maybe in the context of the off-Google environment like AI chat bot, for example, we've seen kind of Meta AI directing to Google Search results. Do you think there's actually a scenario where like AI system can create a step function change in Search volume or use cases of Google? If you can give us more color on what are you seeing right now or what are you expecting to see in that area.
And then the second question on just the comment of YouTube and Cloud exiting at $100 billion run rate. What is informing this outlook or visibility for you? If you can talk about, is it driven by any sort of Cloud demand inflection or step change in the gen AI workload demand, if you can flesh it out a little bit?
Sundar Pichai: On your first question, look, I said this before but to be clear, we view this moment as a positive moment for Search. And I think it allows us to evolve our product in a profound way. And Search is a unique experience. People come, be it if you want answers, if you want to explore more, if you want to get perspectives from across the web, and to be able to do it across the breadth and depth of everything they are looking for and the innovation you would need to keep that up, I think it's what we've been building on for a long time. And so I feel we are extraordinarily well set up, particularly given the innovation path we are on. And overall, I view this moment as a positive moment. So that's how I would say it.
On the second part, Ruth?
Ruth Porat: Sorry, what was it?
Sundar Pichai: YouTube and Cloud.
Jian Li: Yes, in terms of your comment about $100 billion exit rate for YouTube and Cloud, what's driving this visibility for you and any kind of inflection you're seeing in the Cloud demand?
Ruth Porat: I would just say from Sundar's opening comments, it's just the ongoing momentum that we've seen in the business that we've been talking about, the ongoing growth and strong performance. And so what we were really getting at in that comment, what Sundar was getting at, is that we've continued to build strong businesses over time, and that just helps dimension it. We had similar comments last quarter when you talk about our subscription business. We're really proud of all the work that the teams are doing across the company, building new, strong opportunities, delivering for our users, for customers, for advertisers in profound ways. And so it was just helping to dimension what we have built over the years.
Operator: Our next question comes from Ken Gawrelski with Wells Fargo.
Kenneth Gawrelski: Two, if I may. First on GCP, you had nice acceleration in the quarter. Could you talk a little bit about the opportunities and constraints upon GCP's ability to continue to address that large addressable market and accelerate growth? Is it more sales-oriented? Is it more product sales solutions or both? And do you plan to address most of these organically? Or could a partner approach work for you?
And then the second one, just more detail on YouTube and sports rights. Could you reiterate your view on further live sports rights? There's some larger, mostly in the U.S., league rights coming up soon and will be more over the next several years. Could you just talk about your philosophy there beyond NFL Sunday Ticket?
Sundar Pichai: Look, on the Cloud side, obviously, it's definitely a point of inflection overall. I think the AI transformation is making everyone think about their whole stack, and we are engaged in a number of conversations. I think paid AI infrastructure, people are really looking to Vertex AI, given our depth and breadth of model choice, or using Workspace to transform productivity in your workplace, et cetera. So I think the opportunities there are all related to that, both all the work we've built up and AI being a point of inflection in terms of driving conversations. I think you'll see us do it both organically and with a strong partner program as well. So we'll do it with a combination.
And the challenges here, always, there are switching costs to Cloud and the challenges we see is how do we make it easier for people. There's a lot of interest, but there's definitely barriers in terms of people switching. And so that's an area where we are constantly investing to make it easier for our customers.
Philipp Schindler: And with regard to your sports rights question, look, I mean, we've had long-standing and significant partnerships with the most popular sports league here in the U.S., around the globe, federations teams, athletes, broadcasters. And obviously, these partnerships, in combination with our very vast audience of sports fans, drives investment in subscription experiences across many offerings: NFL Sunday Ticket, YouTube TV, YouTube Primetime Channels and so on. But there's nothing that we have to announce at the moment. We're obviously always looking at where we can create more value for our users, for our advertisers, for creators, but nothing specific to talk about at this moment.
Operator: Our next question comes from Ross Sandler with Barclays.
Ross Sandler: Sundar, I had a question about smartphone-based AI searches. So you guys are powering all these new AI interactions and searches on Pixel and on Samsung devices. And I think there's speculation that Gemini might be used on iOS in a future state. So the question is, as users start searching on smartphones and those searches are basically rendered on the model, on the phone, without accessing the web, how do you guys anticipate monetizing some of these smartphone-based behaviors that are kind of run on the edge? Any thoughts on that?
Sundar Pichai: Look, I think if you look at what users are looking for, people are looking for information and an ability to connect with things outside. So I think there will be a set of use cases which you will be able to do on device. But for a lot of what people are looking to do, I think you will need the richness of the cloud, the Web and you have to deliver it to users. So again, to my earlier comments, I think through all these moments, you saw what we have done with Samsung with Circle to Search. I think it gives a new way for people to access Search conveniently wherever they are. And so we view this as a positive way to bring our services to users in a more seamless manner. So I think it's positive from that perspective.
In terms of on-device versus cloud, there will be needs which can be done on-device and we should to help it from a privacy standpoint. But there are many, many things for which people will need to reach out to the cloud. And so I don't see that as being a big driver in the on-cloud versus off-cloud in any way.
Operator: And our last question comes from Colin Sebastian with Baird.
Colin Sebastian: I guess first, a follow-up on some of the questions on SGE in the core Search. I guess I'm wondering, along with some of those changes in behavior, is there a way to quantify that overall engagement shift, whether that's an increase in time spent or the level of increase in queries for both sort of traditional search as well as more generative answers.
And then secondly, on the hardware road map, I assume later this year, we'll hear more about some of the products. But any areas of particular focus or that you would point out that we should keep in mind in terms of hardware launches in the back half?
Sundar Pichai: On the first question on Search, not much more to add to what I said, but what we have seen. And we've been in live experiments just for a few weeks in U.S. and U.K. on a slice of our queries, and all indications are positive that it improves user satisfaction. We see an increase in engagement, but I see this as something which will play out over time.
But if you were to step back at this moment, there were a lot of questions last year, and we always felt confident and comfortable that we would be able to improve the user experience. People question whether these things would be costly to serve, and we are very, very confident we can manage the cost of how to serve these queries. People worried about latency. When I look at the progress we have made in latency and efficiency, we feel comfortable. There are questions about monetization. And based on our testing so far, I'm comfortable and confident that we'll be able to manage the monetization transition here well as well. It will play out over time, but I feel we are well positioned. And more importantly, when I look at the innovation that's ahead and the way the teams are working hard on it, I am very excited about the future ahead.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter 2024 call. Thank you, and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
GILD | 1 | 2,024 | 2024-04-25 00:00:00 | Operator: Good afternoon, everyone, and welcome to Gilead's First Quarter 2024 Earnings Conference Call. My name is Rebecca, and I'll be your host for today. In a moment, we'll begin our prepared remarks. [Operator Instructions] I'll now hand the call over to Jacquie Ross, VP, Investor Relations and Corporate Strategic Finance.
Jacquie Ross: Thank you, Rebecca. Just after market closed today, we issued a press release with earnings results for the first quarter of 2024. The press release, slides and supplementary data are available on the Investors section of our website at gilead.com.
The speakers on today's call will be our Chairman and Chief Executive Officer, Daniel O'Day; our Chief Commercial Officer, Johanna Mercier; our Chief Medical Officer, Merdad Parsey; and our Chief Financial Officer, Andrew Dickinson. After that, we'll open Q&A where the team will be joined by Cindy Perettie, the Executive Vice President of Kite.
Before we get started, let me remind you that we will be making forward-looking statements. Please refer to Slide 2 regarding the risks and uncertainties relating to forward-looking statements that could cause actual results to differ materially.
With that, I'll turn the call over to Dan.
Daniel O'Day: Thank you, Jacquie, and good afternoon, everyone. I want to start by thanking the Gilead teams for delivering a strong first quarter, which you see in our commercial performance and our clinical execution. Total product sales, excluding Veklury, grew 6% year-over-year to $6.1 billion, driven by higher demand across HIV, oncology and liver disease. Veklury sales continue to track with the rates of hospitalization for COVID-19 and reached a total of $555 million.
Once again, sales growth for the quarter reflected the diversity of our portfolio. HIV product sales grew 4% year-over-year. Oncology product sales were up 18%, driven by Trodelvy, which is well established as the #1 regimen for second-line metastatic triple-negative breast cancer and by our transformative cell therapies. As we outlined at the recent Kite analyst event in Maryland, we have exciting plans to build on our clear market leadership in cell therapy, such as expand into community networks in the U.S., more than double our manufacturing capacity, and move into new indications and disease areas with next-generation products.
From an EPS perspective, first quarter results reflect the close of the CymaBay acquisition with an inquired IP R&D charge of $3.9 billion or an expense of $3.14 per share. Excluding this charge, non-GAAP diluted EPS would have been $1.82 for the first quarter, which is above expectations, driven by higher product sales. The CymaBay acquisition brings us an important registrational medicine, seladelpar, which has the potential to address significant unmet need in liver disease. We have filed for regulatory approval of seladelpar as a treatment for primary biliary cholangitis, or PBC, with both FDA and EMA, and we expect an FDA regulatory decision in August.
If approved, we will leverage our industry-leading commercial infrastructure and long-standing expertise in liver disease to bring seladelpar a potentially transformative therapy to people with PBC who might benefit. Moving to clinical execution. We're very pleased with momentum in our HIV pipeline, which was reflected in our 80 data abstracts at CROI. Based on the strength of the data, we've initiated Phase III trials for bictegravir and lenacapavir, our novel once-daily oral regimen, and plan to advance once weekly oral programs, including lenacapavir plus islatravir into Phase III.
Later this year, we will host an HIV analyst event to share details of how we will further shape the HIV landscape with innovative options for prevention and treatment, including the next wave of long-acting therapies.
Before I pass it to Johanna, I will briefly recap our 2024 milestones on Slide 6. We have already achieved first patient in for the Phase III ARTISTRY-1 and ARTISTRY-2 trials, evaluating once-daily lenacapavir in combination with bictegravir as well as Phase II first patient in for SWIFT evaluating GS-1427, our oral alpha-4-beta-7 inhibitor. We are also on track for our upcoming milestones, including updates from 3 Phase III clinical trials for Trodelvy and lenacapavir.
Looking ahead to the rest of 2024, this is a time of focused execution for Gilead. We will see disciplined and agile in our approach, and we will focus the organization on both near-term execution and longer-term plans. With 54 clinical programs in play, no major patent expiration for the decade and many opportunities for growth, we have a lot of potential and a lot to deliver.
My thanks again to the Gilead teams for their great work this quarter and the ongoing progress across our diverse portfolio of therapies. With that, I'll hand it over to Johanna.
Johanna Mercier: Thanks, Dan, and Good after noon, everyone. With the first quarter marking the ninth consecutive quarter of year-over-year growth for our base business, our teams delivered a strong start to 2024, notably navigating the seasonal first quarter dynamics and establishing a firm base on which we can continue to build this year.
Beginning on Slide 8, total product sales, excluding Veklury, were $6.1 billion for the first quarter, up 6% year-one, reflecting solid growth of our HIV, oncology and liver disease businesses. Including Veklury, total product sales were $6.6 billion, up 5% year-over-year.
Moving to HIV on Slide 9. Sales were up 4% year-over-year to $4.3 billion, primarily driven by higher demand as well as favorable pricing dynamics in Europe that are not expected to repeat. Quarter-over-quarter sales were down 7%, driven by the typical seasonality we experienced in the first quarter of the year, partially offset by higher demand. As a reminder, quarterly HIV growth is, in general, more variable and less indicative of overall trends than the full year. This is evident in the first quarter of every year where inventory drawdown typically occurs following a build that generally happens towards the end of the prior year and patient co-pays and deductibles start of every year, and together with shifts in channel mix lowers average realized price in the first quarter.
As always, we typically see these quarterly pricing and inventory dynamics normalize as we progress throughout the year. We continue to expect approximately 4% HIV sales growth for 2024. Supporting that outlook, the treatment market grew in line with our expectations, as shown on Slide 10. Biktarvy remains the leading regimen for HIV treatment across major markets for new starts as well as for those switching regimens with sales up 10% year-over-year to $2.9 billion, reflecting strong demand.
Quarter-over-quarter, sales were down 5% as the higher demand was offset by the typical seasonal factors discussed earlier. It's notable that 6 years after launch, Biktarvy continues to gain market share in the U.S. up 3 percentage points year-over-year to approximately 49% share and once again, outpacing all other branded regimens for HIV treatment. Moreover, we continue to see Biktarvy's benefit extend into broader populations of people with HIV. Most recently, Biktarvy was granted FDA approval for use in virologically suppressed individuals with known or suspected M184 resistance, a common form of treatment resistance.
Turning to prevention. Descovy sales were down 5% year-over-year to $426 million, driven by lower average realized price due to channel mix, partially offset by higher demand. Sequentially, sales were down 16%, reflecting the seasonal dynamics discussed earlier, partially offset by higher demand. While market volumes in February were temporarily disrupted by the cyberattack on Change Healthcare, volumes readily recovered in March. Overall, the PrEP market continued to demonstrate robust growth, up over 11% in the first quarter, with Descovy maintaining over 40% PrEP market share in the U.S. despite the availability of other regimens, including generics.
This is a solid setup as we look to potentially launch lenacapavir as early as late next year as the first and only twice yearly subcutaneous prevention option. Given Gilead's strong commercial foundation across treatment and prevention, we are well positioned to maintain leadership in HIV as we look to the evolving marketplace of daily orals, long-acting orals and long-acting injectables.
Moving to liver disease on Slide 11. Sales for the first quarter were $737 million, up 9% year-over-year, primarily driven by favorable inventory dynamics and the timing of purchases by the Department of Corrections for our HCV products as well as higher demand across HCV, HBV and HDV. Sequentially, sales were up 7%, primarily reflecting the timing of HCV purchases.
Despite fewer HCV starts globally year-over-year, our viral hepatitis portfolio overall has remained stable and continues to be a meaningful contributor to our commercial performance. This strength is underpinned by our extensive global footprint and expertise in the treatment of liver diseases. To that end, pending approval, Gilead is excited to bring seladelpar to patients for the treatment of certain adults with PBC, impacting approximately 130,000 people in the U.S. and about 125,000 people in Europe. With the sales force that covers almost 80% of the U.S. prescriber base for PBC, we expect to readily make seladelpar available to patients upon approval in the second half of this year.
Seladelpar has demonstrated the potential to be best-in-class with a differentiated clinical profile to existing and emerging therapies, particularly on a key symptom of the disease, pruritus. Following its launch in 2024, we expect seladelpar to contribute modestly to sales and more meaningfully in 2025 and beyond.
Turning to Slide 12. Veklury continues to be the standard of care antiviral for hospitalized patients treated with COVID-19, with market share well over 60% in the United States. COVID-related hospitalizations were lower in the first quarter with the winter wave peaking earlier than expected in the U.S. and Europe as compared to other regions such as Japan. As a result, Veklury sales overall were down 3% year-over-year and down 23% sequentially to $555 million.
Shifting to oncology on Slide 13. Sales were up 18% year-over-year to $789 million and are now firmly above a $3 billion annual run rate. Having treated over 50,000 patients to date, we look forward to bringing our portfolio of medicines and future treatments across lines of therapies and tumor types to many more patients around the world.
Moving to Slide 14. Trodelvy sales for the first quarter exceeded $300 million, up 39% year-over-year, reflecting continued demand. Sequentially, sales were up 3%, primarily driven by demand outside the U.S. as well as unfavorable fourth quarter pricing dynamics in Europe that did not repeat. This was partially offset by inventory dynamics in the U.S. where we saw a drawdown in the first quarter.
Overall, Trodelvy’'s strong market share reflects its awareness amongst providers and patients. In second-line metastatic triple-negative breast cancer, Trodelvy remains the leading regimen with approximately 1/3 in the U.S. And in the pre-treated HR+/HER2- metastatic breast cancer setting, Trodelvy has demonstrated continued adoption, most notably in the IHC0 setting.
We are confident Trodelvy continues to differentiate itself with its safety profile and clinically meaningful survival benefits, with over 30,000 patients across tumor types already treated to date. We look forward to potentially extending Trodelvy’s reach to many more patients in the years ahead particularly in bladder cancer, earlier-line breast cancer settings, and lung cancer.
Turning to Slide 15, and on behalf of Cindy and the Kite team, Cell Therapy sales were $480 million in the first quarter, up 7% year-over-year. Sequentially, sales were up 3%, in-line with our guidance of flat to slightly up. We’'re pleased to see continued demand for Yescarta and Tecartus in both existing and new markets across Europe and other geographies, such as in Japan where we have seen good progress in growing brand share and expanding our network of authorized treatment centers to over 20 to date.
In the U.S., and consistent with our recent updates, we see opportunity for growth through expanding the number of authorized treatment centers and affiliated satellites, while also driving increased referrals from the community setting.
For example, we're proud to have established our flagship community collaboration with Tennessee Oncology in the first quarter. We’'ve identified many critical learnings on how we can partner effectively with community oncology practices for cell therapy, and we will continue to refine this “blueprint” so that we become more efficient at onboarding new centers over time. We expect to start seeing the Impact from this initiative towards the end of 2024.
Wrapping up the first quarter, we had a strong start to the year, primarily driven by higher demand across each of our core businesses year-over-year.
We look forward to carrying this momentum through 2024 and as we bring seladelpar to market later this year following approval. I’d like to thank the commercial teams and cross-functional partners across Gilead and Kite for their strong execution as we diligently expand our therapies to new populations, positively impacting more people all around the world.
And with that, I’'ll hand the call over to Merdad.
Merdad Parsey: Thank you, Johanna. We have had a busy first quarter at Gilead, with a cadence of clinical readouts that will continue throughout the rest of the year. Importantly, we anticipate an FDA regulatory decision on seladelpar and 3 Phase III updates across HIV prevention, bladder cancer, and breast cancer.
Starting on Slide 17, we continue to progress our industry-leading Virology pipeline, which is building momentum following a data-rich presence at CROI in March. This included robust virologic suppression data from our once-daily oral combination of bictegravir with Lenacapavir from the Phase III portion of the ARTISTRY-1 trial.
This novel combination has the potential to benefit people with HIV on complex regimens. We have since started 2 Phase III trials of this combination, one in virologically suppressed individuals and another in virologically suppressed treatment-experienced individuals. We expect to complete enrollment in the first half of 2025.
We also have 2 once-weekly oral programs: first, a combination of lenacapavir with Merck’s NRTTI, islatravir, in virologically suppressed people with HIV, expected to advance into Phase III later this year. And second, a combination of a capsid inhibitor with GS-1720, our novel oral integrase inhibitor. We're working to advance this combination into a Phase III study. This second program has the potential to be the first once-weekly oral regimen containing an INSTI agent. INSTIs are the standard-of-care treatment for HIV, and an important treatment option for clinicians who continue to prefer INSTI-based regimens.
Finally, we presented Phase Ib data from our twice-yearly parenteral program of lenacapavir plus our 2 broadly neutralizing antibodies for people with HIV at CROI, and we intend to share data from the Phase III study in the second half of this year.
Moving to PrEP, we plan to share an update from our Phase III PURPOSE-1 trial in the second half of this year. Data from PURPOSE-01, together with data from PURPOSE-2, is expected to support the filing of Lenacapavir for HIV prevention. This PrEP option would not only offer a convenient dosing schedule as the first twice-yearly subcutaneous regimen, but could also be transformative in terms of adherence to HIV prevention regimens.
Turning to Slide 18. Our Trodelvy program continues to be evaluated across a range of solid tumors with 7 Phase 3 trials currently underway across breast, bladder, and metastatic non-small cell lung cancers with plans to start the Phase III trial in endometrial cancer later this year.
Abstract titles were just released yesterday for the upcoming ASCO meeting, and we'’re pleased to have over a dozen Oncology presentations this year. We will be presenting late-breaking Phase III data from our second-line plus metastatic non-small cell lung cancer trial, EVOKE-01. Updated data from first-line, PD-L1 high subjects in Cohort A of the Phase III EVOKE-02 trial will also be shared. We plan on providing updates from Cohorts C and D, evaluating Trodelvy plus pembro and chemotherapy in PD-L1 all-comers at a medical congress in the second half of this year. In addition, presentations for both the Phase III EDGE-Gastric trial and Phase III ARC-9 studies will be highlighted.
Depending on the timing of event accruals, we anticipate 2 more Phase III updates this year for Trodelvy. These include overall survival data from our confirmatory Phase 3 bladder cancer study, TROPiCS-04, that could support Trodelvy’s submission for full regulatory approval in the U.S. and enable ex-U.S. filings.
In TNBC, where Trodelvy is the only ADC to have demonstrated statistically significant improvement in overall survival in the second-line setting, we expect to share an update on the Phase III ASCENT-03 trial in first-line PD-L1 negative patients later this year.
Moving on to Cell Therapy. I’'m pleased to share Kite's approach to the development of novel cell therapies that Cindy and the team presented at last month’'s investor event. As you can see on slide 19 Yescarta and Tecartus established Kite as the leader in Cell Therapy, and we plan to potentially extend this leadership into multiple myeloma, while also paving the way for innovative next-generation constructs.
On anito-cel in later-line multiple myeloma, we expect to provide a Phase III iMMagine-1 trial update in the second half of this year. This update follows the highly encouraging Phase I data presented at ASH last year, where anito-cel demonstrated durable responses with median progression-free survival not yet met at 26.5 months median follow-up –and no cases of parkinsonian symptoms observed in the trial.
For our next generation cell therapy assets, we have bicistronic and optimized manufacturing constructs in Phase I trials, which are aimed at overcoming resistance mechanisms, providing potentially deeper and more sustained responses, and improving product potency. Beyond that, we have early research in allogeneic and in vivo CAR, with plans to expand into a range of other disease areas –such as multiple myeloma with anito-cel, solid tumors, and autoimmune diseases.
Moving to Inflammation on Slide 20. We recently completed our acquisition of CymaBay and added seladelpar, an investigational PPAR-delta agonist to our portfolio. In Phase III clinical trials, seladelpar demonstrated significant improvement in both pruritus and markers of cholestasis related to the risk of progression for PBC. As previously announced, FDA and EMA accepted our regulatory filings for seladelpar for the management of PBC in certain adult patients. We anticipate an FDA regulatory decision by August 14th and a decision from European regulators early next year. We continue to work with global regulatory authorities to expand the reach of seladelpar for PBC patients.
Further, as we look at the rest of our Inflammation pipeline, we have several early phase assets that have progressed into Phase II trials, including our potentially first-in-class oral TPL2 inhibitor, a potentially best-in-class oral alpha-4-beta-7 anti-integrin, and an oral IRAK4 inhibitor.
Wrapping up on Slide 21. We continue to progress on our clinical milestones for the year, and we have had 2 First Patients in and 1 data readout completed in the first quarter and we remain on-track for our remaining milestones.
And now, I’'ll hand the call over to Andy.
Andrew Dickinson: Thank you, Merdad, and good afternoon, everyone. Beginning on Slide 23. It was a strong start to the year with our base business up 6% year-overyear. The solid growth achieved across HIV, Oncology, and Liver Disease offset the decline in Veklury, with total product sales up 5% year-over-year to $6.6 billion. As expected, our base business was down quarter-over-quarter, primarily driven by seasonal inventory and pricing dynamics in HIV.
Moving beyond our revenue results, 2 items significantly impacted our EPS performance in the first quarter, as shown on Slide 24. First, our GAAP and non-GAAP results included an acquired IPR&D charge of $3.9 billion or $3.14 per share, associated with the close of the CymaBay acquisition. As an asset acquisition, this transaction was fully expensed in the first quarter. This was a nondeductible expense item, and as a result, impacted our effective tax rate. Excluding this expense, our non-GAAP EPS would have been $1.82 for the first quarter, above expectations primarily driven by higher sales.
The second item shown on the right hand side is an impairment charge that is included in our GAAP results and excluded from our non-GAAP results. As a reminder, this relates to the carrying value of the IPR&D indefinite-lived intangible assets acquired from Immunomedics.
At the end of 2023, the carrying value was $5.9 billion, all associated with non-small cell lung cancer. As a result of the EVOKE-01 readout in late January, we have re-assessed and reduced the remaining value to $3.5 billion. This primarily reflects the smaller addressable market that Trodelvy could serve among 2L+ metastatic non-small cell lung cancer patients, a delay in expected launch timing, and associated competitive activity.
We remain confident that Trodelvy will deliver attractive returns over time, with sales now exceeding $1 billion a year, a strong IP portfolio, and a development program with multiple shots-on-goal in new indications as well as earlier-lines of therapy, including some opportunities not included in the initial deal model. In the meantime, you can see that the impairment impacted our first quarter GAAP EPS by $1.46 per share.
Moving to the rest of our non-GAAP results on Slide 25. For the first quarter, product gross margin was down modestly to 85.4%, primarily due to product mix. R&D and SG&A were each down 2% year-over-year. This is the second consecutive quarter of operating expense declines on a year-over-year basis, reflecting our continued focus on disciplined expense management. Our effective tax rate in the first quarter was a negative 30%, reflecting the nondeductibility of the CymaBay acquired IPR&D charge.
Overall, our diluted earnings per share was a negative $1.32 compared to a positive $1.37 for the same period last year, primarily reflecting the $3.14 per share expense related to the CymaBay acquisition.
Switching to full-year guidance on Slide 26. There is no change to our revenue expectations for 2024 at this time. We continue to expect total product sales in the range of $27.1 to $27.5 billion; and we continue to expect total product sales, excluding Veklury, in the range of $25.8 to $26.2 billion, representing growth of 4% to 6% for our base business year-over-year. Additionally, there is no change to our Veklury guidance of approximately $1.3 billion for the full year. As discussed last quarter, we do not expect to update our Veklury guidance until our third quarter earnings call, absent a very clear trend in COVID-19 infections.
Shifting to the other parts of the P&L for 2024 on a non-GAAP basis. There is no change to our gross margin guidance where we continue to expect product gross margin in the range of 85% to 86%. We now expect R&D to grow at the higher end of our previous low-to-mid single digit growth range, reflecting the incremental expenses associated with the CymaBay acquisition.
We continue to expect SG&A expenses to decline a mid-single digit percentage relative to 2023. On a dollar basis, SG&A is expected to be modestly higher than our previous SG&A expectations as we incorporate CymaBay expenses. However, we can manage this within the window of the previously-issued operating expense guidance. Acquired IPR&D is now expected to be approximately $4.4B, due to the CymaBay transaction as well as milestones anticipated throughout the rest of the year.
Operating income is now expected in the range of $7 billion to $7.5 billion, reflecting the updated acquired IPR&D guidance and the modest increase to operating expenses associated with the CymaBay transaction. Given the non-deductible impact of the CymaBay acquisition, the effective tax rate for 2024 is expected to be approximately 30%. This includes a negative impact of approximately 11% from the one-time charge for the acquisition of CymaBay. We therefore now expect diluted EPS in the range of $3.45 to $3.85. As shown on Slide 27, this has only been updated to reflect the transactions that were closed in the first quarter of 2024. Excluding these charges, you can see that we are comfortably within the range of the EPS guidance we shared back in early February. On a GAAP basis, we expect full year 2024 diluted EPS to be in the range of $0.10 and $0.50.
Moving to Slide 28. Our capital allocation priorities remain unchanged with sufficient flexibility in our balance sheet. Specifically, as demonstrated in the first quarter, we announced a 2.7% increase to our quarterly dividend and returned approximately $1.4 billion to shareholders. In addition, we acquired CymaBay for $4.3 billion, adding seladelpar to our portfolio. Overall, we’'ll continue to be disciplined in our use of capital. And while we will continue to be flexible and opportunistic–, it is unlikely that Gilead will be engaging in any sizeable M&A transactions in the near-term.
Before I wrap it up, on Slide 29, a quick note on our expectations now that the CymaBay transaction has closed. Pending regulatory approval, we expect to launch seladelpar in the U.S. before the end of 2024, as Johanna highlighted earlier, with a modest revenue contribution expected this year.
Additionally, we have shared that the transaction is expected to add to operating expenses this year as we make incremental investments to support the launch as well as other R&D efforts, all of which we are able to manage within the window of the previously-issued operating expense guidance.
And as we look ahead, while the transaction will be dilutive to our EPS this year, we expect the deal to be breakeven to earnings in 2025, and significantly accretive in 2026 onwards.
And now, I’'ll invite Rebecca to begin the Q&A.
Operator: [Operator Instructions]
Our first question comes from Chris Schott at JPMorgan.
Christopher Schott: Just had a question on the HIV franchise and the impact from the Medicare redesign as we think about 2025, I know this is coming from more and more conversations. Can you just talk a little bit about how you're thinking about that impact to your franchise? And maybe just more broadly, can we directionally still think about top line growth and margin expansion for Gilead next year despite this headwind? So any color you can provide there would be appreciated.
Daniel O'Day: Great, Chris. Welcome, everybody. This is Dan. I'm going to have Johanna cover this question. Thank you.
Johanna Mercier: Thanks, Chris, for the question. So we do expect an impact of the Part D redesign to be weighted towards our HIV business and expect our HIV growth in 2025 to be offset by the Part D redesign impact. So as a result, we expect our HIV sales to be roughly flat year-on-year in 2025. Having said that, overall, we expect our total business to grow despite the impact of the Part D we designed in 2025 with the top line, building momentum in 2020 -- beyond 2025, right, '26 and beyond. So we do expect growth in '25, but our HIV business, the demand of HIV will offset the impact of Part D.
Andrew Dickinson: Chris, it's Andy. I'll take the question on margin expansion. As you know, we don't provide more specific guidance for 2025 beyond what Johanna just mentioned. What we have said historically, and I've underscored, is that we are very focused on disciplined expense management. That will be true in 2025 as it is today. You've seen that in the last 2 quarters. I think on a non-GAAP basis for this quarter, if you look at our operating margin, if you strip out the CymaBay transaction, you see an improvement in our operating margin and we expect that to continue over time. So we do expect broadly for our operating margin to improve over time as you see the continued top line growth and the disciplined expense management. So thanks for the question. More details, of course, to be provided at early next year when we provide our 2025 guidance specifically.
Operator: Our next question comes from Daina Graybosch at Leerink Partners.
Daina Graybosch: It's for Kite. FDA's ODAC recently had 2 important meetings of relevance for multiple myeloma and CAR-T there. One, dealt with the early death risk from CARVYKTI and ABECMA. And the second was to recommend MRD as an intermediate endpoint for accelerated approval in multiple myeloma. And I wonder how you're thinking about both of these ODACs in relation to anito-cel in your earlier line trial design.
Daniel O'Day: Thanks, Daina. We've got Cindy Perettie here, so we'll go right over to her.
Cindy Perettie: Thanks, Daina. So if I start off with the early line ODAC, I think we believe this is positive for everybody. What it's shown is that people recognize the value of having CAR Ts therapies earlier in their disease. They value the disease-free intervals that they get from that. So we were very happy to see that. I think we were equally as excited to see the second ODAC around MRD, minimal residual disease, as a secondary -- as an additional endpoint. I think the piece around this is that we're really encouraged that the ODAC decision is going to open up the door for us to potentially bring anito-cel to market faster for patients. And we're in the process right now of understanding how the MRD surrogate endpoint can be used with regulatory agencies and the application of our program and so more to come on that front.
Operator: Our next question comes from Umer Raffat of Evercore ISI.
Umer Raffat: I just thought I'll spend a quick second on CymaBay given the recent deal. My question is, did Gilead, during the diligence process, deploy independent pathologists to evaluate the cases of "possible" liver pathology that happened in the NASH trial previously as well as the paired liver biopsy data from the PBC trial at the lower dose where CymaBay didn't think it would need safety adjudication? I'd be very curious how you guys did that and if you would ever publish that.
Daniel O'Day: Merdad is here, so I'll let him answer.
Merdad Parsey: Thanks, Umer. Let me start by saying we think seladelpar is one of those medicines that will bring a lot of benefit to patients and really some near-term expansion of our liver portfolio and our -- and what we think will synergize with many of the other -- much of the other work that we're doing in liver disease overall.
We obviously did thorough diligence in our approach to seladelpar and CymaBay. We didn't do a third -- I think your question was around whether we did an independent third-party review of the pathology. We did not do that. However, we did a lot of thorough diligence on the data itself and the outcomes. And we are confident around the outcome and what it means for patients over time.
Obviously, we're waiting right now the -- our upcoming PDUFA date and also the file in the EMA, which we are optimistic about. And following the questions and all those sorts of items that we're in. So we're looking forward to providing an update on that as those filings proceed.
Operator: Our next question comes from Tyler Van Buren at TD Cowen.
Tyler Van Buren: I was hoping you could help set expectations for EVOKE-01 and 02 presentations at ASCO. For EVOKE-02, the late breaker tag is interesting. So is that related to the 3-month OS benefit in the PD-1 refractory patients? Or could we -- or should we be expecting something more? And for EVOKE-02, what should we hope to see with the Cohort A data that should leave us confident in the EVOKE-03 readout next year?
Merdad Parsey: Thanks, Tyler, it's Merdad again here. So it's a little challenging because I can't share too many details now because we're under embargo for both of those. And obviously, happy to fill in a lot of the blanks once the data are released, and we can talk about it in ASCO. I think for EVOKE-01, we think there are a number of pipeline updates in our ASCO presentations that we have upcoming, which were -- we see as a real change for us and a real evolution of our pipeline overall and our ability to build our oncology pipeline and bring new options for patients.
As part of the late breaker session for EVOKE-01, as you mentioned, we will include data on overall survival, on PFS, ORR and duration of response as well as the safety profile, of course. And I wish I could give you more details, but I can't at this point. As you say, we will also be providing other updates there, including the EVOKE-02 Cohort A data looking at the PD-L1 high non-small cell population. And again, it's -- I can't really talk about the details of those data, but we are looking forward to sharing those results with everyone and talking about the implications of that for our broader lung cancer and especially the frontline lung cancer EVOKE-03 study that we are conducting right now is underway with our partners at Merck.
Operator: Our next question comes from the line of Geoff Meacham at Bank of America.
Geoffrey Meacham: Merdad, a question for you. On the cell therapy front, you usually have the anito-cel update later this year, which is big. But beyond that, I wasn't sure what the priority was among the next-gen CAR assets that you've got kind of cartooned on Slide 19. There's a lot of competition in this space, but you guys are among the only players that have real scale and you could move the next-gen stuff, I think, pretty fast. But if you had to pick sort of a priority list, will be good to know.
Daniel O'Day: Thanks, Geoff. This is Dan. We're going to have Cindy Perettie answer that question, if you don't mind. So Cindy, over to you.
Cindy Perettie: So we have 3 products right now, or 3 constructs that are in Phase Ia and b clinical trials. The first one is a bicistronic CD19, CD20 that has 41BB and CD28. The second one is that same construct with fast manufacturing, 3-day manufacturing. And the other one is a CD19 like Yescarta with 3-day manufacturing. So we're looking at all 3 of those in parallel with the goal of picking the winner to advance that rapidly into our pivotal trials. So that's what's coming up next. Obviously, we've shared a lot around anito-cel as well. With anito-cel, we have the iMMagine-1 readout, and we expect to move quickly into earlier lines as it relates to anito-cel, and you'll hear more about that later this year. Hopefully, that answers your question. We certainly have a number of plays in early research, but we would plan to advance our next-generation lymphoma assets quickly. And obviously, with the scale that we have at Kite as well as the integrated fact that we can create the vector as well as the construct in-house.
Operator: Our next question comes from Michael Yee at Jefferies.
Michael Yee: Following up on the Trodelvy data coming at ASCO and your enthusiasm for frontline, can you just remind us, a, do you believe that your data in EVOKE second line that will be at ASCO is at least as competitive or better than Astra, and that is why you're excited about frontline? And b, if you are, do you have a triple therapy on top of chemo combo or is your whole first-line strategy just on top of PD-1?
Merdad Parsey: Thanks, Michael. This is Merdad again. As we've noted, I think, and as you talked about, the EVOKE-01 data in second line will be something that we discuss at ASCO and show those data. And the full data set is -- does motivate us to go forward in lung cancer and including with discussions with regulators. The unmet need in this population is great, and the data give us options, including discussions with health authorities and conducting follow-up trials. We'll be able to share more once the data are provided at ASCO, and so we look forward to having those deeper discussions once we can speak directly to the data.
And I'm sorry, and the second part of your question was around the front line. Again, I think once we are able to share the EVOKE-02 data, the update on EVOKE-02 data, we'll be able to talk more. But it does continue to allow us to think about the frontline and our confidence around about EVOKE-03. And then the last part of your question on other combinations. We do think about our intra-portfolio combinations. For example, we have a combination of dambinelumab and Trodelvy in a trial where we're looking to see if we can get additional efficacy from those sorts of combinations. So we do continuously look at our portfolio and look for opportunities for moving the needle with combinations from within our portfolio.
Operator: Our next question comes from Salveen Richter of Goldman Sachs.
Salveen Richter: So you currently have about $5 billion in cash and noted leverage is back to pre-Immunomedics deal levels. How are you thinking about meaningful or bolt-on BD post the CymaBay acquisition? And is there any preference now between virology, I&I and oncology?
Andrew Dickinson: Salveen, it's Andy. Maybe I'll start with that one. In our prepared remarks, I highlighted that in the near term, we don't expect sizable M&A.
So we have a lot of execution ahead of us. We have a deep portfolio, a lot of growth drivers, including seladelpar. So we're very clearly highlighting that in the short term, we will continue to do ordinary course business development, the standard licensing deals. You saw a couple of those in the first quarter. But it's unlikely that we'd pursue any meaningful M&A in the near term. We've also said historically that deals like CymaBay are exactly what we're looking for and that we should do deals like that on a regular basis over the cycle and whether that's every 2 years on average or more or less, that's a general ballpark. So I think you're appropriately highlighting we have -- we generate a lot of operating cash flow. You saw that again in the first quarter. We will rebuild our cash over time. We're going to continue to invest in the pipeline. But at least in the short run, we don't expect any meaningful M&A in the short run.
Daniel O'Day: And Salveen, this is Dan. Just to answer the end of your question. I mean, we're always therapeutic area agnostic when we approach these. I mean, first of all, we've got robust portfolios around both urology and oncology and a building portfolio in inflammation. So we look, frankly, across those spectrums. Seladelpar is a great example of finding an opportunity within our liver disease or -- franchise and be able to use that channel. But equally, we'll look for opportunities and synergies that complement our portfolio across therapeutic areas. And that's our approach. We think that makes sense. We look for the most attractive science. And as Andy said, we have a lot in our hands now to work through and to execute on. And so we'll keep the bar very high.
Operator: Our next question comes from James Shin at Deutsche Bank.
James Shin: I wanted to ask on Trodelvy's efforts in HR+/HER2-. DESTINY-Breast06 is going to have data pretty soon it seems. And you also have ASCENT-07. Sort of sounds similar to DESTINY-Breast04 versus TROPiCS-02. Can you share like how you think this landscape will play out with these 2 trials?
Merdad Parsey: Thanks for the question, James. Well, it's -- I've learned to try to keep away from prognostication. So that's harder to do. We -- look, maybe the way I would put it is we are proud of the fact that Trodelvy is still the only TROP2 ADC that is approved, and that is in large part driven by the important role that Trodelvy plays in breast cancer right now for patients. And we do continue to want to push that, along with the ASCENT-07. We have a number of other trials ongoing to expand our footprint in breast cancer. I think we are right now in TNBC, the leading regimen.
And as we are continuing to advance our HR+/HER2- and in particular, in the IHC-0 population, I think we remain confident around our place there. We've shown a benefit in randomized clinical trials there, and that's been the basis for our regulatory filings and approvals. So I don't think we can assume success. We'll have to see what the data are. But looking forward into the year that's coming with ASCENT-03 coming up, I think that will provide us additional information to further expand our potential in breast cancer. Johanna, do you want to add?
Johanna Mercier: Maybe just to add to that. I would also say that the more options these patients have, these women have, in HR+ in earlier lines of therapy instead of cycling through chemotherapies, the better. So with DB06 results and moving potentially that compound up earlier, it actually allows for Trodelvy to also play a more important and a bigger population than it is today because of the profile of the TROPiCS-02 label. And so we do believe that there's opportunities for this ADC to move up and also differentiate itself versus other ADCs in this marketplace, depends effect profile, the safety profile, not only on the efficacy. And so in light of the IHC-0 setting being really our strong foothold in HR+/HER2-, we believe that will continue, whether that's in later lines of therapy or earlier lines of these studies play out.
Operator: Our Next question comes from Mohit Bansal, Wells Fargo.
Mohit Bansal: Maybe a big picture question, if you think about medium to longer term because, I mean, yes, you do not have an LOE. But I mean, HIV growth is somewhere around low single digits. And oncology, I mean, again, I mean, it dropped too and all. The expansion opportunities seem limited at this point. So just trying to understand how do you turn this low single digit to more like a high single-digit kind of growth for overall company? CymaBay is definitely an addition, but how are you thinking about it from medium to long term, which probably people like us are missing?
Daniel O'Day: Mohit, maybe I'll start and then have others add. First of all, I think just stepping back and thinking about the portfolio that we've built over the past 4 years now more than doubling the size of the portfolio and with significant advances in our HIV portfolio and oncology and with outside of cell therapy. So as we think about growth moving forward, I mean, first of all, I would say on the HIV side of the business, we have to constantly remind ourselves and others that in addition to the treatment market and the potential for long-acting treatment that we have a very robust program on, and we'll update you a little bit more on towards the second half of this year with an analyst event, we've got the PrEP market that is just beginning to kind of be dimensionalized.
And that is -- I think that provides significant growth opportunity when you think about your time frame, which you mentioned, which is until the end of the decade. So I think it allows us to think about accelerated HIV total growth prevention and treatment as we head towards the second half of the decade. That -- on top of that, then we have the entirety of the oncology portfolio. So both cell therapy within the large B-cell lymphoma area as well as potentially the multiple myeloma entry with the anito-cel. And then on top of that, a very robust oncology portfolio that has both Trodelvy and other novel agents that we'll read out over the course of this decade. And I'll just remind you, again, we've got close to 20 readouts this year, of which 3 of those are in Phase III, including lenacapavir for prep in the second half of this year, 2 Trodelvy Phase III readouts. And then importantly, we've added seladelpar to the mix with a PDUFA date in August.
And then finally, just the opportunity to update you on the anito-cel at the end of the year as well. So we'll be providing more guidance as we continue to look at the entirety of our portfolio, but we really think we have within the company today, by the way, I'll just mention, in addition to complementing where needed from the outside. But within the company today, we have what it takes to drive a substantial growth in our business over the course of the next decade with focus on expense management as well to produce good returns for investors.
Operator: Our next question comes from Simon Baker at Redburn Atlantic.
Simon Baker: One on seladelpar, if I may. And a question really around the competitive dynamics at launch. If all goes according to plan, your launch in August and Ipsen will launch Elafibranor in June. So I was just wondering if that really makes any difference. You've obviously got far greater infrastructure than Ipsen. Is it too early for them to steal in March? Or paradoxically thus having somebody else on the market promoting PBC actually raise disease awareness and help the situation? So any color around the dynamics at launch would be very helpful.
Johanna Mercier: Thanks, Simon. It's Johanna. Let me take that one. And I think you're absolutely right. I think the fact that there is more than one competitor hitting the market is great for patients namely around increasing disease awareness around PDC and the fact that there are 2 options available. Having said that, I also feel incredibly confident that seladelpar is well differentiated to potentially be best in disease when you think about the significant impact and clinically meaningful impact we have with the ALP normalization in the clinical jet Phase III clinical trial we've seen as well as the improvement in pruritus which is a key symptom of the disease. And today, there really is no effective antipruritic options for PBC patients. And so all of that put together, in addition to the fact that we believe our footprint, both commercial and medical is incredibly well established when it comes to liver disease. It already covers about 80% of all U.S. PBC prescribers. And with that strong differentiated profile we were just referring to, I don't think those 3 months make a difference. I think really it's about best-in-class launch and that potential with seladelpar that we look forward for our PDUFA date.
Operator: Our next question comes from Brian Skorney at Baird.
Unknown Analyst: This is Charlie on for Brian. So again, to ask something about seladelpar. Just wondering if you have any ambitions for potentially looking at a label for first line in the future, considering there's a lot of unmet need with pruritus there. As well as any potential synergies you may be considering with the remainder of your liver portfolio?
Merdad Parsey: Thanks, Charlie. This is Merdad. Frontline is a challenge given the -- what is currently the background standard of care. But as you know, we think that seladelpar is going to bring a lot of benefit to a lot of patients, especially given the pruritus and the potential for getting to patients earlier in their course will be really important for us. And so we have to see how the market starts to respond to the presence of seladelpar in the second line. And recall, I think the other thing to recall or think about is the -- how long people actually get frontline therapy before moving on to second-line therapy, given the efficacy profile of the frontline therapies and the fact that there haven't been any options, one could anticipate that patients are moved to second-line therapy relatively early in their treatment course and making -- moving up formally for registrational trials to the frontline potentially superfluous. So I think we'll see how that plays out in the market. And once we see our label and all those sorts of things, so we'll be able to update more after that.
Operator: Our next question comes from Brian Abrahams at RBC Capital Markets.
Brian Abrahams: PURPOSE 1 is obviously an upcoming readout. So I wanted to clarify some elements of its unique design, specifically what's the sensitivity of assessing when HIV infection occurred to accurately project the control infection rate? And then how do you control for potential intrinsic differences in risk behavior that the screened out group serving as the control may have versus individuals who are -- who make it into the trial?
Merdad Parsey: Brian, thanks, it's Merdad again. And I could talk about this for a long time. Let me -- I'll try to give a very concise answer. The recency assay that's been developed for HIV, it has been studied very thoroughly, and we can, based on the diagnosis at the time of screening, create a profile for anyone who's potentially HIV infected at that time as to how recently they were infected. And I think that's a key part. And that relates to the second part of your question in that the -- we don't, in a sense, need to compare risk behaviors before and after randomization and that we'll be looking at the overall incidence of HIV at the time of screening and then comparing in this counterfactual design with what happens after people start therapy. So I think between those 2 elements and all the discussions we've had with the regulators and the experts in the field, we're confident in that the design will provide the information necessary to get us to approval and for adoption.
Operator: Our next question comes from Terence Flynn at Morgan Stanley.
Terence Flynn: Great. Two parts on the CAR-T franchise. So just was wondering, high level, your comment to a anito-cel if it proves there is parkinsonism, so meaning it's less differentiated. And then the second part is, curious where your progress stands with respect to developing the CAR-T for immunology. Obviously, a lot of focus here amongst a number of other companies in the industry. So just curious on Gilead's thoughts on the [ floor ].
Cindy Perettie: Thanks, Terence, for the question. So on the commitment to anito-cel, we're -- as it relates to Parkinson's, we absolutely feel that we're differentiated potentially on both safety and efficacy. As we noted earlier, we have not observed the neurotox that some of the other constructs have observed, and we'll continue to monitor it, but we feel great about the profile right now. And then the efficacy profile, early signals are we think we will be equivalent or could be best-in-class. So we're 100% behind anito-cel and we're looking forward to bringing those data soon.
The second question around autoimmune space. So we continue to monitor the autoimmune space. And as you've heard from Andy and others before, we will play in that space. We are taking time to take a look at what's in the space versus what we have in our portfolio, and we'll be -- I don't have any updates further than that today.
Operator: Our last question comes from Carter Gould at Barclays.
Carter L. Gould: Maybe just to round things out on cell therapy, you flagged the same dynamics that have been kind of persisting in the U.S. as far as the -- some of the constraints of the ATCs. I also saw the Tennessee oncology reference. But I guess putting that all together, just your level of confidence you sort of hit that return to more meaningful growth in the second half of the year. I didn't hear that mentioned and clearly, that's a point of focus. Any commentary there would be appreciated.
Cindy Perettie: Yes. No, we feel very confident that we're going to return to growth in the second half of the year, as we stated. I think just as a reminder, we had shared in quarter 4 our guidance was that we'd be flat to slightly down in quarter 1. And part of that is due to the restructure. So we are putting our strategy into play. We feel very confident about the approach we're taking in the U.S. And we now are looking at having almost a fully stacked sales team back out and working hard. I think a piece that we need to talk about as well as the market dynamics. So the things we're observing. We're observing out-of-class competition with the bispecifics, the ATC constraints that we've spoken about in the past based on multiple myeloma constructs coming in. But what we're seeing is a lot of the hospitals and ATCs are working through those constraints, and we feel really confident about the second half of this year.
Daniel O'Day: Thank you, Cindy. This is Dan again. So I appreciate all of you joining. Maybe just a bit of a summary statement. I want you all to know we at Gilead are very focused on the near-term execution and the long-term plans. We'll continue to stay disciplined and agile in our approach. Just as highlights, we've got 54 active clinical programs, no major patent expiries through the end of the decade, a variety of opportunities for growth and a lot more to deliver. On top of that, we are on track to provide updates from 3 Phase III clinical trials for Trodelvy, lenacapavir. We've got the seladelpar PDUFA date in August. Any update on the anito-cel Phase II update with the management we'll have at the end of the year. So rest assured that we are firmly focused on the many opportunities we have, and we have a lot more potential to deliver. With that, I'll hand over to Jacquie for closing comments.
Jacquie Ross: Thank you, Dan. To close, just one housekeeping item. I can share that we are tentatively planning to release our second quarter 2024 earnings results on Thursday, August 8. Please note that this is day is provisional and could be changed to accommodate scheduling conflicts that arise between now and then. As always, we will announce our confirmed date following the close of the second quarter. We appreciate your continued interest in Gilead and look forward to updating you on our progress throughout the quarter. With that, we'll close our call for today. Thank you. |
GOOG | 1 | 2,024 | 2024-04-25 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet First Quarter 2024 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's First Quarter 2024 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler, and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations, and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now I'll turn the call over to Sundar.
Sundar Pichai: Thank you, Jim, and hello, everyone. It was a great quarter led by strong performance from Search, YouTube, and Cloud.
Today, I want to share how we are thinking about the business and the opportunity more broadly. Of course, that's heavily focused on AI and Search. Then I'll take you through some highlights from the quarter in Cloud, YouTube and beyond.
Let's discuss our momentum and strategy. Taking a step back, it took Google more than 15 years to reach $100 billion in annual revenue. In just the last 6 years, we have gone from $100 billion to more than $300 billion in annual revenue. Of course, Search continues to power that as you see in our Q1 results. But in addition, we expect YouTube overall and Cloud to exit 2024 at a combined annual run rate of over $100 billion. This shows our track record of investing in and building successful new growing businesses.
Now let's look at how well we are positioned for the next wave of AI innovation and the opportunity ahead. There are 6 points to make: one, research leadership; two, infrastructure leadership; three, innovation in Search; four, our global product footprint; five, velocity in execution; six, monetization paths.
First, our foundation of research leadership. We've been an AI-first company since 2016, pioneering many of the modern breakthroughs that power AI progress for us and for the industry. Last week, we further consolidated teams that build AI models under Google DeepMind. This will help simplify development and establish a single access point for our product teams as they build generative AI applications with these models. The teams are making rapid progress, developing Gemini and other models.
In February, we rolled out Gemini 1.5 Pro, which shows dramatic performance enhancements across a number of dimensions. It includes a breakthrough in long context understanding, achieving the longest context window of any large-scale foundation model yet. Combining this with Gemini's native multimodal understanding across audio, video, text code and more, it's highly capable. We are already seeing developers and enterprise customers enthusiastically embrace Gemini 1.5 and use it for a wide range of things. Beyond Gemini, we have built other useful models, including our Gemma open models as well as image and visual models and others.
Second, infrastructure leadership. We have the best infrastructure for the AI era. Building world-leading infrastructure is in our DNA, starting in our earliest days when we had to design purpose-built hardware to power Search. Our data centers are some of the most high-performing, secure, reliable, and efficient in the world. They've been purpose-built for training cutting-edge AI models and designed to achieve unprecedented improvements in efficiency. We have developed new AI models and algorithms that are more than 100x more efficient than they were 18 months ago.
Our custom TPUs, now in their fifth generation, are powering the next generation of ambitious AI projects. Gemini was trained on and is served using TPUs. We are committed to making the investments required to keep us at the leading edge in technical infrastructure. You can see that from the increases in our capital expenditures. This will fuel growth in Cloud, help us push the frontiers of AI models and enable innovation across our services, especially in Search.
AI innovations in Search are the third and perhaps the most important point I want to make. We have been through technology shifts before, to the web, to mobile, and even to voice technology. Each shift expanded what people can do with Search and led to new growth. We are seeing a similar shift happening now with generative AI. For nearly a year, we've been experimenting with SGE in search labs across a wide range of queries. And now we are starting to bring AI overviews to the main Search results page. We are being measured in how we do this, focusing on areas where gen AI can improve the search experience while also prioritizing traffic to websites and merchants.
We have already served billions of queries with our generative AI features. It's enabling people to access new information, to ask questions in new ways and to ask more complex questions. Most notably, based on our testing, we are encouraged that we are seeing an increase in search usage among people who use the new AI overviews as well as increased user satisfaction with the results. And with Circle to Search, people can now circle what they see on their Android screens, ask a question about an image or object in a video and get an AI overview with Lens.
Fourth, our global product footprint beyond Search. We have 6 products with more than 2 billion monthly users, including 3 billion Android devices. 15 products have 0.5 billion users, and we operate across 100-plus countries. This gives us a lot of opportunities to bring helpful gen AI features and multimodal capabilities to people everywhere and improve their experiences. We have brought many new AI features to Pixel, Photos, Chrome, Messages and more. We are also pleased with the progress we are seeing with Gemini and Gemini Advanced through the Gemini app on Android and the Google app on iOS.
Fifth, improved velocity in execution. We've been really focused on simplifying our structures to help us move faster. In addition to bringing together our model-building teams under Google DeepMind, we recently unified our ML infrastructure and ML developer teams to enable faster decisions, smarter compute allocation, and a better customer experience.
Earlier this year, we brought our Search teams together under one leader. And last week, we took another step, bringing together our platforms and devices teams. The new combined team will focus on delivering high-quality products and experiences, bolstering the Android and Chrome ecosystems, and bringing our best innovations to partners faster.
We also remain focused on long-term efforts to durably reengineer our cost base. You can see the impact of this work reflected in our operating margin improvement. We continue to manage our head count growth and align teams with our highest priority areas. This speeds up decision-making, reduces layers, and enables us to invest in the right areas.
Beyond our teams, we are very focused on our cost structures, procurement and efficiency. And a number of technical breakthroughs are enhancing machine speed and efficiency, including the new family of Gemini models and a new generation of TPUs. For example, since introducing SGE about a year ago, machine costs associated with SGE responses have decreased 80% from when first introduced in Labs driven by hardware, engineering, and technical breakthroughs. We remain committed to all of this work.
Finally, our monetization path. We have clear paths to AI monetization through Ads and Cloud as well as subscriptions. Philipp will talk more about new AI features that are helping advertisers, including bringing Gemini models into Performance Max. Our Cloud business continues to grow as we bring the best of Google AI to enterprise customers and organizations around the world. And Google One now has crossed 100 million paid subscribers, and in Q1, we introduced a new AI premium plan with Gemini Advanced.
Okay, those are the 6 points so now let me turn to quarterly highlights from Cloud and YouTube in a bit more detail. In Cloud, we have announced more than 1,000 new products and features over the past 8 months. At Google Cloud Next, more than 300 customers and partners spoke about their generative AI successes with Google Cloud, including global brands like Bayer, Cintas, Mercedes-Benz, Walmart and many more.
Our differentiation in Cloud begins with our AI hypercomputer, which provides efficient and cost-effective infrastructure to train and serve models. Today, more than 60% of funded gen AI start-ups and nearly 90% of gen AI unicorns are Google Cloud customers. And customers like PayPal and Kakao Brain are choosing our infrastructure. We offer an industry-leading portfolio of NVIDIA GPUs along with our TPUs. This includes TPU v5p, which is now generally available and NVIDIA's latest generation of Blackwell GPUs. We also announced Axion, our new Google design and Arm-based CPU. In benchmark testing, it has performed up to 50% better than comparable x86-based systems.
On top of our infrastructure, we offer more than 130 models, including our own models, open source models and third-party models. We made Gemini 1.5 Pro available to customers as well as Imagine 2.0 at Cloud Next. And we shared that more than 1 million developers are now using our generative AI across tools, including AI Studio and Vertex AI. We spoke about how customers like Bristol-Myers Squibb and Etsy can quickly and easily build agents and connect them to their existing systems. For example, Discover Financial has begun deploying gen AI-driven tools to its nearly 10,000 call center agents to achieve faster resolution times for customers. Customers can also now ground their gen AI with Google Search and their own data from their enterprise databases and applications.
In Workspace, we announced that organizations like Uber, Pepperdine University and PennyMac are using Gemini and Google Workspace, our AI-powered agent that's built right into Gmail, Docs sheets and more. We also announced Google Vids, a new application to create stories in short video format. And we introduced Gemini for Meetings and Messaging and Gemini Security for Workspace.
Customers are choosing Workspace because they have deep trust in our powerful security and privacy features.
Our Cloud business is now widely seen as the leader in cybersecurity. I saw this firsthand when I went to the Munich Security Conference in February. Cybersecurity analysts are using Gemini to help spot threats, summarize intelligence and take action against attacks, helping companies like American Family Insurance aggregate and analyze security data in seconds instead of days.
Turning next to YouTube, which continues to grow and lead in streaming. We announced that on average, viewers are watching over 1 billion hours of YouTube content on TVs daily. AI experiments like Dream Screen will give anyone the ability to make AI-generated backgrounds for YouTube Shorts. And on subscriptions, which are increasingly important for YouTube, we announced that in Q1, YouTube surpassed 100 million Music and Premium subscribers globally, including trialers. And YouTube TV now has more than 8 million paid subscribers.
Finally, in Other Bets, Waymo's fully autonomous service continues to grow ridership in San Francisco and Phoenix with high customer satisfaction, and we started offering paid rides in Los Angeles and testing rider-only trips in Austin.
Overall, it was a great quarter, and there's more to come. IO is in less than 3 weeks, followed by Brandcast and Google Marketing Live.
I want to thank our employees around the world who are at the heart of this progress and who continue to focus on building innovative products, helpful services and new opportunities for businesses and partners around the world. Thank you. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone.
Google Services revenue of $70 billion were up 14% year-on-year. Search and other revenues grew 14% year-on-year led again by solid growth in the retail vertical with particular strength from APAC-based retailers, which began in the second quarter of 2023.
YouTube Ads revenues were up 21% year-on-year driven by growth in both direct response and brand. Network revenues declined 1% year-on-year. In subscriptions, platforms and devices, year-on-year revenues increased 18%, driven again by strong growth in YouTube subscriptions.
Let's now talk about a few highlights from the quarter from a product innovation and advertising performance perspective.
First, it bears repeating that AI innovation across our Ads ecosystem is core to every aspect of our product portfolio, from targeting, bidding, creative, measurement, and across campaign types. We've talked about whole solutions like Smart Bidding use AI to predict future ad conversions and their value in helping businesses stay agile and responsive to rapid shifts in demand and how products like broad match leverage LLMs to match ads to relevant searches and help advertisers respond to what millions of people are searching for. This is foundational.
As advances accelerate in our underlying AI models, our ability to help businesses find users at speed and scale and drive ROI just keeps getting better. We're especially excited about the doors gen AI is opening for creative capabilities, helping deliver on the premise of getting the right ad to the right user in the right moment.
Look at Performance Max. In February, we rolled Gemini into PMax. It's helping curate and generate text and image assets so businesses can meet PMax asset requirements instantly. This is available to all U.S. advertisers and starting to roll out internationally in English, and early results are encouraging. Advertisers using PMax asset generation are 63% more likely to publish a campaign with good or excellent ad strength. And those who improve their PMX ad strength to excellent see 6% more conversions on average.
We're also driving improved results for businesses opting into automatically created assets, which are supercharged with gen AI. Those adopting ACA see, on average, 5% more conversions at a similar cost per conversion in Search and Performance Max campaigns.
And then there's Dimension. Advertisers are loving its ability to engage new and existing customers and drive purchase consideration across our most immersive and visual touch points like YouTube, Shorts, Gmail and Discover.
Hollywood film and TV studio, Lionsgate, partnered with Horizon Media to test what campaign type will deliver the most ticketing page views for its The Hunger Games: Ballad of Songbirds and Snakes film. Over a 3-week test, demand gen was significantly more efficient versus social benchmarks with an 85% more efficient CPC and 96% more efficient cost per page view. Lionsgate has since rolled out demand gen for 2 new titles.
We're also bringing new creative features to demand gen. Earlier this month, we announced new generative image tools to help advertisers create high-quality assets in a few steps with a few simple prompts. This will be a win for up-leveling visual storytelling and testing creative concepts more efficiently.
And then there's obviously Search generative experience, which Sundar talked about. I laid out that innovation and the user experience on Search has historically opened up new opportunities for advertisers. We saw this when we successfully navigated from desktop to mobile. We're continuing to experiment with new ad formats, including search and shopping ads alongside search results in SGE. And we shared in March how folks are finding ads either above or below the SGE results helpful. We're excited to have a solid baseline to keep innovating on and confident in the role SGE, including Ads, will play in delighting users and expanding opportunities to meet user needs.
Which brings me to Search and our strong performance in the first quarter. In Q1, retail was again the top contributor. Our focus remains on driving profitability and growth for retailers, helping them optimize digital performance for both online and off-line as well as innovate across our shopping and merchant experiences.
Highlights include continued upsides for retailers, leading into agile budget and bidding strategies across Search, PMax, or both; take-home goods retailer IKEA, who leaned into Google's store sales measurement to understand its total omnichannel revenue opportunity across search. By measuring 2.3x more revenue and using value-based bidding solutions to bid to its omnichannel customers, IKEA drove a significant increase in omni revenue in Q1 and is now scaling this strategy globally. We also expanded local inventory ads into 23 countries, helping drive shopper confidence and off-line sales. Retailers can convert intent into action by showcasing in-store availability, pricing, pickup options and more all in one ad format.
Moving to YouTube. Last quarter, I went deep into our strategy. It all starts with creation, which drives viewership, which leads to monetization. A few updates to build on Sundar's remarks.
First, creation, which is all about giving creators the tools to create amazing content, grow their audiences and build their businesses. In 2023, more people created content on YouTube than ever before, and the number of channels uploading Shorts year-on-year grew 50%. We also hit a new milestone with 3 million-plus channels in our YouTube Partner Program. We recently shared that YPP has paid out more than any other creator monetization platform, including over $70 billion to creators, artists, and media companies over the last 3 years.
From a viewer's perspective, watch time across YouTube continues to grow, with strength in both Shorts and CTV. According to Nielsen, YouTube has been the leader in U.S. streaming watch time for the last 12-plus months. In the first quarter, Livingroom. benefited from a combination of strong watch time growth, innovation in the user and advertiser experience, and a shift in brand advertising budgets from linear TV to YouTube. Viewers are watching YouTube because they expect to access everything in one place across screens and formats, their favorite creators, live sports, breaking use, educational content, movies, music and more. And advertisers continue to lean in to find audiences they can't find elsewhere.
Which brings me to monetization. We're pleased with our Q1 performance across both our ad-supported and subscription offerings. Sundar covered subscription growth. On the Ads front, direct and brand were both strong this quarter. Shorts monetization continued to improve, with Shorts ads now supported on mobile, tablet, Livingroom. and desktop, and available to both performance and brand advertisers.
In the U.S., the monetization rate of Shorts relative to in-stream viewing has more than doubled in the past 12 months, including a 10-point sequential improvement in the first quarter alone. Just last week, we introduced new ways for brands to get the most out of their Shorts ads with new lineups on YouTube Select, including sports, beauty, fashion and lifestyle, and entertainment. For YouTube advertisers, increasing brand lift is one of the core goals. In Q1, we saw strong traction from the introduction of a pause ads pilot on connected TVs, a new non-interruptive ad format that appears when users pause their organic content. Initial results show that pause ads are driving strong brand lift results and are commanding premium pricing from advertisers.
Before I wrap, two quick highlights on how we're helping our partners transform and accelerate impact with the best across Google.
Number one, to help McDonald's build the restaurant of the future, we're deepening our partnership across cloud and ads. Part of this includes them connecting Google Cloud's latest hardware and data technologies across restaurants globally and starting to apply Gen AI to enhance its customer and employee experiences.
Number two, WPP. At Google Cloud Next, we announced a new collaboration that will redefine marketing through the integration of our Gemini models with WPP Open, WPP's AI-powered marketing operating system, already used by more than 35,000 of its people and adopted by key clients, including The Coca-Cola Company, L'Oreal and Nestle. We're just getting started here and excited about the innovation this partnership will unlock.
With that, a huge thank you to our customers and partners, many of whom we're excited to see at Google Marketing Live and Brandcast in just a few weeks. And a huge thank you, as always, to our incredible teams for their agility and hard work this quarter.
Ruth, you're up.
Ruth Porat: Thank you, Philipp. We are very pleased with our financial results for the first quarter driven, in particular, by strength in Search and Cloud as well as the ongoing efforts to durably reengineer our cost base. My comments will be on year-over-year comparisons for the first quarter unless I state otherwise. I will start with results at the Alphabet level, followed by segment results and conclude with our outlook.
For the first quarter, our consolidated revenues were $80.5 billion, up 15% or up 16% in constant currency. Search remained the largest contributor to revenue growth.
In terms of total expenses, the year-on-year comparisons reflect the impact of the restructuring charges we took in the first quarter of 2023 of $2.6 billion as well as the $716 million in employee severance and related charges in the first quarter of 2024. As you can see in our earnings release, these charges were allocated across the expense lines in other cost of revenues and OpEx based on associated head count.
To help with year-on-year comparisons, we included a table in our earnings release to adjust other cost of revenues, operating expenses, operating income, and operating margin to exclude the impact of severance and related office space charges in the first quarter of 2023 versus 2024.
In terms of expenses, total cost of revenues was $33.7 billion, up 10%. Other cost of revenues was $20.8 billion, up 10% on a reported basis, with the increase driven primarily by content acquisition costs associated with YouTube given the very strong revenue growth in both subscription offerings and ad-supported content. On an adjusted basis, other cost of revenues were up 13% year-on-year.
Operating expenses were $21.4 billion, down 2% on a reported basis, primarily reflecting expense decreases in sales and marketing and G&A, offset by an increase in R&D. The largest single factor in the year-on-year decline in G&A expenses was lower charges related to legal matters.
On an adjusted basis, operating expenses were up 5%, reflecting, first, in R&D, an increase in compensation expense, primarily for Google DeepMind and Cloud; and second, in sales and marketing, a slight increase year-on-year, reflecting increases in compensation expense primarily for Cloud sales.
Operating income was $25.5 billion, up 46% on a reported basis, and our operating margin was 32%. On an adjusted basis, operating income was up 31%, and our operating margin was 33%. Net income was $23.7 billion and EPS was $1.89. We delivered free cash flow of $16.8 billion in the first quarter and $69.1 billion for the trailing 12 months. We ended the quarter with $108 billion in cash and marketable securities.
Turning to segment results. Within Google Services, revenues were $70.4 billion, up 14%. Google Search and other advertising revenues of $46.2 billion in the quarter were up 14% led again by growth in retail. YouTube advertising revenues of $8.1 billion were up 21% driven by both direct response and brand advertising. Network advertising revenues of $7.4 billion were down 1%. Subscriptions, platforms and devices revenues were $8.7 billion, up 18%, primarily reflecting growth in YouTube subscription revenues.
TAC was $12.9 billion, up 10%. Google Services operating income was $27.9 billion, up 28%. And the operating margin was 40%.
Turning to the Google Cloud segment. Revenues were $9.6 billion for the quarter, up 28%, reflecting significant growth in GCP with an increasing contribution from AI and strong Google Workspace growth, primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $900 million and an operating margin of 9%.
As to our Other Bets, for the first quarter, revenues were $495 million, benefiting from a milestone payment in one of the Other Bets. The operating loss was $1 billion.
Turning to our outlook for the business. With respect to Google Services, first, within Advertising, we are very pleased with the momentum of our Ads businesses. Search had broad-based strength across verticals. In YouTube, we had acceleration in revenue growth driven by brand and direct response.
Looking ahead, two points to call out: first, results in our advertising business in Q1 continued to reflect strength in spend from APAC-based retailers, a trend that began in the second quarter of 2023 and continued through Q1, which means we will begin lapping that impact in the second quarter; second, the YouTube acceleration in revenue growth in Q1 reflects, in part, lapping the negative year-on-year growth we experienced in the first quarter of 2023.
Turning to subscriptions, platforms, and devices. We continue to deliver significant growth in our subscriptions business, which drives the majority of revenue growth in this line. The sequential quarterly decline in year-on-year revenue growth for the line in Q1 versus Q4 reflects, in part, the fact that we had only 1 week of Sunday Ticket subscription revenue in Q1 versus 14 weeks in Q4. Looking forward, we will anniversary last year's price increase in YouTube TV starting in May.
With regard to platforms, we are pleased with the performance in Play driven by an increase in buyers.
With respect to Google Cloud, performance in Q1 reflects strong demand for our GCP infrastructure and solutions as well as the contribution from our Workspace productivity tools. The growth we are seeing across Cloud is underpinned by the benefit AI provides for our customers. We continue to invest aggressively while remaining focused on profitable growth.
As we look ahead, two points that will affect sequential year-on-year revenue growth comparisons across Alphabet: first, Q1 results reflect the benefit of leap year, which contributed slightly more than 1 point to our revenue growth rate at the consolidated level in the first quarter; second, at current spot rates, we expect a larger headwind from foreign exchange in Q2 versus Q1.
Turning to margins. Our efforts to durably reengineer our cost base are reflected in a 400 basis point expansion of our Alphabet operating margin year-on-year, excluding the impact of restructuring and severance charges in both periods. You can also see the impact in the quarter-on-quarter decline in head count in Q1, which reflects both actions we have taken over the past few months and a much slower pace of hiring. As we have discussed previously, we are continuing to invest in top engineering and technical talent, particularly in Cloud, Google DeepMind and technical infrastructure.
Looking ahead, we remain focused on our efforts to moderate the pace of expense growth in order to create capacity for the increases in depreciation and expenses associated with the higher levels of investment in our technical infrastructure. We believe these efforts will enable us to deliver full year 2024 Alphabet operating margin expansion relative to 2023.
With respect to CapEx, our reported CapEx in the first quarter was $12 billion, once again driven overwhelmingly by investment in our technical infrastructure, with the largest component for servers followed by data centers. The significant year-on-year growth in CapEx in recent quarters reflects our confidence in the opportunities offered by AI across our business. Looking ahead, we expect quarterly CapEx throughout the year to be roughly at or above the Q1 level, keeping in mind that the timing of cash payments can cause variability in quarterly reported CapEx. With regard to Other Bets, we similarly have work streams underway to enhance overall returns.
Finally, as I trust you saw in the press release, we are very pleased to be adding a quarterly dividend of $0.20 per share to our capital return program as well as a new $70 billion authorization in share repurchases. The core of our capital allocation framework remains the same, beginning with investing aggressively in our business as you have heard us talk about today. Given the extraordinary opportunities ahead, we view the introduction of the dividend as further strengthening our overall capital return program.
Thank you. Sundar, Philipp, and I will now take your questions.
Operator: [Operator Instructions] Our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two. The first one, I wanted to ask about overall search behavior. Philipp, I know you talked in the past about how overall query trends continue to grow. Can I ask you to drill a little bit more into monetizable and commercial query trends? Has there been any changes in sort of your commercial query trends growth. There's just been all these new entrants moving around in e-commerce. That is my first one.
Then the second one for Ruth, when you talked about sort of more efforts to moderate expense growth from here, can you just sort of give us some examples of areas where you still see the potential for more optimization or work streams in place to continue to durably reengineer the OpEx base as we go throughout 2024.
Sundar Pichai: Thanks, Brian. To your first question, look, I think broadly, we've always found that over many years, when things work well on the organic side, monetization follows. So typically, the trends we see carry over well. Overall, I think with generative AI in Search, with our AI overviews, I think we will expand the type of queries we can serve our users. We can answer more complex questions as well as, in general, that all seems to carry over across query categories. Obviously, it's still early, and we are going to be measured and put user experience at the front, but we are positive about what this transition means.
Ruth Porat: And on the second question in terms of the various work streams, as both Sundar and I said, we remain very focused on ongoing efforts to slow the pace of expense growth, what we've been calling durably reengineering our cost base. And I made this point in opening comments, but we are very cognizant of the increasing headwind we have from higher depreciation and expenses associated with the higher CapEx, and so these efforts are ongoing. And they're very much the same that we've talked with you about previously. It starts with product and process prioritization, all of the work around organizational efficiency and structure. These are ongoing.
And so as an example, the work that Sundar talked about, combining devices and services with our platforms and ecosystems, product area is a really good example because unifying the teams not only helps us deliver higher-quality products and experiences, but we think it enables us to move with greater velocity and efficiency.
And then the other work streams we've talked to you about in the past, like all of the work around technical infrastructure, which Sundar alluded to; streamlining operations within the company through the use of AI; what we're doing with procurement with our suppliers and vendors, which he also referenced; the work you've seen on real estate optimization, these are all ongoing work streams, which is why we have them under the umbrella, durably reengineering our cost base, and they are ongoing.
Operator: Our next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: Sundar, you talked about bringing more generative AI features into the main Search page. Can you just talk about what kind of queries or scenarios do you think that that's working best for so far? And just how we should think about the cadence of continuing to adopt more of those features within core search.
And then Ruth, on CapEx spending, the $12 billion in 1Q, can we assume that run rating that and above is reasonable for this year? And I know it's very early, but should we generally expect higher CapEx next year as well?
Sundar Pichai: Thanks, Doug. On SGE in Search, we are seeing early confirmation of our thesis that this will expand the universe of queries where we are able to really provide people with a mix of actual answers linked to sources across the Web and bring a variety of perspectives, all in an innovative way. And we've been rolling out AI overviews in the U.S. and the U.K., trying to mainly tackle queries which are more complex, where we think SGE will clearly improve the experience. We've already served billions of queries and it seems to cut across categories, but we are still continuing our testing. And we are metrics-driven in these areas. But I am optimistic that it clearly improves the user experience. Users are telling us that. And we are seeing it in our metrics, and we'll continue evolving it through the course of this year.
Ruth Porat: And then in terms of CapEx, as I said in opening comments, we do expect the quarterly CapEx throughout the year to be roughly at or above the $12 billion cash CapEx we had here in Q1. As I said, you can always have variability in the reported quarterly CapEx just due to the timing of cash payments, but roughly at or above this level. And it really goes to Sundar's opening comment that we're very committed to making the investments required to keep us at the leading edge in technical infrastructure to support the growth in Cloud, all the innovation in Search that he and Philipp has spoken about and our lead with Gemini.
I will note that nearly all of the CapEx was in our technical infrastructure. We expect that our investment in office facilities will be about less than 10% of the total CapEx in 2024, roughly flat with our CapEx in 2023, but is still there. And then with respect to 2025, as you said, it's premature to comment so nothing to add on that.
Operator: Our next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Maybe just one question of a big picture nature for Sundar. Sundar, if we come back to your earlier comments at the beginning of the call and framing up longer-term initiatives and longer-term narratives, I wanted to know if you could talk a little bit about both the opportunities and the challenges of operating at scale in a time like this where there's a lot of technology innovation going on and how you see the elements of trying to strike a balance towards moving the organization forward while still continuing to both invest for growth as well as balance margins.
Sundar Pichai: Thanks, Eric. Great question. Obviously, I think the AI transition, I think it's a once-in-a-generation kind of an opportunity. We've definitely been gearing up for this for a long time. You can imagine we started building TPUs in 2016, so we've definitely been gearing up for a long time. The real opportunities we see is the scale of research and innovation, which we have built up and are going to continue to deliver. I think for the first time, we can work on AI in a horizontal way and it impacts the entire breadth of the company, be it Search, be it YouTube, be it Cloud, be it Waymo and so on. And we see a rapid pace of innovation in that underlying. So it's a very leveraged way to do it, and I see that as a real opportunity ahead.
In terms of the challenges, I think it's been a mindset shift, which we've been driving across the company to make sure that we are embracing this opportunity but being very efficient in how we are approaching it, making sure we are redirecting our people to the highest priorities across the company, building on our 20 years of experience in driving machine efficiencies year-on-year so that we can put our dollars to work as efficiently as possible. So making sure balancing all of that moving forward in a very bold and responsible way at the same time. Those are the important things to get right from my perspective.
Operator: Our next question comes from Stephen Ju with UBS.
Stephen Ju: Philipp, I think it's approaching the 2-year anniversary for the launch of Ads on YouTube Shorts. And you've given us an update on monetization pickup sequentially. But with that in mind, I think YouTube has launched an array of ad products and automation tools to help advertisers transfer what they're doing to the vertical screen. So how is this translating into buy-in among your advertiser clients?
And secondly, based on what you've seen over the last 2 years, are there any structural reasons that you can cite as to why the monetization cannot match what is already the case on the horizontal screen?
Philipp Schindler: Yes. Look, this is a great question, first of all. I mean, let's start with the fact that YouTube performance was very strong in this quarter. And on Shorts specifically in the U.S., I mentioned how the monetization rate of Shorts relative to in-stream viewing has more than doubled in the last 12 months. I think that's what you were referring to. And yes, we're obviously very happy with this development.
The way to think about it is advertisers really only spend with us when they see a positive ROI. So you can assume that this wouldn't be happening unless it were to work for advertisers in the short term and also in the long term. That's an important part, I think.
Overall, Shorts is a long-term bet for the business. It has really helped us respond to both creator and viewer demand for short-form video. We talked about the strong growth, averaging 70 billion daily views. I mentioned the number of channels uploading has increased 50% year-over-year, so again, very happy with us development. And to your question, structural reasons, whether we can't get to a match here, I have a hard time seeing those at the moment over time.
Operator: Our next question comes from Justin Post with Bank of America.
Justin Post: I'm going to ask another one on CapEx. It seems to be your biggest investment area. Just first, you saw the big uptick the last 2 quarters, but you've been investing in AI for years. Is the uptick because supply is getting easier to get? Or do you see more opportunities with the available supply to really fuel AI? So has the GPUs and everything gotten better that you feel more, investing more? And then thinking about the returns, both for Advertising and Cloud on the CapEx, do you feel like this is a higher cost of doing business? Or do you think this is an opportunity to even get better returns on your capital spend than you've had in the past?
Ruth Porat: So the increase in CapEx, as Sundar said and I said, really reflects the opportunity we continue to see across the company. It starts with all that we're doing in support of the Gemini foundational model but then also, clearly, the work across Cloud, on behalf of Cloud customers, and the growth that we're seeing with GCP and the infrastructure work there, and then, of course, as both Sundar and Philipp talked about the application across Search, YouTube and, more broadly, the services that we're able to offer. So it's the growing application and our focus on ensuring that we have the compute capacity to deliver in support of the services and opportunities we see across Alphabet.
And it really goes to the second part of your question, which is that as we're investing in CapEx and applying it across our various businesses, it opens up more services and products, which bring revenue opportunities. And we're very focused on the monetization opportunity. It does underlie everything that we're doing in Google Services and Google Cloud. And as Sundar noted, we're, at the same time, very focused on the efficiency of all elements of delivering that compute capacity from hardware, software and beyond.
Operator: Our next question comes from Mark Mahaney with Evercore.
Jian Li: This is Jian Li for Mark Mahaney. A couple of questions. One, just maybe an expansion on the Search, query questions on before, more like Search volume, and maybe in the context of the off-Google environment like AI chat bot, for example, we've seen kind of Meta AI directing to Google Search results. Do you think there's actually a scenario where like AI system can create a step function change in Search volume or use cases of Google? If you can give us more color on what are you seeing right now or what are you expecting to see in that area.
And then the second question on just the comment of YouTube and Cloud exiting at $100 billion run rate. What is informing this outlook or visibility for you? If you can talk about, is it driven by any sort of Cloud demand inflection or step change in the gen AI workload demand, if you can flesh it out a little bit?
Sundar Pichai: On your first question, look, I said this before but to be clear, we view this moment as a positive moment for Search. And I think it allows us to evolve our product in a profound way. And Search is a unique experience. People come, be it if you want answers, if you want to explore more, if you want to get perspectives from across the web, and to be able to do it across the breadth and depth of everything they are looking for and the innovation you would need to keep that up, I think it's what we've been building on for a long time. And so I feel we are extraordinarily well set up, particularly given the innovation path we are on. And overall, I view this moment as a positive moment. So that's how I would say it.
On the second part, Ruth?
Ruth Porat: Sorry, what was it?
Sundar Pichai: YouTube and Cloud.
Jian Li: Yes, in terms of your comment about $100 billion exit rate for YouTube and Cloud, what's driving this visibility for you and any kind of inflection you're seeing in the Cloud demand?
Ruth Porat: I would just say from Sundar's opening comments, it's just the ongoing momentum that we've seen in the business that we've been talking about, the ongoing growth and strong performance. And so what we were really getting at in that comment, what Sundar was getting at, is that we've continued to build strong businesses over time, and that just helps dimension it. We had similar comments last quarter when you talk about our subscription business. We're really proud of all the work that the teams are doing across the company, building new, strong opportunities, delivering for our users, for customers, for advertisers in profound ways. And so it was just helping to dimension what we have built over the years.
Operator: Our next question comes from Ken Gawrelski with Wells Fargo.
Kenneth Gawrelski: Two, if I may. First on GCP, you had nice acceleration in the quarter. Could you talk a little bit about the opportunities and constraints upon GCP's ability to continue to address that large addressable market and accelerate growth? Is it more sales-oriented? Is it more product sales solutions or both? And do you plan to address most of these organically? Or could a partner approach work for you?
And then the second one, just more detail on YouTube and sports rights. Could you reiterate your view on further live sports rights? There's some larger, mostly in the U.S., league rights coming up soon and will be more over the next several years. Could you just talk about your philosophy there beyond NFL Sunday Ticket?
Sundar Pichai: Look, on the Cloud side, obviously, it's definitely a point of inflection overall. I think the AI transformation is making everyone think about their whole stack, and we are engaged in a number of conversations. I think paid AI infrastructure, people are really looking to Vertex AI, given our depth and breadth of model choice, or using Workspace to transform productivity in your workplace, et cetera. So I think the opportunities there are all related to that, both all the work we've built up and AI being a point of inflection in terms of driving conversations. I think you'll see us do it both organically and with a strong partner program as well. So we'll do it with a combination.
And the challenges here, always, there are switching costs to Cloud and the challenges we see is how do we make it easier for people. There's a lot of interest, but there's definitely barriers in terms of people switching. And so that's an area where we are constantly investing to make it easier for our customers.
Philipp Schindler: And with regard to your sports rights question, look, I mean, we've had long-standing and significant partnerships with the most popular sports league here in the U.S., around the globe, federations teams, athletes, broadcasters. And obviously, these partnerships, in combination with our very vast audience of sports fans, drives investment in subscription experiences across many offerings: NFL Sunday Ticket, YouTube TV, YouTube Primetime Channels and so on. But there's nothing that we have to announce at the moment. We're obviously always looking at where we can create more value for our users, for our advertisers, for creators, but nothing specific to talk about at this moment.
Operator: Our next question comes from Ross Sandler with Barclays.
Ross Sandler: Sundar, I had a question about smartphone-based AI searches. So you guys are powering all these new AI interactions and searches on Pixel and on Samsung devices. And I think there's speculation that Gemini might be used on iOS in a future state. So the question is, as users start searching on smartphones and those searches are basically rendered on the model, on the phone, without accessing the web, how do you guys anticipate monetizing some of these smartphone-based behaviors that are kind of run on the edge? Any thoughts on that?
Sundar Pichai: Look, I think if you look at what users are looking for, people are looking for information and an ability to connect with things outside. So I think there will be a set of use cases which you will be able to do on device. But for a lot of what people are looking to do, I think you will need the richness of the cloud, the Web and you have to deliver it to users. So again, to my earlier comments, I think through all these moments, you saw what we have done with Samsung with Circle to Search. I think it gives a new way for people to access Search conveniently wherever they are. And so we view this as a positive way to bring our services to users in a more seamless manner. So I think it's positive from that perspective.
In terms of on-device versus cloud, there will be needs which can be done on-device and we should to help it from a privacy standpoint. But there are many, many things for which people will need to reach out to the cloud. And so I don't see that as being a big driver in the on-cloud versus off-cloud in any way.
Operator: And our last question comes from Colin Sebastian with Baird.
Colin Sebastian: I guess first, a follow-up on some of the questions on SGE in the core Search. I guess I'm wondering, along with some of those changes in behavior, is there a way to quantify that overall engagement shift, whether that's an increase in time spent or the level of increase in queries for both sort of traditional search as well as more generative answers.
And then secondly, on the hardware road map, I assume later this year, we'll hear more about some of the products. But any areas of particular focus or that you would point out that we should keep in mind in terms of hardware launches in the back half?
Sundar Pichai: On the first question on Search, not much more to add to what I said, but what we have seen. And we've been in live experiments just for a few weeks in U.S. and U.K. on a slice of our queries, and all indications are positive that it improves user satisfaction. We see an increase in engagement, but I see this as something which will play out over time.
But if you were to step back at this moment, there were a lot of questions last year, and we always felt confident and comfortable that we would be able to improve the user experience. People question whether these things would be costly to serve, and we are very, very confident we can manage the cost of how to serve these queries. People worried about latency. When I look at the progress we have made in latency and efficiency, we feel comfortable. There are questions about monetization. And based on our testing so far, I'm comfortable and confident that we'll be able to manage the monetization transition here well as well. It will play out over time, but I feel we are well positioned. And more importantly, when I look at the innovation that's ahead and the way the teams are working hard on it, I am very excited about the future ahead.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter 2024 call. Thank you, and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
META | 1 | 2,024 | 2024-04-24 00:00:00 | Operator: Good afternoon. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Meta First Quarter Earnings Conference Call. [Operator Instructions] This call will be recorded. Thank you very much.
Ken Dorell, Meta's Director of Investor Relations, you may begin.
Kenneth Dorell: Thank you. Good afternoon, and welcome to Meta Platform's First Quarter 2021 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO; and Susan Li, CFO.
Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's earnings press release and in our annual report on Form 10-K filed with the SEC.
Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events.
During this call, we will present both GAAP and certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The earnings press release and an accompanying investor presentation are available on our website at investor.fb.com.
And now I'd like to turn the call over to Mark.
Mark Zuckerberg: All right. Thanks, Ken, and everyone, thanks for joining. It's been a good start to the year, both in terms of product momentum and business performance. We estimate that more than 3.2 billion people use at least one of our apps each day, and we're seeing healthy growth in the U.S. And I want to call out WhatsApp specifically, where the number of daily actives and message sends in the U.S. keeps gaining momentum, and I think we're on a good path there. We've also made good progress on our AI and metaverse efforts, and that's where I'm going to focus most of my comments today.
So let's start with AI. We're building a number of different AI services, from Meta AI, our AI assistant that you can ask any question across our apps and glasses, to creator AIs that help creators engage their communities and that fans can interact with, to business AIs that we think every business eventually on our platform will use to help customers buy things and get customer support to internal coding and development AIs to hardware like glasses for people to interact with AIs and a lot more.
Last week, we had the major release of our new version of Meta AI that is now powered by our latest model, Llama 3. And our goal with Meta AI is to build the world's leading AI service, both in quality and usage.
The initial rollout of Meta AI is going well. Tens of millions of people have already tried it. The feedback is very positive. And when I first checked in with our teams, the majority of feedback we were getting was people asking us to release Meta AI for them wherever they are. So we've started launching Meta AI in some English speaking countries, and we'll roll out in more languages and countries over the coming months.
You all know our product development playbook by this point. We release an early version of a product to a limited audience to gather feedback and start improving it, and then once we think it's ready, then we make it available to more people. That early release was last fall and with this release, we are now moving to that next growth phase of our playbook. We believe that Meta AI with Llama 3 is now the most intelligent AI assistant that you can freely use. And now that we have the superior quality product, we are making it easier for lots of people to use it within WhatsApp, Messenger, Instagram and Facebook.
Now in addition to answering more complex queries, a few other notable and unique features from this release. Meta AI now creates animations from still images and now generates high-quality images so fast that it can create and update them as you are typing, which is pretty awesome. I've seen a lot of people commenting about that experience online and how they've never seen or experienced anything like it before.
In terms of the core AI model and intelligence that's powering Meta AI, I'm very pleased with how Llama 3 has come together so far. The 8 billion and 70 billion parameter models that we released are best-in-class for their scale. The 400-plus billion parameter model that we're still training seems on track to be industry leading on several benchmarks. And I expect that our models are just going to improve further from open source contributions.
Overall, I view the results our teams have achieved here as another key milestone in showing that we have the talent, data and ability to scale infrastructure to build the world's leading AI models and services. And this leads me to believe that we should invest significantly more over the coming years to build even more advanced models and the largest scale AI services in the world. As we're scaling CapEx and energy expenses for AI, we'll continue focusing on operating the rest of our company efficiently. But realistically, even with shifting many of our existing resources to focus on AI, we'll still grow our investment envelope meaningfully before we make much revenue from some of these new products.
I think it's worth calling that out that we've historically seen a lot of volatility in our stock during this phase of our product playbook, where we're investing in scaling a new product but aren't yet monetizing it. We saw this with Reels, Stories as newsfeed transition to mobile and more. And I also expect to see a multiyear investment cycle before we fully scale Meta AI, business AIs and more into the profitable services I expect as well. Historically, investing to build these new scaled experiences in our apps has been a very good long-term investment for us and for investors who have stuck with us. And the initial signs are quite positive here, too. But building the leading AI will also be a larger undertaking than the other experiences we've added to our apps, and this is likely going to take several years.
On the upside, once our new AI services reach scale, we have a strong track record of monetizing them effectively. There are several ways to build a massive business here, including scaling business messaging, introducing ads or paid content into AI interactions and enabling people to pay to use bigger AI models and access more compute. And on top of those, AI is already helping us improve app engagement, which naturally leads to seeing more ads and improving ads directly to deliver more value. So if the technology and products evolve in the way that we hope, each of those will unlock massive amounts of value for people and business for us over time.
We're seeing good progress on some of these efforts already. Right now, about 30% of the posts on Facebook feed are delivered by our AI recommendation system. That's up 2x over the last couple of years. And for the first time ever, more than 50% of the content that people see on Instagram is now AI recommended. AI has also been a huge part of how we create value for advertisers by showing people more relevant ads. And if you look at our 2 end-to-end AI-powered tools, Advantage+ shopping and Advantage+ app campaigns, revenue flowing through those has more than doubled since last year.
We're also going to continue to be very focused on efficiency as we scale Meta AI and other AI services. Some of this will come from improving how we train and run models. Some improvements will come from the open source community, and we're improving cost efficiency is one of the main areas that I expect that open sourcing will help us improve similar to what we saw with Open Compute. We'll also keep making progress on building more of our own silicon. Our Meta training and inference accelerator chip has successfully enabled us to run some of our recommendations-related workloads on this less expensive stack. And as this program matures over the coming years, we plan to expand this to more of our workloads as well. And of course, as we ramp these investments, we will also continue to carefully manage headcount and other expense growth throughout the company.
Now in addition to our work on AI, our other long-term focus is the metaverse. It's been interesting to see how these 2 themes have come together.
This is clearest when you look at glasses. I used to think that AR glasses wouldn't really be a mainstream product until we had full holographic displays -- and I still think that, that's going to be awesome and is the long-term mature state for the product. But now it seems pretty clear that there's also a meaningful market for fashionable AI glasses without a display. Glasses are the ideal device for an AI assistant because you can let them see what you see and hear what you hear. So they have full context on what's going on around you as they help you with whatever you're trying to do. Our launch this week of Meta AI with Vision on the glasses is a good example where you can now ask questions about things that you're looking at.
Now one strategy dynamic that I've been reflecting on is that an increasing amount of our Reality Labs work is going towards serving our AI efforts. We currently report on our financials as if Family of Apps and Reality Labs were 2 completely separate businesses, but strategically, I think of them as fundamentally the same business with the vision of Reality Labs to build the next generation of computing platforms in large part so that we can build the best apps and experiences on top of them. Over time, we'll need to find better ways to articulate the value that's generated here across both segments so it doesn't just seem like our hardware costs increase as our glasses ecosystem scales, but all the value flows to a different segment.
The Ray-Ban Meta glasses that we built with Essilor Luxottica continue to do well and are sold out in many styles and colors. So we're working to make more and release additional styles as quickly as we can. We just released the new cat-eye Skyler design yesterday, which is more feminine. And in general, I'm optimistic about our approach of starting with the classics and expanding with an increasing diversity of options over time. If we want everyone to be able to use wearable AI, I think eyewear is a bit different from phones or watches in that people are going to want very different designs. So I think our approach of partnering with the leading eyewear brands will help us serve more of the market.
I think a similar open ecosystem approach will help us expand the virtual and mixed reality headset market over time as well. We announced that we're opening up Meta Horizon OS, the operating system we've built to power Quest. As the ecosystem grows, I think there will be sufficient diversity in how people use mixed reality, that there will be demand for more designs than we'll be able to build. For example, a work-focused headset may be slightly less designed for motion but may -- you want to be lighter by connecting to your laptop; a fitness-focused headset may be lighter with sweat-wicking materials; an entertainment-focused headset may prioritize the highest resolution displays over everything else; a gaming-focused headset may prioritize peripherals and haptics or a device that comes with Xbox controllers and a game pass subscription out of the box.
Now to be clear, I think that our first-party Quest devices will continue to be the most popular headsets as we see today, and we'll continue focusing on advancing the state-of-the-art tech and making it accessible to everyone. But I also think that opening our ecosystem and opening our operating system will help the overall mixed reality ecosystem grow even faster.
Now in addition to AI and the metaverse, we're seeing good improvements across our apps. I touched on some of the most important trends already with WhatsApp growth in the U.S. and AI-powered recommendations in our feeds and reels already. But I do want to mention that video continues to be a bright spot. This month, we launched an updated full-screen video player on Facebook that brings together reels, longer videos and live content into a single experience with a unified recommendation system. On Instagram, reels and video continue to drive engagement, with reels alone now making up 50% of the time that's spent within the app.
Threads is growing well, too. There are now more than 150 million monthly actives, and it continues to generally be on the trajectory that I hoped to see. And of course, my daughters would want me to mention that Taylor Swift is now on Threads, that one was a big deal in my house.
All right. That is what I wanted to cover today. I am proud of the progress we've made so far this year. We've got a lot more execution ahead to fulfill the opportunities ahead of us. A big thank you to all of our teams who are driving all these advances and to all of you for being on this journey with us. And now here is Susan.
Susan Li: Thanks, Mark, and good afternoon, everyone. Let's begin with our consolidated results. All comparisons are on a year-over-year basis unless otherwise noted. Q1 total revenue was $36.5 billion, up 27% on both a reported and constant currency basis. Q1 total expenses were $22.6 billion, up 6% compared to last year.
In terms of the specific line items, cost of revenue increased 9% as higher infrastructure-related costs were partially offset by lapping Reality Labs' inventory-related valuation adjustments. R&D increased 6%, driven mostly by higher headcount-related expenses and infrastructure costs, which were partially offset by lower restructuring costs.
Marketing and sales decreased 16% due mainly to lower restructuring costs, professional services and marketing spend. G&A increased 20% as higher legal-related expenses were partially offset by lower restructuring costs.
We ended the first quarter with over 69,300 employees, up 3% from Q4. First quarter operating income was $13.8 billion, representing a 38% operating margin. Our tax rate for the quarter was 13%. Net income was $12.4 billion or $4.71 per share.
Capital expenditures, including principal payments on finance leases, were $6.7 billion, driven by investments in servers, data centers and network infrastructure. Free cash flow was $12.5 billion. We repurchased $14.6 billion of our Class A common stock and paid $1.3 billion in dividends to shareholders, ending the quarter with $58.1 billion in cash and marketable securities and $18.4 billion in debt.
Moving now to our segment results. I'll begin with our Family of Apps segment. Our community across the Family of Apps continues to grow, with approximately 3.2 billion people using at least one of our Family of Apps on a daily basis in March. Q1 total Family of Apps revenue was $36 billion, up 27% year-over-year. Q1 Family of Apps ad revenue was $35.6 billion, up 27% or 26% on a constant currency basis. Within ad revenue, the online commerce vertical was the largest contributor to year-over-year growth, followed by gaming and entertainment and media.
On a user geography basis, ad revenue growth was strongest in Rest of World and Europe at 40% and 33%, respectively. Asia Pacific grew 25% and North America grew 22%. In Q1, the total number of ad impressions served across our services increased 20%, and the average price per ad increased 6%. Impression growth was mainly driven by Asia Pacific and Rest of World. Pricing growth was driven by advertiser demand, which was partially offset by strong impression growth, particularly from lower-monetizing regions and services.
Family of Apps other revenue was $380 million in Q1, up 85%, driven by business messaging revenue growth from our WhatsApp business platform. We continue to direct the majority of our investments toward the development and operation of our Family of Apps. In Q1, Family of Apps expenses were $18.4 billion, representing approximately 81% of our overall expenses. Family of Apps expenses were up 7% due mainly to higher legal and infrastructure costs that were partially offset by lower restructuring costs.
Family of Apps operating income was $17.7 billion, representing a 49% operating margin. Within our Reality Labs segment, Q1 revenue was $440 million, up 30%, driven by Quest headset sales. Reality Labs expenses were $4.3 billion, down 1% year-over-year as higher head count-related expenses were more than offset by lapping inventory-related valuation adjustments and restructuring costs. Reality Labs operating loss was $3.8 billion.
Turning now to the business outlook. There are 2 primary factors that drive our revenue performance: our ability to deliver engaging experiences for our community and our effectiveness at monetizing that engagement over time. On the first, we remain pleased with engagement trends and have strong momentum across our product priorities. Our investments in developing increasingly advanced recommendation systems continue to drive incremental engagement on our platform, demonstrating that people are finding added value by discovering content from accounts they are not connected to. The level of recommended content in our apps has scaled as we've improved these systems, and we see further opportunity to increase the relevance and personalization of recommendations as we advance our models.
Video also continues to grow across our platform, and it now represents more than 60% of time on both Facebook and Instagram. Reels remains the primary driver of that growth, and we're progressing on our work to bring together Reel's longer-form video and live video into one experience on Facebook.
In April, we rolled out this unified video experience in the U.S. and Canada, which is increasingly powered by our next-generation ranking architecture that we expect will help deliver more relevant video recommendations over time.
We're also introducing deeper integrations of generative AI into our apps in the U.S. and more than a dozen other countries. Along with using Meta AI within our chat surfaces, people will now be able to use Meta AI in search within our apps as well as feed and groups on Facebook. We expect these integrations will complement our social discovery strategy as our recommendation systems help people to discover and explore their interests, while Meta AI enables them to dive deeper on topics they're interested in. Threads also continues to see good traction as we continue to ship valuable features and scale the community.
Now to the second driver of our revenue performance, increasing monetization efficiency. There are 2 parts to this work. The first is optimizing the level of ads within organic engagement. Here, we continue to advance our understanding of users' preferences for viewing ads to more effectively optimize the right time, place and person to show an ad to.
For example, we are getting better at adjusting the placement and number of ads in real time based on our perception of a user's interest and ad content and to minimize disruption from ads as well as innovating on new and creative ad formats. We expect to continue that work going forward, while surfaces with relatively lower levels of monetization, like video and messaging, will serve as additional growth opportunities.
The second part of improving monetization efficiency is enhancing marketing performance. Similar to our work with organic recommendations, AI is playing an increasing role in these efforts. First, we are making ongoing ads modeling improvements that are delivering better performance for advertisers. One example is our new ads ranking architecture, Meta Lattice, which we began rolling out more broadly last year. This new architecture allows us to run significantly larger models that generalize learnings across objectives and surfaces in place of numerous smaller ad models that have historically been optimized for individual objectives and surfaces. This is not only leading to increased efficiency as we operate fewer models but also improving ad performance.
Another way we're leveraging AI is to provide increased automation for advertisers. Through our Advantage+ portfolio, advertisers can automate one step of the campaign setup process, such as selecting which ad creative to show, or automate their campaign completely using our end-to-end automation tools, Advantage+ shopping and Advantage+ app ads. We're seeing growing use of these solutions, and we expect to drive further adoption over the course of the year while applying what we learned to our broader ads investments.
Next, I'd like to discuss our approach to capital allocation. We continue to see compelling investment opportunities to both improve our core business in the near term and capture significant longer-term opportunities in generative AI and Reality Labs. As we develop more advanced and compute-intensive recommendation models and scale capacity for our generative AI training and inference needs, we expect that having sufficient infrastructure capacity will be critical to realizing many of these opportunities. As a result, we expect that we will invest significantly more in infrastructure over the coming years.
Our other long-term initiatives that we're continuing to make significant investments in is Reality Labs. We are also starting to see our AI initiatives increasingly overlap with our Reality Labs work. For example, with Ray-Ban Meta smart glasses, people in the U.S. and Canada can now use our multimodal Meta AI assistant for daily tasks without pulling out their phone.
Longer term, we expect generative AI to play an increasing role in our mixed reality products, making it easier to develop immersive experiences. Accelerating our AI efforts will help ensure we can provide the best version of our services as we transition to the next computing platform. We expect to pursue these opportunities while maintaining a focus on operating discipline, and we believe our strong financial position will allow us to support these investments while also returning capital to shareholders through share repurchases and dividends.
In addition, we continue to monitor an active regulatory landscape, including the increasing legal and regulatory headwinds in the EU and the U.S. that could significantly impact our business and our financial results. We also have a jury trial scheduled for June in a suit brought by the state of Texas regarding our use of facial recognition technology, which could ultimately result in a material loss.
Turning now to the revenue outlook. We expect second quarter 2024 total revenue to be in the range of $36.5 billion to $39 billion. Our guidance assumes foreign currency is a 1% headwind to year-over-year total revenue growth based on current exchange rates.
Turning now to the expense outlook. We expect full year 2024 total expenses to be in the range of $96 million to $99 billion, updated from our prior outlook of $94 million to $99 billion due to higher infrastructure and legal costs.
For Reality Labs, we continue to expect operating losses to increase meaningfully year-over-year due to our ongoing product development efforts and our investments to further scale our ecosystem.
Turning now to the CapEx outlook. We anticipate our full year 2024 capital expenditures will be in the range of $35 billion to $40 billion, increased from our prior range of $30 billion to $37 billion as we continue to accelerate our infrastructure investments to support our AI road map. While we are not providing guidance for years beyond 2024, we expect CapEx will continue to increase next year as we invest aggressively to support our ambitious AI research and product development efforts.
On to tax. Absent any changes to our tax landscape, we expect our full year 2024 tax rate to be in the mid-teens.
In closing, Q1 was a good start to the year. We're seeing strong momentum within our Family of Apps and are making important progress on our longer-term AI and Reality Labs initiatives that have the potential to transform the way people interact with our services over the coming years.
With that, Krista, let's open up the call for questions.
Operator: [Operator Instructions] And your first question comes from the line of Eric Sheridan from Goldman Sachs.
Eric Sheridan: Maybe I'll ask a two-parter. Mark, you used the analogy of other investments cycles you've been through around products like Stories and Reels. I know you're not giving long-term guidance today, but using those analogies, how should investors think about the length and depth of this investment cycle with respect to either AI and/or Reality Labs more broadly and mixed reality?
And you both talked about the impact AI is having on the advertising ecosystem. What are you watching for in terms of adoption or utility on the consumer side to know that AI adoption is tracking along with the investment cycle?
Mark Zuckerberg: Yes. In terms of the timing, I think it's somewhat difficult to extrapolate from previous cycles. But I guess like the main thing that we see is that we will usually take, I don't know, a couple of years, I mean, it could be a little more, it could be less to focus on building out and scaling the products. And we typically don't focus that much on monetization of the new areas until they reach significant scale because it's so much higher leverage for us just to improve monetization on other things before these new products are at scale.
So you enter this period where I think kind of smart investors see that the product is scaling and that there's a clear monetizable opportunity there even before the revenue materializes. And I think we've seen that with Reels and with Stories and with the shift to mobile and all these things, where basically, we build out the inventory first for a period of time and then we monetize it.
And during that time, when it's scaling, sometimes it's not just the case that we're not making money from that thing. It can often actually be the case that it displaces other revenue from other things. So like you saw with Reels, I mean, it scaled and there was a period where it was not profitable for us as it was scaling before it became profitable. So I think that's more the analogy that I'm making on this.
But I think it's -- what that suggests is that what we should all be focused on for the next period is as the consumer products scale, Meta AI really just launched in a meaningful way so we don't have any kind of hard stats to share on that. But I'd say that's the main thing that I'm focused on for this year and probably a lot of next year is growing that product and the other AI products and the engagement around them. And I think we should all have quite a bit of confidence that if those are on a good track to scale, then they're going to end up being very large businesses. So that's the main point that I was trying to make there.
Operator: Your next question comes from the line of Brian Nowak from Morgan Stanley.
Brian Nowak: Thanks for taking my questions, I have 2. The first one is on sort of the recommendation engine improvements and even, Susan, when you talked about further opportunities to increase the relevance of the models. Could you just unpack that a little bit for us? Can you give us examples of where you're still running the model in a suboptimal basis or opportunities for improved signal capture use or data you're not using? Where are sort of the areas of improvement you see from here?
And then the second one, when you talk about driving incremental adoption of AI tools for advertisers, what are sort of some of the main gating factors you've encountered to get advertisers to test these tools? And how do you think about sort of addressing that throughout '24 and '25?
Susan Li: Thanks, Brian. So to your first question, where are there more opportunities for us to leverage and improve our recommendations models to drive engagement? One of the things I would say is, historically, each of our recommendation products, including Reels, in-feed recommendations, et cetera, has had their own AI model.
And recently, we've been developing a new model architecture with the aim for it to power multiple recommendations products. We started partially validating this model last year by using it to power Facebook Reels. And we saw meaningful performance gains, 8% to 10% increases in watch time as a result of deploying this.
This year, we're actually planning to extend the singular model architecture to recommend content across not just Facebook Reels, but also Facebook's video tab as well. So while it's still too early to share specific results, we're optimistic that the new model architecture will unlock increasingly relevant video recommendations over time. And if it's successful, we'll explore using it to power other recommendations.
And analog exists, I would say, on the ad side. We've talked a little bit about the new model architecture Meta Lattice that we deployed last year that consolidates smaller and more specialized models into larger models that can better learn what characteristics improve ad performance across multiple services, like feed and Reels and multiple types of ads and objectives at the same time. And that's driven improved ad performance over the course of 2023 as we deployed it across Facebook and Instagram to support multiple objectives.
And over the course of 2024, we expect to further enhance model performance and include support for even more objectives like web and app and ROAS. So there's a lot of work that we're investing in, in the underlying model architecture for both organic engagement and ads that we expect is going to continue to deliver increasing ads performance over time.
The second question you asked was around getting advertisers to test and adopt gen AI tools. There are 2 flavors of this. The more near-term version is around the gen AI ad creative features that we have put into our ads creation tools. And it's early, but we're seeing adoption of these features across verticals and different advertiser sizes.
In particular, we've seen outsized adoption of image expansion with small businesses, and this will remain a big area of focus for us in 2024, and I expect that improvements to our underlying foundation models will enhance the quality of the outputs that are generated and support new features on the road map. But right now, we have features supporting text variations, image expansion and background generation, and we're continuing to work to make those more performant for advertisers to create more personalized ads at scale.
The longer-term piece here is around business AIs. We have been testing the ability for businesses to set up AIs for business messaging that represent them in chats with customers, starting by supporting shopping use cases such as responding to people asking for more information on a product or its availability. So this is very, very early. We've been testing this with a handful of businesses on Messenger and WhatsApp, and we're hearing good feedback with businesses saying that the AIs have saved them significant time while customer -- consumers noted more timely response times. And we're also learning a lot from these tests to make these AIs more performant over time as well. So we'll be expanding these tests over the coming months, and we'll continue to take our time here to get it right before we make it more broadly available.
Operator: Your next question comes from the line of Mark Shmulik from Bernstein Research.
Mark Shmulik: I guess back to that product playbook that we talked about a few times, with kind of Reels now such a large share of kind of time spent on Instagram and Facebook, how do we think about the next leg of kind of monetization growth from here? In particular, as we kind of get back to kind of shopping on platform or other ways to monetize, any color there on the road map kind of just beyond ad insertion from here?
And then, Susan, just on the ad market, in particular, previously, we heard a lot about kind of Chinese-based advertiser contribution. Any color you could share there on kind of how that spend is trending?
Susan Li: Sure. Thanks, Mark. So Reels revenue continued to grow across Instagram and Facebook in Q1, and that's driven both by higher engagement and increased monetization efficiency through our ads ranking and delivery improvements. And we -- as we've mentioned before, we don't plan on quantifying the impact from Reels going forward, but it remains a positive contributor to overall revenue. And we expect that there are going to be opportunities for us to continue improving performance and growing supply.
So on the performance improvements, we are investing in ongoing ranking improvements. We're continuing to make ads easier and more intuitive to interact with through work like optimizing call to actions and post-click experiences, which are especially important for DR performance. And we're also optimizing ads to feel more native to Reels.
In Q1, we rolled out our gen AI image expansion tools across Facebook and Instagram Reels after having introduced it to Instagram feed in Q4, and we're seeing, again, outsized adoption with small businesses. So we're excited about the opportunities to continue making these ads more performant. And even though ads -- the Reels ad loads, sorry, has increased over the last year, it remains lower on a per time basis than both Feed and Stories. So we're going to continue to look for opportunities to thoughtfully grow it in the future and invest in creative ways to address the structural supply constraints of the Reels format being more video-heavy, including higher density experiences and formats and increasingly personalizing ad loads, which we think will make sure that we're really putting ads in front of people when they're most likely to be interested and engaged with them.
The second question you asked was around China. Growth in spend from China advertisers remained strong in Q1. This was driven by online commerce and gaming, and it's reflected in our Asia Pacific advertisers segment, which remained the fastest-growing region, at 41% year-over-year in Q1. Now we did see strength across other geographies as well, including a 6-point acceleration in total revenue growth from North America advertisers.
So I would say that we aren't quantifying the Q1 contribution from China, and we don't have forward-looking expectations to share on quarterly China-based ad revenue, but I will say that we are lapping periods of increasingly strong demand over the course of 2024 given the recovery of China-based advertisers in 2023 from their prior pandemic-driven headwinds.
Operator: Your next question comes from the line of Doug Anmuth from JPMorgan.
Douglas Anmuth: Can you just talk about what's changed most in your view in the business and the opportunity now versus 3 months ago? And is there anything you're more cautious about in revenue in the ad market? And is the AI opportunity just even bigger, and therefore, requiring more investment than expected?
And then, Susan, can you also just comment on how you're thinking about that ability to sustain growth rates over the next few quarters as you face tougher comps off a big base of ad dollars?
Mark Zuckerberg: Yes, I can speak to the first one. I think we've gotten more optimistic and ambitious on AI. So previously, I think that our work in this -- I mean when you were looking at last year, when we released Llama 2, we were very excited about the model and thought that, that was going to be the basis to be able to build a number of things that were valuable that integrated into our social products. But now I think we're in a pretty different place. So with the latest models, we're not just building good AI models that are going to be capable of building some new good social and commerce products. I actually think we're in a place where we've shown that we can build leading models and be the leading AI company in the world. And that opens up a lot of additional opportunities beyond just ones that are the most obvious ones for us.
So that's -- this is what I was trying to refer to in my opening remarks where I just view the success that we've seen with the way that Llama 3 and Meta AI have come together as a real validation technically that we have the talent, the data and the ability to scale infrastructure to do leading work here.
And with Meta AI, I think that we are on our path to having Meta AI be the most used and best AI assistant in the world, which I think is going to be enormously valuable. So all of that basically encourages me to make sure that we're investing to stay at the leading edge of this.
And we're doing that at the time when we're also scaling the product before it is making money. So that's the analogy that I was making before, which is we've gone through some of those cycles before. But fundamentally, I think if you look at the facts of what our team is able to produce, I think it just -- our optimism and ambition have just grown quite a bit, and I think that this is just going to end up being quite an important set of products for us. So it was already going to be. Now I think it has the potential to be even more important.
Susan Li: And I can take that second question, Doug. So we aren't giving full year 2024 guidance. And obviously, our revenue for the full year will be influenced by many factors, including macro conditions and things that are harder to predict the further out you go. And of course, over the course of 2024, we will also be lapping periods of increasingly strong demand. With that said, we expect to see good opportunities to continue growing engagement across our products, driven by the investments we made in AI-based content recommendations, our ongoing video work. And we also expect that we will continue to drive ads performance gains and continue to make our ads sort of more effective and deliver increasing value to advertisers.
One thing I'd share, for example, is that we actually grew conversions at a faster rate than we grew impressions over the course of this quarter. So we are -- we're expecting to -- which basically suggests that our conversion grade is growing and is one of the ways in which our ads are becoming more performant. So I feel like there's a lot of opportunity for us, both with our organic engagement growth and with continuing to make the ads better and to continue driving more results for advertisers.
Operator: Your next question comes from the line of Justin Post from Bank of America.
Justin Post: First on the CapEx, mostly, you're kind of talking about an investment cycle here. Is there any way you could kind of use some of the metaverse spend over into AI? Are they converging and kind of use some of the money from the other areas to kind of fund the AI?
And then second, longer-term investors are very focused on returns on capital. Obviously, great returns on CapEx in the past with your margins today. How do we think about the returns on the capital you're spending? How are you thinking about it, I guess, going forward 2, 3 years out?
Susan Li: So on the -- I would say -- well, I can start with the second part, and then I'll defer to Mark on the first one. In terms of measuring the ROI on our CapEx investments, we've broadly categorized our AI investments into 2 buckets. I think of them as sort of core AI work and then strategic bets, which would include gen AI and the advanced research efforts to support that. And those are just really at different stages as it relates to being able to measure the return and drive revenue for our business. So with our core AI work, we continue to have a very ROI-driven approach to investment, and we're still seeing strong returns as improvements to both engagement and ad performance have translated into revenue gains.
Now the second area, strategic bets, is where we are much earlier. Mark has talked about the potential that we believe we have to create significant value for our business in a number of areas, including opportunities to build businesses that don't exist on us today. But we'll need to invest ahead of that opportunity to develop more advanced models and to grow the usage of our products before they drive meaningful revenue.
So while there is tremendous long-term potential, we're just much earlier on the return curve than with our core AI work. What I'll say though is we're also building our systems in a way that gives us fungibility in how we use our capacity so we can flex it across different use cases as we identify what are the best opportunities to put that infrastructure toward.
Mark Zuckerberg: And then on the question of shifting resources from other parts of the company. I would say, broadly, we actually are doing that in a lot of places in terms of shifting resources from other areas, whether it's compute resources or different things in order to advance the AI efforts. For Reality Labs specifically, I'm still really optimistic about building these new computing platforms long term. I mentioned in my remarks upfront that one of the bigger areas that we're investing in Reality Labs is glasses. We think that that's going to be a really important platform for the future.
Our outlook for that, I think, has improved quite a bit because previously, we thought that, that would need to wait until we have these full holographic displays to be a large market. And now we're a lot more focused on the glasses that we're delivering in partnership with Ray-Ban, which I think are going really well. And -- so that, I think, has the ability to be a pretty meaningful and growing platform sooner than I would have expected. So it is true that more of the Reality Labs work, like I said, is sort of focused on the AI goals as well. But I still think that we should focus on building these long-term platforms, too.
Operator: Your next question comes from the line of Youssef Squali from Truist Securities.
Youssef Squali: Mark, with the upcoming ban or sale of TikTok signed into law earlier today, how do you think that will impact the U.S. social media landscape? And then, in particular, what do you say to people who believe that this is potentially a slippery slope in terms of the government picking up -- picking winners and losers?
And Susan, how big is Advantage+ in terms of the spend on the platform and just in terms of its impact on overall CPM stabilizing?
Susan Li: Thanks, Youssef. We've obviously been following the events related to TikTok closely, but at this stage, it is just too early, I think, to assess its impact or what it would mean for our business.
To your second question on Advantage+, we're continuing to see good traction across our Advantage+ portfolio, including both with solutions, I mentioned this, that automate individual steps of a campaign creation setup as well as ones that automate the full end-to-end process. So on the single-step automation, Advantage+ audience, for example, has seen significant growth in adoption since we made it the default audience creation experience for most advertisers in Q4. And that enables advertisers to increase campaign performance by just using audience inputs as a suggestion rather than a hard constraint. And based on tests that we ran, campaigns using Advantage+ audience targeting saw, on average, a 28% decrease in cost per click or per objective compared to using our regular targeting.
On the end-to-end automation products like Advantage+ shopping and Advantage+ app campaigns, we're also seeing very strong growth. Mark mentioned the combined revenue flowing through those 2 has more than doubled since last year. And we think there's still significant runway to broaden adoption, so we're trying to enable more conversion types for Advantage+ shopping. In Q1, we began expanding the list of conversions that businesses could optimize for. So previously, it only supported purchase events, and now we've added 10 additional conversion types. And we're continuing to see strong adoption now across verticals.
So generally, I would say we are building a lot more functionality into the Advantage+ tools over time. also where a lot of our gen AI ads creative features have been introduced and where advertisers have the opportunity to experiment with those. And we'll keep looking to apply what we learn from these products more broadly to our ads investments over the course of the year.
Operator: Your next question comes from the line of Ken Gawrelski from Wells Fargo.
Kenneth Gawrelski: As you look out through the coming period of product investment, how should we think about the relationship between Family of Apps revenue and cost growth? Is there any insight you can give us there?
And then maybe just one that's a little bit more specific to the G&A growth in 1Q. You called out legal expenses. Just wanted to see if there's anything onetime in there that would cause the elevated growth in 1Q.
Susan Li: Yes. On the second part of your question first, so on the G&A side, that was really driven by legal expenses. We recognized some accruals in Q1 related to ongoing legal matters, and you'll see more detail on that in the 10-Q.
On the first part of your question, which is really about sort of the kind of long-term margin profile of Family of Apps, we aren't giving guidance on that per se. But one of the things that we really have been very disciplined about over the course of 2023 and continuing is really operating the business in a very efficiency oriented way. So we're being very disciplined with allocation of new resources. This is a muscle that we really built over 2023 that we believe is important for us to keep carrying forward. And I think you'll see us continue to emphasize that, especially with the Family of Apps business being at the scale that it is.
Operator: Your next question comes from the line of Ross Sandler from Barclays.
Ross Sandler: Great. Mark, you partnered with Google and Bing for Meta AI organic search citations. So I guess stepping back, do you think that Meta AI longer term could bring in search advertising dollars at some point? Or do you view this as what others are doing, where you kind of attach a premium subscription tier once people kind of get going on it?
And then the second question is, you mentioned that you guys are working on building AI tools for businesses and creators. So just, I guess, how do you see the business model evolving when we all get to the stage of interacting with something like Taylor Swift's custom AI for merchandise or tickets or something like that. How is that going to play out?
Mark Zuckerberg: All right. So yes, on the Google and Microsoft partnerships, yes, I mean we work with them to have real-time information in Meta AI. It's useful. I think it's pretty different from search. We're not working on search ads or anything like that. I think this will end up being a pretty different business.
I do think that there will be an ability to have ads and paid content in Meta AI interactions over time as well as people being able to pay for whether it's bigger models or more compute or some of the premium features and things like that. But that's all very early in fleshing out.
The thing that I actually think is probably -- the biggest clear opportunity is all the work around business messaging. That's in addition to the stuff that we're already doing, just generate to increase engagement and ads quality in the apps. But business messaging thing, I mean, whether it's a creator or one of the 100-plus million businesses on our platform, we basically want to make it very easy for all of these folks to set up an AI to engage with their community. For a business, that's going to be able to do sales and commerce and customer support. And I think it will be similar for creators, although there will be more of a kind of just fun and engaging part there, but a lot of creators are on the platform because they see this as a business too, whether they're trying to sell concert tickets or products or whatever it is that their business goal is.
And a lot of these folks either aren't advertising as much as they could or, in business, the business messaging parts, I think, are still relatively undermonetized compared to where they will be. And I think a lot of that is because the cost of engaging with people in messaging is still very high. But AI should bring that down just dramatically for businesses and creators. And I think that, that has the potential. That's probably the -- beyond just increasing engagement and increasing the quality of the ads, I think that, that's probably one of the nearer-term opportunities, even though that will -- it's not like next quarter or the quarter after that scaling thing, but it's -- but that's not like a 5-year opportunity either.
So I think -- that is one that I think is going to be pretty exciting to look at. But yes, I mean, as Meta AI scales too, I think that, that will have its own opportunities to monetize, and we'll build that out over time. But like I tried to emphasize, we're in the phase of this where the main goal is getting many hundreds of millions or billions of people to use Meta AI as a core part of what they do. That's the kind of next goal, building something that is super valuable. We think this has the potential to be at a very large scale. And that's sort of the next step on the journey.
Kenneth Dorell: Krista, we have time for one last question.
Operator: And that question comes from the line of Ron Josey from Citi.
Ronald Josey: Mark, I want to follow up on a prior question that you mentioned optimism has grown internally quite a bit just with all the improvements and investments and innovations you're making. And we're seeing that in the experience for a few days of Meta AI. So can you just talk to us maybe how the $400 billion parameter model just might evolve the experience on Meta or how you think things might change over the next, call it, months, years, et cetera, as maybe messaging becomes a greater focus and things along those lines? So just a vision longer term.
Mark Zuckerberg: Yes. I mean I think that the next phase for a lot of these things are handling more complex tasks and becoming more like agents rather than just chat bots, right? So when I say chatbot, what I mean is you send it a message and it replies to your message, right? So it's almost like almost a 1:1 correspondence.
Whereas what an agent is going to do is you give it an intent or a goal, then it goes off and probably actually performs many queries on its own in the background in order to help accomplish your goal, whether that goal is researching something online or eventually finding the right thing that you're looking to buy. There's a lot of complexity and sort of different things. I think people don't even realize that they will be able to ask computers to do for them.
And I think basically, the larger models and then the more advanced future versions that will be smaller as well are just going to enable much more interesting interactions like that. So I mean if you think about this, I mean, even some of the business use cases that we talked about, you don't really just want like sales or customer support chatbot that can just respond to what you say. And if you're a business, you have a goal, right? You're trying to support your customers well and you're trying to position your products in a certain way and encourage people to buy certain things that map to their interests and would they be interested in? And that's more of like a multiturn interaction, right?
So the type of business agent that you're going to be able to enable with just a chatbot is going to be very naive compared to what we're going to have in a year even, but beyond that, too, is just the reasoning and planning abilities if these things grow to be able to just help guide people through the business process of engaging with whatever your goals are as a creator of a business.
So I think that that's going to be extremely powerful. And I think the opportunity is really big. So -- and on top of that, I think what we've shown now is that we have the ability to build leading models in our company. So I think it makes sense to go for it, and we're going to. And I think it's going to be a really good long-term investment. But I did just want to spell out on this call today, the extent to which we're focusing on this and investing in this for the long term because that's what we do.
Kenneth Dorell: Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again soon.
Operator: This concludes today's conference call. Thank you for your participation, and you may now disconnect. |
TSLA | 1 | 2,024 | 2024-04-23 22:30:10 | Martin Viecha: Tesla's First Quarter 2024 Q&A Webcast. My name is Martin Viecha, VP of Investor Relations, and I'm joined today by Elon Musk, Vaibhav Taneja, and a number of other executives. Our Q1 results were announced at about 3.00 p.m. Central Time in the Update Deck we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events and results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. During the question-and-answer portion of today's call, please limit yourself to one question and one follow-up. Please use the raise hand button to join the question queue. But before we jump into Q&A, Elon has some opening remarks. Elon?
Elon Musk: Thanks, Martin. So to recap in Q1 we navigated several unforeseen challenges as well as the ramp of the updated Model 3 in Fremont. There was, as we all have seen, the EV adoption rate globally is under pressure and a lot of other auto manufacturers are pulling back on EVs and pursuing plug-in hybrids instead. We believe this is not the right strategy and electric vehicles will ultimately dominate the market. Despite these challenges, the Tesla team did a great job executing in a tough environment and energy storage deployments, the Megapack in particular, reached an all time high in Q1, leading to record profitability for the energy business, and that looks likely to continue to increase in the quarters and years ahead. It will increase. We actually know that it will, so significantly faster than the car business as we expected. We also continue to expand our AI training capacity in Q1, more than doubling our training compute sequentially. In terms of the new product roadmap, there has been a lot of talk about our upcoming vehicle line in the next – in the past several weeks. We've updated our future vehicle lineup to accelerate the launch of new models ahead, previously mentioned startup production in the second half of 2025, so we expect it to be more like the early 2025, if not late this year. These new vehicles, including more affordable models, will use aspects of the next generation platform as well as aspects of our current platforms, and will be able to produce on the same manufacturing lines as our current vehicle lineup. So it's not contingent on any new factory or massive new production line. It'll be made on our current production lines much more efficiently. And we think this should allow us to get to over 3 million vehicles of capacity when realized to the full extent. Regarding FSD Version 12, which is the pure AI-based self-driving, if you haven't experienced this, I strongly urge you to try it out. It's profound and the rate of improvement is rapid so – and we've now turned that on for all cars with the cameras and inference computer and everything from Hardware 3 on in North America. And so it's been pushed out to, I think, around 1.8 million vehicles and we're seeing about half of people use it so far and that percentage is increasing with each passing week. So we now have over 300 billion miles that have been driven with FSD V12. Since the launch of full self-driving, supervised full self-driving, it's become very clear that the vision-based approach with end to end neural networks is the right solution for scalable autonomy. It's really how humans drive. Our entire road network is designed for biological neural nets and eyes. So naturally cameras and digital neural nets are the solution to our current road system. To make it more accessible, we've reduced the subscription price to $99 a month, so it's easy to try out. And as we've announced, we'll be showcasing our purpose-built robotaxi, or Cybercab, in August. Yes. Regarding AI compute, over the past few months, we've been actively working on expanding Tesla's core AI infrastructure. For a while there, we were training constrained in our progress. We are, at this point, no longer training constrained and so we're making rapid progress. We've installed and commissioned, meaning they're actually working 35,000 H100 computers or GPUs, GPU is wrong word, they need a new word. I always feel like a wince when I say GPU because it's not – GPU stands – G stands for graphics, and it doesn't do graphics. But anyway roughly 35,000 H100s are active, and we expect that to be probably 85,000 or thereabouts by the end of this year and training, just for training. We are making sure that we're being as efficient as possible in our training. It's not just about the number of H100s, but how efficiently they're used. So in conclusion, we're super excited about our autonomy road map. I think it should be obvious to anyone who's driving Version 12 and it tells that that it is only a matter of time before we exceed the reliability of humans and not much time with that. And we're really headed for an electric vehicle, an autonomous future. And I'll go back to something I said several years ago that in the future, gasoline cars that are not autonomous will be like riding a horse and using a flip phone. And that will become very obvious in hindsight. We continue to make the necessary investments that will drive growth and profits for Tesla in the future, and I wanted to thank the Tesla team for incredible execution during this period and look forward to everything that we have planned ahead. Thanks.
Martin Viecha: Thank you very much, and Vaibhav has some comments as well.
Vaibhav Taneja: Thanks. It's important to acknowledge what Elon said, from our auto business perspective. We did see a seasonal decline in revenues quarter-over-quarter and those were primarily because of seasonality, uncertain macroeconomic environment and the other reasons, which Elon had mentioned earlier. Auto margins declined from 18.9% to 18.5%. Excluding the impact of Cybertruck, the impact of pricing actions was largely offset by reductions in per unit costs and the recognition of revenue from Autopark feature for certain vehicles in the U.S. that previously did not have that functionality. Additionally, while we did experience higher cost due to the ramp of Model 3 in Fremont and disruptions in Berlin, these costs were largely offset by cost reduction initiatives. In fact, if we exclude Cybertruck and Fremont Model 3 ramp costs, the revenue from Autopark, auto margins improved slightly. Currently normalized Model Y cost per vehicle in Austin and Berlin are already very close to that of Fremont. Our ability to reduce costs without sacrificing on quality was due to the amazing efforts of the team, in executing Tesla's relentless pursuit of efficiency across the business. We've also witnessed that as other OEMs are pulling back on their investments in EV, there is increasing appetite for credits, and that means a steady stream of revenue for us. Obviously, seeing others pull back from EV is not the future we want. We would prefer it the whole industry went all in. On the demand front, we've undertaken a variety of initiatives, including lowering the price of both the purchase and subscription options for FSD launching extremely attractive leasing specials for the Model 3 in the U.S. for $299 a month and offering attractive financing options in certain markets. We believe that our awareness activities, paired with attractive financing, will go a long way in expanding our reach and driving demand for our products. Our Energy business continues to make meaningful progress with margins reaching a record of 24.6%. We expect the energy storage deployments for 2024 to grow at least 75% higher from 2023. And accordingly, this business will begin contributing significantly to our overall profitability. Note that there is a bit of lumpiness in our storage deployments due to a variety of factors that are outside of our control, so deployments may fluctuate quarter-over-quarter. On the operating expense front, we saw a sequential increase from our AI initiatives, continued investment in future projects, marketing and other activities. We had negative free cash flow of $2.5 billion in the first quarter. The primary driver of this was an increase in inventory from a mismatch between builds and deliveries as discussed before, and our elevated spend on CapEx across various initiatives, including AI compute. We expect the inventory build to reverse in the second quarter and free cash flow to return to positive again. As we prepare the company for the next phase of growth, we had to make the hard but necessary decision to reduce our head count by over 10%. The savings generated are expected to be well in excess of $1 billion on an annual run rate basis. We are also getting hyper focused on CapEx efficiency and utilizing our installed capacity in a more efficient manner. The savings from these initiatives, including our cost reductions will help improve our overall profitability and ultimately enable us to increase the scale of our investments in AI. In conclusion, the future is extremely bright and the journey to get there while challenging will be extremely rewarding. Once again, I would like to thank the whole Tesla team for delivering great results. And we can open it up to Q&A.
A - Martin Viecha: Okay. Let's start with investor Q&A. The first question is, what is the status of 4680. What is the current output? Lars?
Lars Moravy : Sure. 4680 production increased about 18% to 20% from Q4 reaching greater than 1K a week for Cybertruck, which is about 7 gigawatt hours per year as we posted on X. We expect to stay ahead of the Cybertruck ramp with the cell production throughout Q2 as we ramp the third of four lines in Phase 1, while maintaining multiple weeks of cell inventory to make sure we're ahead of the ramp. Because we're ramping, COGS continues to drop rapidly week-over-week driven by yield improvements throughout the lines and production volume increases. So our goal, and we expect to do this is to beat supplier cost of nickel-based cells by the end of the year.
Martin Viecha: Thank you. The second question is on Optimus. So what is the current status of Optimus? Are they currently performing any factory tasks? When do you expect to start mass production?
Elon Musk: We are able to do simple factory tasks or at least, I should say, factory tasks in the lab. In terms of – we do think we will have Optimus in limited production in the natural factory itself, doing useful tasks before the end of this year. And then I think we may be able to sell it externally by the end of next year. These are just guesses. As I've said before, I think Optimus will be more valuable than everything else combined. Because if you've got a sentient humanoid robots that is able to navigate reality and do tasks at request, there is no meaningful limit to the size of the economy. So that's what is going to happen. And I think Tesla is best positioned of any humanoid robot maker to be able to reach volume production with efficient inference on the robot itself. I mean this perhaps is a point that is worth emphasizing Tesla's AI inference efficiency is vastly better than any other company. There is no company even close to the inference efficiency of Tesla. We've had to do that because we were constrained by the inference hardware in the car, we didn't have a choice. But that will pay dividends in many ways.
Martin Viecha: Thank you. The third question is, what is the current assessment of the pathway towards regulatory approval for unsupervised FSD in the U.S. And how should we think about the appropriate safety threshold compared to human drivers?
Elon Musk: Sure.
Lars Moravy: I can start. There are a handful of states that already have adopted autonomous vehicle laws. These states are paving the way for operations, while the data for such operations guides a broader adoption of driver-less vehicles. I think Ashok can talk a little bit about our safety methodology, but we expect that these states and the work ongoing as well as the data that we're providing will pave a way for a broad-based regulatory approval in the U.S. at least and then in other countries as well?
Ashok Elluswamy: Yes. It's actually been pretty helpful that other autonomous car companies have been cutting a path through the regulatory jungle, which is absurd. That's actually quite helpful. And they have obviously been operating in San Francisco for a while. I think they got approval for City of LA. So these approvals are happening rapidly. I think if you've got at scale, a statistically significant amount of data that shows conclusively that the autonomous car has, let's say, half the accident rate of a human-driven car, I think, that's difficult to ignore because at that point, stopping autonomy means killing people. So I actually do not think that there will be significant regulatory barriers provided there was conclusive data that the autonomous car is safer than a human-driven car. And in my view, this will be much like elevators. Elevators used to be operated by a guy with relay switch. But sometimes that guy would get tired or drunk or just make a mistake, and shatter somebody in half between floors. So we just get an elevator and press button, we don't think about it. In fact, it's kind of weird if somebody is standing there with a relay switch. And that will be how cars work. You just summon the car using your phone, you get in, it takes you to a destination, you get out.
Vaibhav Taneja: You don't even think about it?
Elon Musk: You don't even think about it. Just like an elevator, it takes you to your floor. That's it. Don't think about how the elevator is working or anything like that. And something I should clarify is that Tesla will be operating the fleet. So you can think of like how Tesla, think of it’s like some combination of Airbnb and Uber, meaning that there will be some number of cars that Tesla owns itself and operates in the fleet. There will be some number of cars and then there'll be a bunch of cars where they're owned by the end user. That end user can add or subtract their car to the fleet whenever they want, and they can decide if they want to only let the car be used by friends and family or only by 5-star users or by anyone at any time they could have the car come back to them and be exclusively theirs, like an Airbnb. You could rent out your guest room or not, any time you want. So as our fleet grows, we have 7 million cars going to – 9 million cars going to, eventually tens of millions of cars worldwide. With a constant feedback loop, every time something goes wrong, that gets added to the training data and you get this training flywheel happening in the same way that Google Search has the sort of flywheel, it's very difficult to compete with Google because people are constantly doing searches and clicking and Google is getting that feedback loop. It’s the same with Tesla. But at a scale that is maybe difficult to comprehend, but ultimately, it will be tens of millions. I think there's also some potential here for an AWS element down the road where if we've got very powerful inference because we've got a Hardware 3 in the cars, but now all cars are being made with Hardware 4. Hardware 5 is pretty much designed and should be in cars, hopefully towards the end of next year. And there's a potential to run – when the car is not moving to actually run distributed inference. So kind of like AWS, but distributed inference. Like it takes a lot of computers to train an AI model, but many orders of magnitude less compute to run it. So if you can imagine future, perhaps where there's a fleet of 100 million Teslas, and on average, they've got like maybe a kilowatt of inference compute. That's 100 gigawatts of inference compute distributed all around the world. It's pretty hard to put together 100 gigawatts of AI compute. And even in an autonomous future where the car is, perhaps, used instead of being used 10 hours a week, it is used 50 hours a week. That still leaves over 100 hours a week where the car inference computer could be doing something else. And it seems like it will be a waste not to use it.
Martin Viecha: Ashok, do you want to chime in on the air process and safety?
Ashok Elluswamy: Yes, we have multiple tiers of validating the safety in any given week, we train hundreds of neural networks that can produce different trajectories for how to drive the car, we replay them through the millions of clips that we have already collected from our users and our own QA. Those are like critical events, like someone jumping out in front or like other critical events that we have gathered database over many, many years, and we replay through all of them to make sure that we are net improving safety. And on top of it, we have simulation systems that also try to recreate this and test this in closed loop fashion. And some of this is validated, we give it to our own QA drivers. We have hundreds of them in different cities, in San Francisco, Los Angeles, Austin, New York, a lot of different locations. They are also driving this and collecting real-world miles, and we have an estimate of what are the critical events, are they a net improvement compared to the previous week’s builds. And once we have confidence that the build is a net improvement, then we start shipping to early users, like 2,000 employees initially that they would like it to build, they will give feedback on like if it's an improvement there or they're noting some new issues that we did not capture in our own QA process. And only after all of this is validated, then we go to external customers. And even when we go external, we have like live dashboards of monitoring every critical event that's happening in the fleet sorted by the criticality of it. So we are having a constant pulse on the build quality and the safety improvement along the way. And then any failures like Elon alluded to, we get the data back, add it to the training and that improves the model in the next cycle. So we have this like constant feedback loop of issues, fixes, evaluations and then rinse and repeat. And especially with the new V12 architecture, all of this is automatically improving without requiring much engineering interventions in the sense that engineers don't have to be creative in like how they code the algorithms. It's mostly learning on its own based on data. So you see that, okay, every failure or like this is how a person shows, this is how you drive this intersection or something like that, they get the data back. We add it to the neural network, and it learns from that trained data automatically instead of some engineers saying that, oh, here, you must rotate the steering wheel by this much or something like that. There's no hard inference conditions, it's everything is neural network, it's very soft, it's probabilistic. So it will adapt its probability distribution based on the new data that it's getting.
Elon Musk: Yes. We do have some insight into how good the things will be in like, let's say, three or four months because we have advanced models that are far more capable than what is in the car, but have some issues with them that we need to fix. So they are like there'll be a step change improvement in the capabilities of the car, but it will have some quirks that are – that need to be addressed in order to release it. As Ashok was saying, we have to be very careful in what we release the fleet or to customers in general. So like – if we look at say 12.4 and 12.5, which are really could arguably even be Version 13, Version 14 because it's pretty close to a total retrain of the neural nets in each case are substantially different. So we have good insight into where the model is, how well the car will perform, in, say, three or four months.
Ashok Elluswamy: Yes. In terms of scaling laws, people in the AI community generally talk about model scaling laws where they increase the model size a lot and then their corresponding gains in performance, but we have also figured out scaling laws and other access in addition to the model side scaling, making also data scaling. You can increase the amount of data you use to train the neural network and that also gives similar gains and you can also scale up by training compute, you can train it for much longer or make more GPUs or more Dojo nodes and that also gives better performance, and you can also have architecture scaling where you count with better architectures that for the same amount of compute for produce better results. So a combination of model size scaling, data scaling, training compute scaling and the architecture scaling, we can basically extract like, okay, with the continue scaling based on this – at this ratio, we can sort of predict future performance. Obviously, it takes time to do the experiments because it takes a few weeks to train, it takes a few weeks to collect tens of millions of video clips and process all of them, but you can estimate what’s going to be the future progress based on the trends that we have seen in the past, and they’re generally held true based on past data.
Martin Viecha: Okay. Thank you very much. I’ll go to the next question, which is, can we get an official announcement of the time line for the $25,000 vehicle?
Lars Moravy: I think we – Elon mentioned it in the opening remarks. But as you mentioned, we’re updating our future vehicle lineup to accelerate the launch of our low-cost vehicles in a more CapEx efficient way. That’s our mission to get the most affordable cars to customers as fast as possible. These new vehicles we built on our existing lines and open capacity, and that’s a major shift to utilize all our capacity with marginal CapEx before we go spend high CapEx to do anything.
Elon Musk: Yes. We’ll talk about this more on August 8. But really, the way to think of Tesla is almost entirely in terms of solving autonomy and being able to turn on that autonomy for a gigantic fleet. And I think it might be the biggest asset value appreciation history when that day happens when you can do unsupervised full self-driving.
Lars Moravy: 5 million cars?
Elon Musk: Yes.
Lars Moravy: A little less?
Elon Musk: Yes. It will be 7 million cars in a year or so and then 10 million and then eventually, we’re talking about tens of millions of cars. Not eventually, it’s like, yes, for the end of the decade, its several tens of millions of cars I think.
Martin Viecha: Thank you. The next question is, what is the progress of Cybertruck ramp?
Lars Moravy: I can take that one too. Cybertruck had 1K a week just a couple of weeks ago. This happened in the first four to five months since we SOP [ph] late last year. Of course, volume production is what matters. That’s what drives costs and so our costs are dropping, but the ramp still faces like a lot of challenges with so many new technologies, some supplier limitations, et cetera, and continue to ramp this year, just focusing on cost efficiency and quality.
Martin Viecha: Okay. Thank you. The next question, have any of the legacy automakers contacted Tesla about possibly licensing FSD in the future?
Elon Musk: We’re in conversations with one major automaker regarding licensing FSD.
Martin Viecha: Thank you. The next question is about the robotaxi unveil. Elon already talked about that. So we’ll have to wait till August. The following question is about the next-generation vehicle. We already talked about that. So let’s go to the semi. What is the time line for scaling semi?
Elon Musk: I think…
Lars Moravy: So we’re finalizing the engineering of the semi to enable like a super cost-effective high-volume production with our learnings from our fleet and our pilot fleet and Pepsi’s fleet, which we are expanding this year marginally. In parallel, as we showed in the shareholders’ deck, we have started construction on the factory in Reno. Our first vehicles are planned for late 2025 with external customers starting in 2026.
Martin Viecha: Okay. A couple more questions. So our favorite, can we make FSD transfer permanent until FSD is fully delivered with Level 5 autonomy?
Lars Moravy: Yes.
Martin Viecha: Okay. Next question, what is the getting the production ramp at Lathrop, where do you see the Megapack run rate at the end of the year. Mike?
Unidentified Company Representative: Yes. Yes, Lathrop is ramping as planned. We have our second GA line allowing us to increase our exit rate from 20 gigawatt hours per year to – at the start of this year to 40 gigawatt hours per year by the end of the year, that lines commissioned. There’s really nothing limiting the ramp. Its given the longer sales cycles for these large projects, we typically have order visibility 12 months to 24 months prior to ship dates. So we’re able to plan – the build plan several quarters in advance. So this allows us to ramp the factory to align with the business and order growth. Lastly, we’d like to thank our customers globally for their trust in Tesla as a partner for these incredible projects.
Martin Viecha: Okay. Thank you very much. Let’s go to analyst questions. The first question comes from Tony Sacconaghi from Bernstein. Tony, please go ahead and unmute.
Tony Sacconaghi: Thank you for taking the question. I was just wondering if you can elaborate a little bit more on kind of the new vehicles that you talked about today. Are these like tweaks on existing models, given that they’re going to be running on the same lines? Are these like new models? And how should we think about them in the context of like the Model 3 Highland update, what will these models be like relative to that? And given the quick time frame, Model 3 Highland has required a lot of work and a lot of retooling. Maybe you can help put that all in context. Thank you, and I have a follow-up, please.
Elon Musk: I think we've said, we were on that front. So what’s your follow-up?
Tony Sacconaghi: It’s a more personal one for you, Elon, which is that you’re leading many important companies right now. Maybe you can just talk about where your heart is at in terms of your interests and do you expect to lessen your involvement with Tesla at any point over the next three years?
Elon Musk: Tesla constitutes a majority of my work time and I work pretty much every day of the week. It’s rare for me to take a Sunday afternoon. So I’m going to make sure Tesla is quite prosperous. And it is – like it is prosperous and it will be very much so in the future.
Martin Viecha: Okay. Thank you. Let’s go to Adam Jonas from Morgan Stanley. Adam, please go ahead and unmute.
Adam Jonas: Okay. Great. Hey, Elon. So you and your team on volume expect a 2024 growth rate, notably lower than that achieved in 2023. But what's your team's degree of confidence on growth above 0%? Or in other words, does that statement leave room for potentially lower sales year-on-year?
Elon Musk: No, I think we'll have higher sales this year than last year.
Adam Jonas: Okay. My follow-up, Elon, on future product. If you had nailed execution, assuming that you nail execution on your next-gen cheaper vehicles, more aggressive giga castings, I don't want to say one piece, but getting closer to one piece, structural pack, unboxed, 300-mile range, $25,000 price point, putting aside robotaxi, those features unique to you. How long would it take your best Chinese competitors to copy a cheaper and better vehicle that you could offer a couple of years from now? How long would it take your best Chinese competitors to copy that? Thanks.
Elon Musk: I mean, I don't know what our competitors could do, except we've done relatively better than they have. If you look at the drop in our competitors in China sales versus our drop in sales, our drop was less than theirs. So we're doing well. But I think Cathy Wood said it best, like really, we should be thought of as an AI or robotics company. If you value Tesla as just like an auto company, you just have to – fundamentally, it's just the wrong framework and it will come to be. If you ask the wrong question, then the right answer is impossible. So I mean, if somebody doesn't believe Tesla is going to solve autonomy, I think they should not be an investor in the company. Like, that is – but we will and we are. And then you have a car that goes from 10 hours of use a week, like 1.5 hours a day to probably 50%, but it costs the same.
Vaibhav Taneja: I think that's the key thing to remember, right, especially if you look at FSD Supervised, if you didn't believe in autonomy, this should give you a review that this is coming. It's actually getting better day by day.
Elon Musk: Yes. If you've not tried the FSD 12.3, and like I said, 12.4 is going to be significantly better and 12.5 even better than that. And we have visibility into those things. Then you really don't understand what's going on. It's not possible.
Vaibhav Taneja: Yes. And that's why we can't just look at just as a car company because a car company would just have a car. But here, we have more than a car company because the cars can be autonomous. And like I said, it's happening.
Ashok Elluswamy: Yes. This is all in addition to Tesla – the overall AI community is just like increasing – like, improving rapidly.
Elon Musk: Yes. I mean we're putting the actual auto in automobile. So sort of – we go like, well, sort of like tell us about future horse carriages you're making. I'm like, well, actually, it doesn't need a horse that's the whole point. That's really the whole point.
Martin Viecha: Okay, thank you. The next question comes from Alex Potter from Piper Sandler. Alex, please go ahead and unmute.
Alex Potter: Great, thanks. Yes, so I couldn't agree more. The thesis hinges completely on AI, the future of AI, full self-driving neural net training, all of these things. In that context, Elon, you've spoken about your desire to obtain 25% voting control of the company. And I understand completely why that would be. So I'm not necessarily asking about that. I'm asking if you've come up with any mechanism by which you can ensure that you'll obtain that level of voting control. Because if not, then the core part of the thesis could potentially be at risk. So any additional commentary you might have on that topic.
Elon Musk: Well, I think no matter what Tesla, even if I got kidnapped by aliens tomorrow, Tesla will solve autonomy, maybe a little slower, but it would solve autonomy for vehicles at least. I don't know if it would winon with respect to Optimus or with respect to future products, but it would that there's enough momentum for Tesla to solve autonomy even if I disappeared for vehicles. Yes, there's a whole range of things we can do in the future beyond that. I'll be more reticent with respect to Optimus, if we have a super-sentient humanoid robot that can follow you indoors and that you can escape, we're talking terminator-level risk. And yes, I'd be uncomfortable with. If there's not some meaningful level of influence over how that is deployed. And if there's shareholders have an opportunity to ratify or reratify the sort of competition because I can't say that. That is a fact. They have an opportunity. And yes, we'll see. If the company generates a lot of positive cash flow, we could obviously buy back shares.
Alex Potter: All right. That's actually all very helpful context. Thank you. Maybe one final question and I'll pass it on. OpEx reductions, thank you for quantifying the impact there. I'd be interested also in potentially more qualitative discussion of what the implications are for these headcount reductions. What are the types of activities that you're presumably sacrificing as a result of parting ways with these folks? Thanks very much.
Vaibhav Taneja: So like we said, we've done these headcount reductions across the board. And as companies grow over time, there are certain redundancies. There's some duplication of efforts, which happens in certain areas. So you need to go back and look at where all these pockets are, get rid of it. So we're basically going through that exercise wherein we're like, hey, how do we set this company right for the next phase of growth. And the way to think about it is any tree which grows, it needs pruning. This is the pruning exercise which we went through. And at the end of it, we'll be much stronger and much more resilient to deal with the future because the future is really bright. Like I said in my opening remarks, we just have to get through this period and get there.
Elon Musk: Yes, we're not giving up anything that is significant that I'm aware of. So we've had a long period of prosperity from 2019 to now. And so if a company sort of organizationally is 5% wrong per year, that accumulates to 25%, 30% of inefficiency. We've made some corrections along the way. But it is time to reorganize the company for the next phase of growth and you really need to reorganize it, just like a human when we start off with one cell and kind of zygote, blastocyst and you start growing arms and legs and briefly, you have a tail. And so…
Alex Potter: But you shed the tail.
Elon Musk: You shed the tail, hopefully. And then you're baby, you basically, you have to be the organism – a company is kind of like creature growing. And if you don't reorganize it for different phases of growth, it will fail. You can't have the same organizational structure if you're 10 cells versus 100 cells versus 1 million cells versus 1 billion cells versus 1 trillion cells. Humans are around 35 trillion cells, doesn't feel like it feels like, like one person. But you're basically a walking cell colony of roughly 35 trillion depending on your body mass and about three times that number in bacteria. So anyway, you've got to reorganize the company for a new phase of growth or will fail to achieve that growth.
Martin Viecha: Thank you. Let's go to Mark Delaney from Goldman Sachs. Mark please go ahead and unmute.
Mark Delaney: Yes. Good afternoon. Thanks very much for taking the question. The company previously characterized potential FSD licensing discussions in the early phase and some OEMs had not really been believing in it. Can you elaborate on how much the licensing business opportunity you mentioned today has progressed? And is there anything Tesla needs to achieve with the technology in terms of product milestones in order to be successful at reaching a licensing agreement in your view?
Elon Musk: Well, I think we just need to – it just needs to be obvious that our approach is the right approach. And I think it is. I think we've now with 12.3, if you just have the car drive you around; it is obvious that our solution with a relatively low-cost inference computer and standard cameras can achieve self-driving. No LiDARs, no radars, no ultrasonic nothing.
Vaibhav Taneja: No heavy integration work for vehicle manufacturers.
Elon Musk: Yes. So it really just be a case of having them use the same cameras and inference computer and licensing our software. But once it becomes obvious that if you don't have this in a car, nobody wants your car. It's a smart car. I still remember in, back when Nokia was king of the hill, Yes, crushing. And they certainly come out with a smartphone that was basically a break with limited functionality. And then the iPhone and Android, people still do not understand that all the phones are going to be that way. There's not going to be any flip [ph] phones. If there will be a niche product.
Lars Moravy: Or home phones.
Elon Musk: Yes, no even exactly. When is the last time you saw a home phone.
Lars Moravy: No idea in a hotel, sometimes in hotels.
Elon Musk: Yes, the hotels have them. Yes. So the people don't understand all cars will need to be smart cars, or you will not sell or the car will not – nobody would buy it. Once that becomes obvious, I think licensing becomes not optional.
Mark Delaney: It becomes a method of survival?
Elon Musk: Yes, absolutely, it is. License it or nobody will buy your car.
Vaibhav Taneja: I mean one other thing which I'll add is in the conversations, which we've had with some of these OEMs, I just want to also point out that they take a lot of time in their product life cycle.
Elon Musk: Yes.
Vaibhav Taneja: They're talking about years before they will put it in their product. We might have a licensing deal earlier than that, but it takes a while. So this is where the big difference between us and them is, right?
Elon Musk: Yes, I mean, really a deal signed now would result in it being in a car probably three years.
Vaibhav Taneja: That would be early.
Elon Musk: Yes. That's like lightening basically.
Lars Moravy: That's in eager [ph] OEM.
Elon Musk: Yes. So I wouldn't be surprise if we do sign a deal. I think we have a good chance we do sign a deal this year, maybe more than one. But yes, it would be probably three years before it's integrated with a car. Even though all you need is cameras and our inference computer. So just talking about a massive design change.
Vaibhav Taneja: Yes. And again, just to clarify, it's not the work which we have to do. It's the work which they have to do, which will take the time.
Elon Musk: Yes.
Vaibhav Taneja: Mark, is it helpful?
Mark Delaney: Yes, very helpful. Thank you. My follow-up was to better understand Tesla's approach to pricing going forward. Previously, the company had said that the price reductions were driving incremental demand with how affordable the cars have become, especially for vehicles that have access to IRA credits and some of the leasing offers that Tesla has in place. Do you still see meaningful incremental price reductions as making sense from here for the existing products? And can the company meaningfully lower prices from here and also stay free cash flow positive on an annual basis with the current product set? Thanks.
Elon Musk: Yes. I think we can be free cash flow positive meaningfully.
Lars Moravy: I think Vaibhav said it in his opening remarks, like our cost down efforts, we basically were offsetting the price cut like we’re trying to give it back to the customers.
Elon Musk: Yes. I mean the end of the day, like for any given company, if you sell a great product at a great price – if you have a great product at a great price, the sales will be excellent. That’s true of any area. So over time, we do need to keep making sure that we’re – that it’s a great product at a great price. And moreover, that price is accessible to people. So it’s not – you have to solve both the value for money and the fundamental affordability question. The fundamental affordability question is sometimes overlooked. If somebody is earning several hundred thousand dollars a year, they don’t think of a car from a fundamental affordability standpoint. But from vast majority of people are living paycheck to paycheck. So it actually makes a difference if the cost per month for lease refinancing is $10 one way or the other. So it is important to keep improving the affordability and to keep making the price.
Lars Moravy: More accessible.
Elon Musk: Yes, exactly. Make the price more accessible, the value for money better, and to keep improving that over time.
Lars Moravy: But also make kick as cost that people want to buy.
Elon Musk: Yes, it’s going to be a great product and at a great price. And the standards for what constitutes great product at a great price keep increasing. So there’s like – you can’t just be static. You have to keep making the car better, improving the price, but improving the cost of production, and that’s what we’re doing.
Vaibhav Taneja: Yes. And in fact, like I said in my opening remarks also, like the revised – the updated Model 3 is a fantastic car. I don’t think people fully even understand that lot of engineering effort which has gone and Lars and team have actually put out videos explaining how much the car is different. I mean it looks and feels different. Not only it looks and feels different. We’ve added so much value to it, but you can lease it for like as low as $299 a month.
Lars Moravy: Without gas.
Vaibhav Taneja: Yes.
Martin Viecha: All right. The next question comes from George from Canaccord. George, please go ahead and unmute.
Unidentified Analyst: Hi, thank you for taking my question. First, could you please help us understand some of the timing of launching FSD in additional geographies, including maybe clarifying your recent comment about China? Thank you.
Elon Musk: I mean like new markets, yes, we are – there are a bunch of markets where we don’t currently sell cars that we should be selling cars in. We’ll see some acceleration of that.
Unidentified Analyst: And FSD new markets?
Elon Musk: Yes. So think about the end-to-end neural net-based autonomy is that just like a human, it actually works pretty well without modification in almost any market. So we plan on – with the approval of the regulators, releasing it as a supervised autonomy system in any market that – where we can get regulatory approval for that, which we think includes China. So yes, it’s – just like a human, you can go rent a car in a foreign country and you can drive pretty well. Obviously, if you live in that country, you’ll drive better. And so we’ll make the car drive better in these other countries with country-specific training. But it can drive quite well almost everywhere.
Vaibhav Taneja: The basics of driving are basically same everywhere like car is a car, the traffic lights, road is the road. Yes.
Elon Musk: It understands that it shouldn’t hit things, no matter what the road rules are.
Vaibhav Taneja: Exactly. There are some road rules that you need to follow. And in China, you shouldn’t cross over a solid line to do a lane change. In U.S. it’s a recommendation I think. In China, you get fined heavily if you do that. We have to do some more actions, but it’s mostly smaller reduction. It’s not like the entire change or type or something.
Elon Musk: Yes.
Martin Viecha: Hey, George, do you have a follow-up?
Unidentified Analyst: Yes. So my follow-up has to do with the first quarter deliveries and I’m curious as to whether or not you feel that supply constraints that you mentioned throughout the release impacted the results and maybe can you help us quantify that? And is that why you have some confidence in unit growth in 2024?
Vaibhav Taneja: Yes. I think we did cover this a little bit in the opening remarks to you. Q1 had a lot of different things which are happening. Seasonality was a big one, continued pressure from the macroeconomic environment. We had attacks at our factory. We had Red Sea attacks, we are ramping Model 3, we’re ramping Cybertruck. All these things are happening. I mean, it almost feels like a culmination of all those activities in a constrained period. And that gives us that confidence that, hey, we don’t expect these things to recur.
Elon Musk: Yes. We think Q2 will be a lot better.
Vaibhav Taneja: Yes.
Lars Moravy: It’s just one thing after another. Our Cybertrucks are crazy. Thank you.
Elon Musk: Yes, exactly. It’s just – if you’ve got cars that are sitting on ships, they obviously cannot delivered to people. And if you’ve got the excess demand for Model 3 and Model Y in one market, but you don’t have it there. It’s quite a – it’s extremely complex logistics situation. So I’d say also the – we did overcomplicate the sales process, which we’ve just in the past week or so have greatly simplified. So it became far too complex to buy a Tesla, whereas it should just be you can buy the car in under a minute. So we’re getting back to that you can buy a Tesla in under an minute interface from what was quite complex.
Martin Viecha: Okay, thank you. Let’s go to Colin Rusch from Oppenheimer. Colin, go ahead and unmute, please.
Colin Rusch: Thanks so much, guys. Given the pursuit of Tesla really as a leader in AI for the physical world, in your comments around distributed inference, can you talk about what that approach is unlocking beyond what’s happening in the vehicle right now?
Elon Musk: Do you want to say something?
Ashok Elluswamy: Yes. Like Elon mentioned like the car even when it's a full robotaxi it's probably going to be used 150 hours a week.
Elon Musk: That's my guess like a third of the hours of the week.
Ashok Elluswamy: Yes. It could be more or less, but then there's certainly going to be some hours left for charging and cleaning and maintenance in that world, you can do a lot of other workloads, even right now we are seeing, for example, these LLM companies have these like batch workloads where they send a bunch of documents and those run through pretty large neural networks and take a lot of compute to chunk through those workloads. And now that we have already paid for this compute in these cars, it might be wise to use them and not let them be idle, be like buying a lot of expensive machinery and leaving to them idle. Like we don't want that, we want to use the computer as much as possible and close to like basically 100% of the time to make it a use of it.
Elon Musk: That’s right. I think it's analogous to Amazon Web Services, where people didn't expect that AWS would be the most valuable part of Amazon when it started out as a bookstore. So that was on nobody's radar. But they found that they had excess compute because the compute needs would spike to extreme levels for brief periods of the year and then they had idle compute for the rest of the year. So then what should they do to pull that excess compute for the rest of the year? That's kind of...
Ashok Elluswamy: Monetize it
Elon Musk: Yes, monetize it. So, it seems like kind of a no-brainer to say, okay, if we've got millions and then tens of millions of vehicles out there where the computers are idle most of the time that we might well have them do something useful.
Ashok Elluswamy: Exactly.
Elon Musk: And then, I mean, if you get like to the 100 million vehicle level, which I think we will, at some point, get to, then – and you've got a kilowatt of useable compute and maybe your own hardware 6 or 7 by that time. Then you really – I think you could have on the order of 100 gigawatts of useful compute, which might be more than anyone more than any company, probably more than a company.
Ashok Elluswamy: Yes, probably because it takes a lot of intelligence to drive the car anyway. And when it's not driving the car, you just put this intelligence to other uses, solving scientific problems or answer in terms of someone else.
Elon Musk: It's like a human, ideally. We've already learned about deploying workloads to these nodes
Ashok Elluswamy: Yes. And unlike laptops and our cell phones, it is totally under Tesla's control. So it's easier to distribute the workload across different nodes as opposed to asking users for permission on their own cell phones to be very tedious.
Elon Musk: Well, you're just draining the battery on the phone.
Ashok Elluswamy: Yes, exactly. The battery is also...
Elon Musk: So like technically, I suppose like Apple would have the most amount of distributed compute, but you can't use it because you can't get the – you can't just run the phone at full power and drain the battery.
Ashok Elluswamy: Yes.
Elon Musk: So, whereas for the car, even if you're a kilowatt level inference computer, which is crazy power compared to a phone. If you've got 50 or 60 kilowatt hour pack, it's still not a big deal to run if you are plugged it – whether you plugged it or not – you could be plugged in or not like you could run for 10 hours and use 10-kilowatt hours of your kilowatt of compute power.
Lars Moravy: Yes. We got built in like liquid cold thermal management.
Elon Musk: Yes, exactly.
Lars Moravy: Exactly for data centers, it's already there in the car.
Elon Musk: Exactly. Yes. Its distributed power generation – distributed access to power and distributed cooling, that was already paid for.
Ashok Elluswamy: Yes. I mean that distributed power and cooling, people underestimate that costs a lot of money.
Vaibhav Taneja: Yes. And the CapEx is shared by the entire world sort of everyone wants a small chunk, and they get a small profit out of it, maybe.
Elon Musk: Yes.
Colin Rusch: Thanks so much guys. And just my follow-up is a little bit more mundane. Looking at the 4680 ramp, can you talk about how close you were to target yields and when you might start to accelerate incremental capacity expansions on that technology?
Elon Musk: We're making good progress on that. But I don't think it's super important for at least in the near term. As Lars said, we think it will be exceed the competitiveness of suppliers by the end of this year and then we'll continue to improve.
Lars Moravy: Yes. I mean, I think it's important to note also that like the ramp right now is relevant to the Cybertruck ramp.
Elon Musk: Yes.
Lars Moravy: And so like we're not going to just randomly build 4680s unless we have a place to put them and so we're going to make sure we're prudent about that. But we also have a lot of investments with all our cell suppliers and vendors. They're great partners, and they've done great development work with us and a lot of the advancements in technologies and chemistry we found 4680, they're also putting into their cells.
Elon Musk: Yes. I mean a big part of the 4680, Tesla doing internal cells was a hedge against what would happen with our suppliers because for a while they are it was very difficult because every big carmaker put in massive battery orders, and so the price per kilowatt hour of lithium-ion batteries went to crazy numbers, crazy levels.
Vaibhav Taneja: Bonkers.
Elon Musk: Yes, just bonkers. So like, okay, we've got to have some hedge here to deal with cost per kilowatt hours of numbers that were double what we anticipated. If we have an internal cell production, then we have that hedge against demand shocks, we have too much demand. That's really the way to think about it. It's not like we want to take on a whole bunch of problems just for the hell of it. We did the cell program in order to address the crazy increase in cost per kilowatt hour from our suppliers due to gigantic orders placed by every carmaker on earth.
Martin Viecha: Okay. Thank you. And the last question comes from Ben Kallo from Baird. Ben, go ahead and unmute. Ben, you're still muted.
Elon Musk: Well, I want to say again, we'd just like to strongly recommend that anyone who is, I guess, thinking about the Tesla stock should really drive FSD 12.3. It really – you can't – it's impossible to understand the company if you do not do this.
Martin Viecha: All right. So since Ben is not unmuting. Let's try Shreyas Patil from Wolfe Research. Final question.
Shreyas Patil: Thanks so much. Just Elon, during the Investor Day last year, you mentioned that auto COGS per unit for the next-gen vehicle would decline by 50% versus the current three and Y. I think that was implying something around $20,000 of COGS. About one-third of that was coming from the on-box manufacturing process. But I'm curious if you see an opportunity that the – some of the other drivers around powertrain cost reduction or material cost savings, would those be largely transferable to some of the new products that you're now talking about introducing?
Lars Moravy: Yes, sure. I mean, in short, yes, I mean, like the on-box manufacturing method is certainly great and revolutionary, but with it comes some risks because new production lines and not, but all the subsystems we developed, whether it was powertrains, drive units, battery improvements in manufacturing and automation, thermal systems, seating, integration of interior components and reduction of LV controllers, all that's transferable, and that's what we're doing, trying to get it in their products as fast as possible. And so yes, that engineering work, we're not trying to just throw it away and put a cars and we're going to take it and utilize it and utilize it to the best advantage of the cars we make and the future cars make.
Shreyas Patil: Okay. Great. And then just on that topic of 4680 cells, I know you mentioned it, you really thought of it more as like a hedge against rising battery costs from other OEMs. But it seems even today, it seems like you would have a cost advantage against some of those other automakers. And I'm wondering, given the rationalizing of your vehicle manufacturing plans that you're talking about now, if there's an opportunity to maybe convert the 4680 cells and maybe sell those to other automakers and really generate an additional revenue stream. I'm just curious if you have any thoughts about that.
Elon Musk: Great. What seems to be happening is that the I'm missing something, the orders for batteries from other automakers have declined dramatically. So we're seeing much more competitive prices for sales from our suppliers, dramatically more competitive than in the past. It is clear that a lot of our suppliers have excess capacity.
Vaibhav Taneja: Yes. In addition to what Elon, this is kind of in addition to what Elon said, about 4680, what 4680 did for us from a supply chain perspective was help us understand the supply chain that's upstream of our cell suppliers. So a lot of the deals that we had struck for 4680, we can also supply those materials to our partners, help reducing the overall cost back to Tesla. So we're basically inserting ourselves in the upstream supply chain by doing that. So that's also been beneficial in reducing the overall pricing in addition to the excess capacity that these suppliers have.
Elon Musk: Yes. No, I mean this is going to wax and wane, obviously. So there's going to be a boom and bust in battery cell production where production exceeds supply and then supply exceeds production and back and forth kind of like, I don't know, DRAM or something. But Yes. So it's like what is true today will not be true in the future, there's going to be somewhat of a boom and bust cycle here. And then there are additional complications with government incentives like the Inflation Reduction Act, the IRA, Joe [ph] has found like a funny name.
Vaibhav Taneja: Comical name.
Elon Musk: Yes, it is like Irish Republican Army, The Internet Research Agency from Russia.
Vaibhav Taneja: Independent retirement account.
Elon Musk: Yes, exactly. Roth IRA. It's like Spider-Man situation, which IRA wins. So but it is complicate the incentive structure. So that is there's the stronger demand for cells that are produced in the U.S. than outside the U.S. But then how long is that the IRA last, I don't know.
Vaibhav Taneja: Which is why it's important that we have both internet [ph] cells and vendor cells that hedge against all of this.
Martin Viecha: Okay. Thank you very much. That's all the time we have today. But at the same time, I would like to make a short announcement. And I wanted to let the investment community know that about a month ago, I met up with Elon and Vaibhav and announced that I'll be moving on from the world of Investor Relations. I'll be hanging around for another couple of months or so. So feel free to reach out at any time. But after the seven year sprint, I'm going to be taking a break and spending some good quality time with my family. And I wanted to say that these seven years have been the greatest privilege of my professional life. I'll never forget the memories from I started literally at the beginning of production hell and just watching the company from the inside to see what it's become today. And especially super thankful to the people in this room and dozens of people outside of this room that I've worked for over the years. I think the team's strength and teamwork at Tesla is unlike anything else I've seen in my career. Elon, thank you very much for this opportunity that I got back in 2017. Thank you for seeking investor feedback and regularly and debating it with me.
Elon Musk: Yes. Well, I mean the reason I reached out to you was because I thought your analysis of Tesla was the best that I had seen.
Martin Viecha: Thank you.
Elon Musk: So, thank you for helping Tesla to get to where it is today over seven years. It's been a pleasure working with you.
Martin Viecha: Thank you so much. And yes, thank you for all the thousands of shareholders that we've met over the years and walked around factories and loved all the interactions, even the tough ones. And yes, looking forward to the call in the next three months, but I'll be on the other side, listening in. Thank you very much.
Vaibhav Taneja: Thanks. |
TXN | 1 | 2,024 | 2024-04-23 18:48:07 | Dave Pahl: Welcome to the Texas Instruments First Quarter 2024 Earnings Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Financial Officer, Rafael Lizardi. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. In addition, today's call is being recorded and will be available via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description. Today, we'll provide the following updates: First, I'll start with a quick overview of the quarter. Next, I will provide insight into first quarter revenue results, with some details of what we are seeing with respect to our end-markets. Lastly, Rafael will cover the financial results, give an update on capital management, as well as share the guidance for the second quarter of 2024. Starting with a quick overview of the quarter: Revenue in the quarter came in about as expected at $3.7 billion, a decrease of 10% sequentially and 16% year-over-year. Analog revenue declined 14% year-over-year, and Embedded Processing declined 22%. Our Other segment declined 33% from the year-ago quarter. Now I'll provide some insight into our first quarter revenue by end-market. Revenue declined sequentially across all of our end-markets. Our results reflect the current environment, as customers continue to reduce their inventory levels. Similar to last quarter, I'll focus on sequential performance, as it is more informative at this time. First, the industrial market was down upper-single digits. The automotive market was down mid-single digits. Personal electronics was down mid-teens. Next, communications equipment was down about 25%. And lastly, enterprise systems was down mid-teens. Rafael will now review profitability, capital management and our outlook. Rafael?
Rafael Lizardi: Thanks Dave, and good afternoon everyone. As Dave mentioned, first quarter revenue was $3.7 billion. Gross profit in the quarter was $2.1 billion, or 57% of revenue. From a year ago, gross profit decreased primarily due to lower revenue and to a lesser extent, higher manufacturing costs associated with reduced factory loadings and our planned capacity expansions. Gross profit margin decreased 820 basis points. Operating expenses in the quarter were $933 million, flat from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.7 billion, or 22% of revenue. Operating profit was $1.3 billion in the quarter, or 35% of revenue, and was down 34% from the year-ago quarter. Net income in the first quarter was $1.1 billion or $1.20 per share. Earnings per share included a $0.10 benefit that was not in our original guidance, primarily due to the sale of a property. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1 billion in the quarter and $6.3 billion on a trailing 12-month basis. Capital expenditures were $1.2 billion in the quarter and $5.3 billion over the last 12 months. Free cash flow on a trailing 12-month basis was $940 million. In the quarter, we paid $1.2 billion in dividends, and in the past 12 months, we returned $4.8 billion to our owners. Our balance sheet remains strong with $10.4 billion of cash and short-term investments at the end of the first quarter. In first quarter, we issued $3 billion in debt. Total debt outstanding is now $14.3 billion with a weighted average coupon of 3.8%. Inventory at the end of the quarter was $4.1 billion, up $84 million from the prior quarter and days were 235, up 16 days sequentially. For the second quarter we expect TI revenue in the range of $3.65 billion to $3.95 billion and earnings per share to be in the range of $1.05 to $1.25. We continue to expect our effective tax rate to be about 13%. In closing, we will stay focused in the areas that add-value in the long-term. We continue to invest in our competitive advantages, which are manufacturing and technology, a broad-product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash flow per share growth over the long-term. With that, let me turn it back to Dave.
Dave Pahl: Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator.
Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. Rafael, I'm wondering if you can give us an update on any CHIPS Act money that you may have gotten. I know, basically all the money for the advanced nodes has been allocated and has been announced, but there is still like $9 billion outstanding for mature nodes. So can you kind of talk about that for us?
Rafael Lizardi: Yes. No, happy to do it. First let me address the grants, which I think is what you're referring to. On that, frankly we don't have an update to give. We're still going through that process. Submitted our application late last year, we are working through the details with the CHIPS Program Office. As we said before, we believe our investments in manufacturing in both Texas and Utah are well-positioned with the objectives of the CHIPS Program Office. Now let me give you an update on the ITC, the Investment Tax Credit. To-date, we have accrued about $1.5 billion on that credit, and based on the recently released regulations, we will be receiving the ITC cash benefit throughout the year in 2024 and beyond. And starting next quarter, so in second quarter, we expect to receive about $300 million and a total of $1 billion for all of 2024. Okay, do you have a follow-up?
Timothy Arcuri: I do, yeah. I wanted to ask about factory loadings and sort of where you think inventory goes for June. If I look at your guidance, the gross margins implied pretty flat ex-depreciation. So it seems like loadings have sort of leveled-off in June. Is that right? And kind of what do you expect for inventory in June? It seems like it should start to come down a tick maybe in June. Thanks.
Rafael Lizardi: Yes. Sure. Of course we give a guidance. We give a range on revenue, we give a range on EPS, and then 90 days from now, we'll discuss that more or less. But for now, I'll tell you that in first quarter, we adjusted factory loadings, as we neared our desired inventory levels. And as we said during the prepared remarks, we grew inventory about [$80-some million] (ph). And then for second quarter, we are going to adjust those loadings depending on future demand.
Dave Pahl: Thank you Tim. We’ll go to next caller please.
Operator: Our next question is from Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi guys. Thanks for taking my question. I wanted to follow up on that. If and when revenues begin to recover, how do we think about what that would imply for your factory utilization given your current inventory position, as well as additional capacity coming online, which I guess sort of just naturally gives a downward bias to utilization anyways? Like I guess, how long would you need to take utilizations up? Or how much revenue growth would you need to start taking utilizations up given your positioning on inventories and capacity additions?
Rafael Lizardi: Yes. So Stacy, it's a good question, but it's a complex question and is -- at the end of the day, it is going to depend. It's going to depend on a number of factors, what kind of revenue profile you – we are faced with and not just in one quarters or two quarters but really over a longer horizon. Maybe the best thing I can tell you is don't expect a significant or even any drain on inventory because just given our business model and how we want to run the company, keeping lead time short and also the upside potential that we have with having this inventory and the capacity in place, is so much higher than the downside risk. So hopefully, that gives you some -- some good insight into how we're thinking. Do you have a follow-up?
Stacy Rasgon: I do. Thanks. I was wondering if you could talk a little bit about pricing. So I think last quarter, you'd suggested that pricing was sort of resuming historical trends, which -- I think, it suggests it was down -- I think, it was low to mid-single digits. Is there any update on what you are seeing in terms of the pricing environment? Is that still the environment that we are in? Are things better -- are things worse? Like where do you see that going as we go forward?
Dave Pahl: Yes. Stacy, I'll comment on that. And as I said last quarter, really we began seeing things change mid-last year -- in the back half of last year as we began discussions with customers for their demand in the following year and out in time, whatever those pricing windows would open up. And those are really just going back to what we've seen in the last 10 years, 20 years kind of pre-pandemic. So describe it roughly in the low to very low single-digit declines over time. And I would say, just generally that's what we are continuing to see.
Rafael Lizardi: Let me add one more thing, Stacy. I want to give you a bonus answer. You always ask about OpEx. So you are not asking, but I'm going to give you OpEx. Remember that second quarter has a full three months of raises whereas first quarter only had two months of raises. So it's something for your modeling.
Stacy Rasgon: Thank you.
Dave Pahl: Thank you Stacy. We will go to the next caller please.
Operator: Our next question is from Vivek Arya with Bank of America Securities. Please proceed with your question.
Vivek Arya: Thank you for taking my question. I think in the prepared remarks, you said customers continue to reduce inventory levels, but you are also guiding Q2 sales to be up 4% sequentially. So my question is, should we think of Q2 as kind of a normal seasonal quarter? Just any more color on what you are seeing real time. Are we past the industry inventory correction? Are we kind of getting back to some semblance of -- on normalcy from a demand perspective? Any other color you could give from an end-market or geo perspective. Just -- you are the largest, right most influential vendor in the market. So I think, your perspectives would be very useful to understand where we are in the inventory and the broader demand cycle.
Dave Pahl: Yes. Vivek, let me start with what we saw happen in the last quarter because I think, it's helpful. First, we saw personal electronics was the first market that went into the correction. It really is -- was the first to come out in the last few quarters, I'd describe it as behaving more seasonal. If you go to the other end of the spectrum, we have, had industrial, which has been declining sequentially from some time. And over the last few quarters, we've been talking about how there's some asynchronous behavior inside of the 12, 13 sectors that we have there. That continued inside of the quarter. So we have got some of the later-cycle sectors that are continuing to decline and declining at double-digit rates. But there are some that are beginning to -- begin to slow in the declines and even a couple that grew sequentially. So that I would just describe as being more mixed this quarter, which is certainly different than last quarter. So -- and if you look -- historically, second quarter is a seasonally strong quarter for us. So it's not unusual for us to see sequential growth sequentially. Do you have a follow-on?
Vivek Arya: Yeah, thank you Dave. Maybe if I press a little bit on that. For Q2, specifically industrial and automotive, do you think -- is your assumption that customers will continue to work down inventory? Or do you think that they have worked down most of the inventory and we are getting back to some semblance of what normal demand looks like for TI in Q2? Like what does your guidance actually imply that are we below seasonal? Are we seasonal? Or -- are we something different?
Dave Pahl: Well, again, we're not in the practice of giving guidance by end-market. And -- but even inside of last quarter, as we looked at it inside of industrial, there obviously were some customers that are nearing the end of that inventory depletion cycle. So as you know, we don't -- we try to be very cautious and not to try to predict tops or bottoms or those types of things and just report what we see and just stick to the facts. So thank you Vivek. We’ll go to the next caller please.
Operator: Our next question is from Thomas O'Malley with Barclays. Please proceed with your question.
Thomas O'Malley: Hi good afternoon. Thanks for taking my question. Mine is in regards to China. 2023 data came out recently, and it looks like some of the larger North American players didn't really lose share despite some concerns on the trailing edge that you would have some increased China competition. Can you talk -- has there been any change in the way that customer behavior has kind of trended over the last couple of months? And can you talk about just that competitive environment? Are you seeing more players there? Are you seeing players that you didn't see before? Any color on China would be super useful. Thank you.
Dave Pahl: Sure. Yes. Thanks, Tom for that question. And I’d say, no change over the last couple of months. But I think, certainly over the last few years, there's many things that are changing in China. We've got very competent local competitors there as well as there’s subsidized capacity going in place. And when you compare that to five years or 10 years ago, is it harder to compete there? It certainly is. But again, I would not describe that as a competitive landscape that's changing overnight. And we've talked about that for some years. So China is an important market for us that -- it continues to be a growing market. And we can and will compete there to support our customers. So our competitive advantages, whether that's our manufacturing and technology, the breadth of the portfolio, the reach of the markets all [serve] (ph) us very, very well in China. Do you have a follow-on?
Thomas O'Malley: Yes. Just on auto particularly. I know that you're not guiding the out quarter, but just conversations that you've had since you last updated us with those customers? I think you just mentioned that inventories are coming down. But through the pandemic, there was a kind of change of stated ordering patterns of just-in-time to just-in-case. Do you see that kind of persisting -- or do you think that we are moving back to a situation in which customers really want to have much lower inventory on their balance sheet. Obviously, you have a unique supply chain, but just any thoughts on just the auto environment, particularly through the last several months. Thank you.
Dave Pahl: Sure. Yes. Thanks again, Tom. I would say that many customers and especially those in automotive, as they went through and dealt with the disruptions that they had in supply chains actually we are very thoughtful in looking at where their supply is coming from, what things that they can do differently well beyond just carrying extra days of inventory. And when they went through that analysis, I think many found that they have a pretty significant dependence on wafers coming out of both China and Taiwan. And what they described that to us is geopolitically dependable capacity is what they're seeking. And again, we have talked about that before in our capital management updates. We believe that -- that's going to be highly sought after it is -- we are seeing that today. And so I think, we are in a position to be able to support customers, and that growth that will come from that. So thank you Tom, we will go to the next caller please.
Operator: Our next question is from Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi guys thanks. I'm going to ask a couple of questions. I guess for the first one, Dave, I know you don't want to guide by the segments but you gave the quarter-over-quarters. Could you give us what the year-over-years were by end-market in the first quarter, please?
Dave Pahl: I can do that, yes. So the industrial market was down about 25% from a year ago. Automotive was down lower single digits. Personal electronics was actually up single digits. Comms equipment was down about 50%, and enterprise system was down mid-teens. Do you have a follow-on, Ross?
Ross Seymore: I do. Rafael, you talked a little bit about the trajectory of the grant side of the CHIPS Act -- or excuse me, the ITC side and where you are getting the money in over time. Does any of that inflows of cash have a differing impact on the income statement? Or is it just the same, it's just a matter of timing and when you're getting that $1 billion as opposed to, I think you said $500 million before?
Rafael Lizardi: Right. No, no direct impact on the income statement. That's already played in as the lower depreciation and are already flowing through the P&L and in our expectations on depreciation. Of course, having more cash, does have an impact in terms of you have more cash, you're going to have more interest income. But put that aside, that's kind of below the profit the operating profit line. So speaking of depreciation, let me give you an update on that. We've been talking about depreciation for this year, $1.5 billion to $1.8 billion. That is -- we continue to expect that -- but we're more likely to come in at the bottom half of that range. And for 2025, we continue to expect $2 billion to $2.5 billion in depreciation.
Dave Pahl : Thank you Ross. We will go to the next caller please.
Operator: Our next question is from Chris Danely with Citibank. Please proceed with your question.
Chris Danely: Hey, thanks guys. Rafael, just another question on the balance sheet and cash. So you guys have seen the share count kind of flatten out here for the last 4 quarters or 5 quarters and then you're building cash and increasing your debt. I guess what's changed? Traditionally, you've sort of taken the share count down slowly but steadily. Any sort of changes in the long-term thinking there on cash, usage of cash, et cetera?
Rafael Lizardi: Yes. When it comes to capital management, it all depends, and it depends on circumstances. And at the moment our objective when it comes to -- you've known us for a while. We return all cash flow – [or cash] (ph) flow to the owners of the company, and we do that over time. But there are times to increase liquidity and to build up cash. So you have seen us over the last couple of years do that and steadily increase the cash on the balance sheet. We finished at $10.4 billion last quarter. And we've done that very consciously, right to protect the investments that we're making, particularly the $5 billion per year CapEx investments in manufacturing because that is the most important allocation of capital has been for the last few years and will continue to be for the next three years. So with that in mind, we've had that in mind as we have made overall capital allocation decisions, including the decisions on repurchases.
Dave Pahl: Do you have a follow-on, Chris?
Chris Danely: Yes, thanks Dave. Just another question on China but more on the, I guess, the insourcing side. So some of your competitors have talked about this impacting them. Do you guys see an impact of this on TI? Would or will this alter your long-term, I guess growth expectations or thoughts on your China business? Just any color there would be very helpful. Thanks.
Rafael Lizardi: Yes. So I'll start and, Dave, if you want to chime in. But as Dave alluded to earlier on the call, China is a very important market. We need to compete there, we do compete there and we compete to win there. China, there -- it's pretty clear that there's an incentive to design local semiconductor suppliers. I think, that's what you're referring to as insourcing. And today, that share, my guess -- my sense is 10% to 15% of the local content is sourced by local semiconductor suppliers. I think, the exact number is 12%, the one I saw. So that means there's another 88% that -- that is shared now between U.S. and European suppliers. And our goal is to continue that fight and maintain and gain that share, competing with local suppliers but also competing with US and European semiconductor suppliers.
Dave Pahl: Yes. And maybe I'll just add in China -- in any market, we've just got to have the best parts. And when we have that -- that means we've got to be ahead of competitors, whether that's on performance, on support, availability and cost. So -- and we have customers in every region that are beginning to think about where they're sourcing products from. So customers that aren't in China are looking at our -- as they describe it, geopolitically dependable capacity. And that's about 80% of our revenue. The 20% that's in China, we have customers in China that have and support global markets. And they're coming and describing our geopolitical dependable capacity and wanting to have access to it because it is very unique. We're the only ones that are building at scale outside of China and Taiwan capacity. So customers understand that. They understand it both in China, as well as outside. So thank you for that Chris. We will go to the next caller please.
Operator: Our next question is from Joe Moore with Morgan Stanley. Please proceed with your question.
Joe Moore: Great. Thank you. I've asked this question before, but it keeps coming up. Can you talk about how you think about pricing kind of more strategically as you contemplate having a decent amount of capacity, more 300 millimeter capacity, more subsidization? Does that change the pricing paradigm at all? Are there markets where you might be more price-aggressive than you wouldn't be, if any of that were different?
Dave Pahl: Yes. Joe, the answer will be amazingly consistent with how you've asked it before. But we haven't changed our strategy on pricing. You know that pricing doesn't move quickly in our industry, and it -- isn't the primary reason why customers choose our products overall. So we regularly monitor pricing for all of our products. That includes all end markets and all product categories and all regions. And we price to be competitive, and we can do that because we've got a great product portfolio and we've got great access to the markets through our channels. And we've got competitive products because we build it on 300 millimeter. So hopefully, that's amazingly consistent. Do you have a follow-on?
Joe Moore: Yeah. Thank you for that. Yes, in terms of the embedded business, I know you've had a number of kind of vertical markets that you de-emphasized and things like that with kind of a focus on more of a core kind of catalog strategy in that business. Where are you in that? Do you expect that you would -- that your embedded business would sort of track the broader microcontroller business? Or just how do you think about the transitions that are happening there?
Dave Pahl: Yes. I think that we continue to make progress overall in our embedded business. The goal there is to have that business growing and contributing to our free cash flow over a long time. We think it's a great business and continue to invest. So we are very happy with that strategic progress. So I think, in the near-term, of course, we're not going to be immune to cycle-related corrections. It is a little bit later because of the constraints that we have due to embedded relying on foundry supply. And as you know, we are investing to put capacity in place. And we'll have control of that in the future and really are in a good position to gain share there. So thank you for that Joe, we will go to the next caller please.
Operator: Our next question is from Tore Svanberg with Stifel. Please proceed with your question.
Tore Svanberg: Yes, thank you. Dave, I had a question about the Q4 -- I mean the Q2 outlook. So I know, obviously, you can't guide by market and things like that. But from a bookings perspective, are we starting to see sort of a broad-based recovery in bookings? Or would you still say it's quite selective in all the different applications that you are targeting?
Dave Pahl: Yes. So let me speak to bookings at the top level. We saw bookings increase each month of the quarter. That is very typical that we would see in a first quarter. I don't have bookings by end market. If there's something very unusual going on, of course, that would jump out at us. So that's just not something I have here in front of me. But I would describe it as behaving as we would expect it to. And of course those bookings and other demand signals that we get from our customers are obviously [imbued] (ph) into our guidance. Do you have a follow-on, Tore?
Tore Svanberg: Yes. That's very helpful. As my follow-up, you mentioned there's a few segments within the industrial category that are starting to grow or perhaps have found the bottom from an inventory correction perspective. Can you talk about which segments those are?
Dave Pahl: Yes. Again, as we talked about over the last several quarters now that there was markets that were behaving -- or sectors that were behaving asynchronously. So there are shorter cycle investment sectors that began to roll earlier, longer-term investment cycles that were rolling later, really just the last couple of quarters into it. So it is really -- if you had to kind of divide them out, that's what they would look like. Thank for you that Tore, we will go to the next caller please. And this will be our last caller.
Operator: Our last question is from Chris Caso with Wolfe Research. Please proceed with your question.
Chris Caso: Yes. Thanks. Good evening. First question is related to the buybacks, and I think you addressed this in a prior question. But I guess the question is, what would be the trigger for being able to resume some degree of buybacks? We realize that the intention is to return 100% of excess free cash flow. But at what point does the cash in the balance sheet and kind of industry conditions allow you to kind of come back to what you've been doing previously?
Rafael Lizardi: Yes. Well a couple of things. For example, the data point I will give you is our free cash flow for the trailing 12 months was $940 million. And we returned in -- also in trailing 12 months, $4.8 billion. So one catalyst for a change there would be once we're past this investment phase that is consuming a good chunk of that free cash flow. Another catalyst is obviously revenue and how that behaves over a number of years. But -- so these are just some of the puts and takes that we think about when we are allocating capital.
Dave Pahl: Do you have a follow-on, Chris?
Chris Caso: I do. Thanks. And I guess the question is about where TI is allocating the R&D investment going forward and how that may be changing. Over last year, it looks like auto industrial is about 70% of your revenue, and I know that's by design. But you've got some segments such as comm equipment that have been down a lot more. As we look out over the next two years or so, do you think that percentage of revenue on the segments kind of stays about where it is right now? Or based on the R&D investments you are making, do you think that changes substantially?
Dave Pahl: Yes. And it's a great question, Chris. So let me just use as a backdrop for those that hadn't looked at our capital management slide deck. And Slide 21, shows our percentage of our revenue by end-market. And the middle column there talks about what we're doing directionally from an R&D spend. So -- and we've talked about for some time that -- our belief that there is going to be secular trends and increasing semiconductors and industrial and automotive. And as a result of that, we have been taking investments up there. And the other markets though, if you look at personal electronics and communications equipment, our investments there have been and continue to be very steady because we can find great opportunities inside of those markets. And so we'll continue those investments. And then enterprise systems, we've taken up the investments there slightly. And there is just opportunities, and enterprise systems likely will be a good grower as well. It doesn't have quite the same dynamics, as industrial and automotive for us. But certainly, things that sit inside of enterprise we believe will make that an above-average grower over the next decade [plus] (ph). So with that, I'll turn it over to Rafael to wrap up.
Rafael Lizardi: Okay. Thanks, Dave. Let me wrap up by emphasizing what we have said previously. At our core, we are engineers and technology is the foundation of our company. But ultimately, our objective and the best metric to measure progress and generate value for owners is the long-term growth of free cash flow per share. While we strive to achieve our objective, we will continue to pursue our three ambitions. We will act like owners who will own the company for decades. We will adapt and succeed in a world that's ever changing. And we will be a company that we're personally proud to be a part of and would [want] (ph) as our neighbor. When we're successful, our employees, customers, communities and owners all benefit. Thank you and have a good evening.
Operator: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. |
PEP | 1 | 2,024 | 2024-04-23 09:11:08 | Operator: Good morning and welcome to PepsiCo's 2024 First Quarter Earnings question-and-answer session. Your lines are being placed on listen-only until it's your turn to ask the question. Today's call is being recorded and will be archived at www.pepsico.com. It is now my pleasure to introduce Mr. Ravi Pamnani, Senior Vice President of Investor Relations. Mr. Pamnani, you may begin.
Ravi Pamnani: Thank you, operator and good morning everyone. I hope everyone has had a chance this morning to review our press release and prepared remarks, both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans and 2024 guidance. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today, April 23rd, 2024, and we are under no obligation to update them. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to our first quarter 2024 earnings release and first quarter 2024 Form 10-Q available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. Joining me today are PepsiCo's Chairman and CEO, Ramon Laguarta; and PepsiCo's Executive Vice President and CFO, Jamie Caulfield. We ask that you please limit yourself to one question. And with that, I will turn it over to the operator for the first question.
Operator: Thank you. [Operator Instructions] Our first question comes from Dara Mohsenian with Morgan Stanley. Your line is open.
Dara Mohsenian: Hey guys, good morning.
Ravi Pamnani: Goof morning Dara.
Dara Mohsenian: So, really strong international profit results for the third quarter in a row here. Can you just take a step back, Ramon, and maybe give us some perspective on that international performance over the last few quarters? And, A, just looking forward, short-term, how confident are you in the sustainability of that in the balance of the year? But, B, also just long-term as you think about international development over the last few quarters give us some perspective looking out over the next few years, both from a top line perspective and then the margin flow through? Thanks.
Ramon Laguarta: Great. Thank you, Dara. And yes we're very pleased with the performance of international businesses in Q1, but also in the last few quarters, as you mentioned. And this has been an area of investment for us now for a few years, both in snacks and in beverages and trying to build scaled businesses in most of the markets where the scale in terms of population and profitable growth. So, I feel very good about our ability to continue to outperform our categories in international and to keep our categories growing both food and beverages in the future. Our innovation is strong. Our ability to understand local rituals and local food and beverage occasions is better than ever. We are adapting our portfolio to that. Our ability to attract the best talent in the markets where we participate and build really capable teams is better than ever. We've been investing in capacity. We're -- right now, we're in the process of opening factories in Vietnam and in China and in India and in Mexico, and we just opened one in Poland. So we keep expanding our manufacturing and our go-to-market capabilities in those markets. So we feel good, and I think that it's going to continue to be a big source of growth for us. As we mentioned in CAGNY, I think our international business is already $36 billion and it's growing at a very high single-digit level and with very good profitability. So it is part of the future growth story for PepsiCo for sure.
Operator: Thank you. One moment for our next question. Our next question comes from Bonnie Herzog with Goldman Sachs. Your line is open.
BonnieHerzog: Hi. Thank you. Good morning, everyone. I had a question on Frito-Lay op margins, which were a little soft in the quarter. So hoping you could talk through some of the key puts and takes on your margins in the quarter and then moving forward? And then is it realistic to assume Frito-Lay's op margins will expand in 2024? And I'm thinking about that in the context of commodity cost pressures easing a bit, or how do we think about your level of reinvestment as these cost savings maybe in an effort to drive faster top line growth? And then ultimately, curious to hear if Frito-Lay margins can ultimately return to the low 30% range? And if so, by when, how do we think about that? Thank you.
JamieCaulfield: Hey, Bonnie, it's Jamie here. How are you? Yeah on Frito, when you look at the Q1 profit, the thing to keep in mind is last year, we're lapping 24% growth in the first quarter of last year. I think we had 180 basis points of margin improvement last year. And we don't want to push the P&L that hard. The growth last year, growth this year, part of that has to do with investment timing, the flow of productivity. But I think you'll see margin improvement over time at Frito, but this is a business that has very healthy margins already, and we want to make sure that we're investing back in the business to sustain growth.
Ramon Laguarta: Yeah, Bonnie. I think on top of what Jamie said, for the long term, the key goal for Frito in the US is to continue to grow the salty, savory category at a very high rate and continue to get occasions from other parts of macro snacks into the savory and from meals into savory, and continue to gain share of that category as it has been doing and including Q1. So that's the ultimate goal. Because that, if you think about the high margin that we have in that business and the impact it would have in the overall PepsiCo margins, that's the role that Frito-Lay has in the portfolio.
Operator: Thank you. One moment for our next question. Our next question comes from Bryan Spillane with BofA. Your line is open.
Bryan Spillane: Thanks, operator. Good morning, everybody. Ramon, I guess, a question on PBNA and specifically on Gatorade and Mountain Dew. The volumes are still -- with Gatorade noticeably weak in the quarter. And so can you just talk about, one, how much in the quarter might have been affected by the weather? And then second, I guess, as we're thinking about volume recovery for the whole for the enterprise at PBNA, just what's on tap for both Mountain Dew and Gatorade to stabilize the volume trend?
Ramon Laguarta: That's good, Bryan. Just actually we feel good about those two brands. Those two brands actually gained share in Q1, so Mountain Dew and Gatorade, in their own category. So that's a meaningful good performance, I would say. Now Gatorade, as you mentioned, a little bit of weather impact. So we're not concerned about Gatorade this year as the weather improves, I think we have the right investments, the right commercial programs. Our G2DSD was impactful to us last year operationally. I think we've learned a lot on how to deal with a very high seasonality product and category and give the better service to our customers and maintain the product in stock and available. So we feel good about we have the platform to take Gatorade to higher market share in a faster growing category. Now with regards to Dew, the launch of bubly burst has been very, very good to the brand. We launched it as a permanent additional flavor to the portfolio early in the year. It's been obviously successful. We knew it was a successful LTR and therefore, it's a successful permanent product. And it's been bringing incremental consumers to the brand and help us gain share now. Obviously, we will keep investing in the portfolio and the brand, and we have strong programs for the summer. Hopefully, that will deliver as we expect, and we'll continue to build Mountain Dew in the category. So feeling good about those two brands.
Operator: Thank you. One moment for our next question. Our next question comes from Lauren Lieberman with Barclays. Your line is open.
Lauren Lieberman: Great. Thanks, good morning. In the prepared remarks, I noticed in the discussion of PBNA and plans to improve profitability there. There were two new bullets. The first two talking about deemphasizing certain product and package combinations and the second around revenue management and increasingly precise consumer value proposition. So I was curious if you could just -- I know there's new management for that business as well. So I would love to get a little bit more color maybe around those two points? I thought would be helpful. Thanks.
Ramon Laguarta: Yes. Lauren, I think the -- I don't know, maybe we have put a bit more detail, but the intentionality was always there. And I mentioned last time on the last couple of calls that we're making choices in PBNA in terms of making sure that we deliver profitable growth, and we'll continue to make those choices emphasizing the parts of the portfolio where there is a better return on the investments for us and eliminating those parts of the portfolio where the margins are not that attractive and they're going to get probably not that better over time. So we've been referring to categories like packed water or some of the less profitable take-home formats, where we will be making choices. We feel good about both the productivity at PBNA under margin expansion of PBNA. And we feel that, that will continue based on the ideas that we have and the organizational focus that the team has been putting under the new management, but also the old management in PBNA. There's much more focus on becoming a better operating machine in the supply chain and sales and expanding the margin. So, we feel good about PBNA margin expansion and profitable growth delivery this year.
Operator: Thank you. Our next question comes from Andrea Teixeira with JPMorgan. Your line is open.
Andrea Teixeira: Hi, good morning. Thank you. So, Ramon, if you can please comment on the overall consumption and in particular for snacks and how consumer behavior evolved in the context of your comments about normalization? And then a clarification for Jamie, on the margin outlook. On the prepared remarks, you mentioned a more benign commodities environment, but that has recently changed in particular, for oil and looking at DSD. Hoping to get some clarification on the diesel impact or this is going to be more further down and perhaps not even impacting 2024? Thank you.
Ramon Laguarta: Yes. So, listen, Andrea hi. The -- I would say the consumer globally, we think is very resilient. And we see it in, as you saw from our international business performance. And it's basically supported by two facts, very low unemployment or quite low unemployment globally and wages growing at a good pace in majority of the countries where we participate. So, those two things make us feel quite good about the consumer. Now, when you double click, there is probably two areas that were -- that probably surface. One is Chinese consumers. I think Chinese consumers are being very cautious and we're seeing the savings rate really going very high in China. Our category is still resilient in China, but especially we're delivering growth through share of market gains in China. So, that's a good performance by the team, but an area of watch out for us. The other double-click is in the, I would say, the lower income consumer in the U.S. The lower income consumer in the U.S. is stretched, is making a lot of -- he is strategizing a lot to make their budgets get to the end of the month. And that's a consumer that is choosing what to buy, where to buy and making a lot of choices. That's a consumer that we're emphasizing in our commercial programs. I think we're learning how best to keep that consumer in our categories and the frequency that we want that consumer, and we are pivoting our commercial plans, our innovation, giving that consumer the right innovation, the right value in different parts of the month through different channels, digital and physical. Making sure that the ROI on the investments are the best ROIs. So, those two are the consumers that I would say we're paying more attention in terms of specific commercial programs. But I would say the consumer is very resilient everywhere else. And our teams, I think, are pivoting to maintain our brands top of mind in their baskets at the frequency that we want and continue to gain market share. So, this applies to beverages and to snacks. Your question was more on snacks, but I think it applies to both categories. So, I know Jamie on.
Jamie Caulfield: Yes. Andrea, on commodities, really no change in the outlook. A couple of points I just want to emphasize. One is the diversity of the inputs in the basket, so no single commodity accounts for more than 10% of the total. So that diversification kind of smooth things out. And the other point I'd make is we do tend to forward buy and hedge, so that we've got good visibility for the year that helps us with planning the business overall. And so outlook Q2 through Q4, so relatively benign inflation and not a lot of volatility in the rate of inflation quarter-to-quarter.
Operator: Thank you. One moment for our next question. Our next question comes from Peter Grom with UBS. Your line is open.
Peter Grom: Thanks operator and good morning, everyone. So I was hoping to get an update on the CELSIUS agreement and kind of just your broader energy drink strategy at this point. In the release, you spoke positively about the partnership, but I think there were some changes to the incentive structure a few weeks back. So maybe first, just any thoughts on how the brand is performing as part of your energy portfolio? And then just like anything you can share in terms of what changed with the agreement? But maybe specifically, how does it really help Pepsi? And maybe what benefit does it provide for CELSIUS, if anything? Thanks.
Ramon Laguarta: Yeah. Thank you, Peter. I will not talk too much about the agreement other than saying that it's a good alignment of the long-term interest of both companies, and it's great for PepsiCo shareholders. The partnership with CELSIUS is strong, and it's helping us to gain scale in our go-to-market, specifically in some channels where we need volume to justify some of the economics of the call. So that role continues. We're pleased with the partnership. Energy is a fast-growing category, profitable, that is great for our portfolio. So that's what I would say. We remain pleased with the partnership and we'll continue to build the partnership going forward.
Operator: Thank you. One moment for our next question. Our next question comes from Filippo Falorni with Citi. Your line is open.
Filippo Falorni: Hey, good morning, everyone. So I wanted to go back to Frito but on the top line trends. Clearly, you guys were setting the toughest comp of the year in Frito-Lay. You mentioned you expect some sequential improvement. So maybe you could talk about volume trajectory, particularly for the business? And Ramon, you spoke in the past about the cycling of this shift towards smaller pack sizes. So maybe you can give us an update on that, and also any potential impact from cycling the reduction in SNAP benefits from last year? Thank you.
Ravi Pamnani: Yeah. I would say the Frito-Lay continues to outperform the category. And as I said earlier, the big opportunity for Frito-Lay is continue to create occasions for our savory category, bringing them from broader macro snacks or snacks and meals overlap, how do we bring more category stores, more occasion store snacking. So those are the two big strategic objectives of Frito-Lay. And all our innovation and pricing and channel mix and everything else is against that large objective and do it faster than others, so that we continue to gain shares. So as we -- as we look at the business performance, as you said, this is the toughest lap. I think last year, we grew 16% in Q1, and that lap is still high in Q2, but then it gets much better than half two. So we should expect a gradual sequential improvement of our volume for Frito-Lay, especially in the second half of the year, and we'll continue to be the guardians of the savory category and make sure it's valued properly, and it generates growth for our customers ahead of what food generates for our customers, and we continue to capture a disproportionate share of that very fast-growing and profitable business.
Operator: Thank you. One moment for our next question. Our next question comes from Kaumil Gajrawala with Jefferies. Your line is open.
Kaumil Gajrawala: Thanks. Good morning, everyone. Just you mentioned multiple times on gaining share within the category. Could you just give us some -- in multiple regions, can you just give us some context on what the categories are growing or at least what -- maybe what they're expected to grow as you think about the next – next year or so?
Ramon Laguarta: We -- yes, I mean, like what I said is that our goal is always for our categories to grow faster than overall food and beverages. I think that makes us a very attractive partner with our retail partners, and we deliver growth for them. And our categories are profitable. So it's a good combination of growth and profitability for our customers. So that's what we're trying to do. I think our categories will continue to grow faster than food and beverages in the majority of the countries around the world, given the trends on urbanization and the secular trends that we've been talking about both for convenient foods and beverages. So we feel good about that and our commercial programs, innovation and investments are in to deliver that for our partners. Obviously, there's countries around the world where we do better, others we do less well. And our goal is to keep emphasizing the ones we do better and improve the ones that we don't do so well. And that's how we're managing the company.
Operator: Thank you. One moment for our next question. Our next question comes from Robert Moskow with TD Cowen. Your line is open.
Robert Moskow: Hi. Thanks for the question. The 4% price mix benefit in Frito-Lay North America is pretty impressive in a food industry where there's just not a lot of pricing left. And I imagine a lot of it is from price pack architecture or maybe even consumers shifting to different pack sizes. Can you help delineate a little bit more like what's -- which of those is driving it more than the other? Or if it's about the same? And how do you expect it to evolve for the rest of the year? Do you expect it to be pretty constant?
Jamie Caulfield: Hey, Robert. It’s Jamie. And its majority is price but there’s an element of mix in there. I’d put it that probably two-thirds price and one-third mix. And yes, it comment earlier on our inflationary trends would expect them to be fairly moderate for the balance of the year, fairly smooth through the balance of the year. So I wouldn't expect a lot of volatility in that buying revenue relationship.
Operator: Thank you. One moment for our next question. Our next question comes from Robert Ottenstein with Evercore ISI. Your line is open.
RobertOttenstein: Great. Thank you very much. Two kind of follow-ups, if I may. Can you please talk about the spring shelf sets? Is it pretty much done? And how do you feel good about what you're seeing both on the Frito-Lay side and on the beverage side? And I understand on the beverage side, you're discontinuing some SKUs. So are you gaining shelf space where you want to? And then just a follow-up to an earlier question on CELSIUS. Maybe if you can give us an idea of how your energy drink strategy overall is evolving and what's going on with Rockstar, Starbucks, Mountain Dew in terms of the overall energy drink strategy? Thank you.
Ramon Laguarta: Yeah. Listen, I'll step back a little bit. I would say our customer negotiations have been good and completed all over the world and especially Europe took a bit longer, but it's a very positive impact to our overall, I would say, European business and other parts of the world are less impacted by this type of negotiations -- are good. We feel good, including the US. To your specific question on space gains, I think it's going to be a good reset time for us across snacks and beverages. It's not completed yet. It's way normally I would say, probably another six weeks or so. We're feeling good about where we've seen already reset the performance improvement in the business. So that's good, well done by the commercial teams. So yeah, we feel good overall, and that's why we are reaffirming our guidance to grow at least over 4% in our net revenue for this year.
Operator: Thank you. One moment for our next question. Our next question comes from Chris Carey with Wells Fargo Securities.
Chris Carey: Hi, everyone. So one question on APAC division. Ramon, I think you were a bit more cautious or balanced on the Chinese consumer and yet double-digit growth in the quarter in China. I just wonder how APAC came in relative to your own expectations that whether there's any timing dynamic here or whether you see these results as perhaps a bit more durable going forward? And if I could just sneak in from the at-home versus away-from-home consumption globally, as you see some of the weaker trends from the lower income consumer, are you seeing any acceleration in that shift, which might be helping your business on a global basis as well? Thanks.
Ramon Laguarta: Two things, thanks. Good questions. I think the APAC performance is a little bit impacted by the timing of Chinese New Year. So there is a bit of benefit in our Q1 numbers versus Q2. It was a bit earlier this year. But the reality is that the APAC region is improving, I would say, outside of China. China still, as I mentioned earlier, I think the consumer is cautious and the consumer is saving a lot. And it might not impact so much the low price, let's say, products as ours. It might probably impact some other categories a bit harder than ours. The truth is that in China, as I said earlier, our team is not only this year, but already consistently for the last four, five years, been gaining share and creating a very capable and profitable business in China, we're very proud of. Now, to your other question on away-from-home, in-home, we're seeing mobility obviously, going back to pre-pandemic times anything we all forgot COVID anymore. And we're seeing, obviously, that impact in the consumption of food between home and away-from-home, especially in the U.S., I would say, it's probably the country that is having more impact. So, yes, away-from-home is growing faster than in-home for us and we're pivoting resources to away-from-home both in our food business and our beverage business, and we're trying to capture as much as possible that consumption that is moving to away-from-home. Internationally as well, I would say that is a huge wide space for growth for our business, both in trying to improve the availability of our current products and also creating new solutions that are more targeting meals and meal replacement as consumers buy more food away-from-home. And I think our brands belong in some of those occasions and as I mentioned at CAGNY, we're building both innovation and business models that can help us capture this meal location away-from-home with some of our large brands like Lays, Doritos, Tostidos, some of our well-known global brands.
Operator: Thank you. Our next question comes from Steve Powers with Deutsche Bank. Your line is open.
Steve Powers: Hey thanks and good morning. Ramon, maybe it ties to the pressures you mentioned earlier on the lower-income consumers in the U.S. or maybe even your comments just now on at home versus away-from-home. But if I think back over the last six-plus months, we've seen arguably unexpected slowing across many categories, but really in many immediate consumption categories where I think it was most unexpected across savory snacks, sweet snacks, arguably a number of beverage categories as well. Do you agree with that kind of unexpected slowing comments? And if so, how do you see the drivers? How do you stack up the drivers? Where do you think we are in that cycle? And how does that factor into your expectations on momentum recovery across your North American beverages -- sorry, North American businesses? I think the easing comps are obvious. I'm just -- I'm curious about sort of the -- your expectations on demand itself sequentially improving?
Ramon Laguarta: That's great. Now, this is a great question and I think we need to step back and look at the bigger numbers. Obviously, there was huge inflation in our categories driven by input inflation over the last couple of years and operating cost inflation. Now, what makes us feel optimistic is a couple of data. Number one, I think wages are growing above inflation, and we see that not only in the U.S., but across the world. And we see our consumer packaged food inflation below, I would say, total CPI. So, those two numbers make us feel comfortable that the consumers will start coming back to our categories at the frequency and with the same level of -- or higher frequency than in the past. So those are two big numbers. Obviously, each one of us with our commercial programs, our innovation, our channel strategy is trying to accelerate that pivot back. But we feel good about the price volume mix that we see in our business, and that's how we think that we will continue to sequentially improve over the balance of the year into further years. Our North Star remains the same, is to make sure that, as I said earlier, we have innovation and consumer programs and channel programs that continue to drive savory snacks, ahead of micro snacks, ahead of food and the same with LRB, ahead of overall liquid consumption and ahead of food and beverages. So that drives value for our business and that drives value for our customers and that's how we think about driving the company long-term.
Operator: Thank you. One moment for our next question. Our next question comes from Brett Cooper with Consumer Edge Research. Your line is open.
Brett Cooper: Good morning. A question on the international business. On these calls over the years, PepsiCo has spoken about managing international profit delivery to provide affordability to consumers and support recruitment. And if we look at margins in the international business, they're up versus COVID or versus pre-COVID levels. So can you help us understand beyond the headline financial results that we can see, I guess, evidence of what you look at to ensure you're providing proper levels of affordability for category development to support the very long-term for that business? Thanks.
Ramon Laguarta: Yes. And the -- we're always very conscious of the relative value of our product versus other potential substitute products in the categories that we participate. So if you think about snacks, the big opportunities to transform and packaged snacks into packet snacks or other macro snacks into savory snacks. And we always look at that value ratio in every market, in every geography for different types of consumers. Now the same with beverages, right, moving from non-commercial beverages to commercial beverages, that is always the opportunity for us as an industry. We look at that very carefully. Now why are our margins expanding internationally because as we gain scale and obviously, that our fixed cost leverage is much better, and that's how we're getting to more profitable businesses in international markets, especially the large markets, whilst we keep affordability at the center of our strategy because that's long-term, including other things that we do, obviously, with availability and with innovation. We make our categories continue to grow at a very fast pace. But as you mentioned, affordability and relative value of our category is a key KPI that we measure all the time in every market because it's the key source of continuous growth for our categories.
Operator: Thank you. One moment for our next question. Our next question comes from Gerald Pascarelli with Wedbush Securities. Your line is open.
Gerald Pascarelli: Great. Thanks very much. Question on Europe. Another really strong quarter here, like the seventh consecutive quarter of double-digit revenue growth. It looks like it accelerated on an underlying two-year basis. So maybe if you could provide some color on the driver markets, ones that maybe came in better than your expectations? And then how you would compare how developed markets in Europe are performing relative to what we're seeing in the US? Thanks.
RamonLaguarta: Yeah. Thank you and a good observation. I think our team in Europe is doing a fantastic work. It started with strong productivity, simplifying the business and driving cost control, eliminating duplication and then reinvesting that money back into our brands and becoming more competitive and also driving our availability and driving our brand preference. And that is a flywheel that is working for us across both developing and developed markets in Europe. Obviously, developing markets a bit more. So if you think about Eastern Europe markets are growing a little bit faster than Western Europe markets. Western Europe markets have been impacted a little bit in this first quarter by some of the negotiations, and that's not atypical in Europe. But I think we have a good flywheel in Europe, and Europe will be expanding its portfolio along the lines of what the US has been doing, which will give us additional consumers and additional penetration in households across developed and developing markets. So we feel good about the flywheel in Europe. But at the center of that is a very strong productivity, cost discipline and reinvestment strategy that is, in a way, what we're trying to do across the full company, elevating our productivity and driving their investments both into affordability, availability, a better brand equity and then investing back into our future, digitalization and sustainability at the center of that investment. So it's a flywheel that we're trying to do for all the world. Clearly, Europe is doing a good job at implementing it.
Operator: Thank you. Ladies and gentlemen, this does conclude the question-and-answer session. I would like to turn the call back to Ramon Laguarta for any closing remarks.
Ramon Laguarta : Yeah. Thank you, everyone, for joining us this morning and for the confidence that you've placed in us and in our stock. And we hope that you all stay healthy and safe. Thank you.
Operator: Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.
Ravi Pamnani: Thank you, gentlemen. Appreciate your help.
Operator: You're welcome. |
NFLX | 1 | 2,024 | 2024-04-18 19:39:09 | Spencer Wang: Good afternoon, and welcome to the Netflix Q1 2024 Earnings Interview. I'm Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Co-CEOs, Ted Sarandos and Greg Peters; and CFO, Spence Neumann. As a reminder, we will be making forward-looking statements and actual results may vary.
A - Spencer Wang: With that, we will now take questions that have been submitted by the analyst community. And we'll begin first with some questions about paid membership reporting in our results and forecast. So for our first question, it comes from Justin Patterson of KeyBanc. And I'll direct this at Greg initially. Greg, could you please talk about the decision to stop reporting quarterly membership and ARM data in 2025? Why eliminate this? And since you said success stems - starts with engagement, how are you thinking of expanding these disclosures?
Greg Peters: Yes. As we noted in the letter, we've evolved and we're going to continue to evolve developing our revenue model and adding things like advertising and our extra member feature, things that aren't directly connected to a number of members. We've also evolved our pricing and plans with multiple tiers, different price points across different countries. I think those price points are going to become increasingly different. So each incremental member has a different business impact. And all of that means that historical simple math that we all did, number of members times the monthly price is increasingly less accurate in capturing the state of the business. So this change is really motivated by wanting to focus on what we see are the key metrics that we think matter most to the business. So we're going to report and guide on revenue, on OI, OI margin, net income, EPS, free cash flow. We'll add a new annual guidance on our revenue range to give you a little bit more of a long-term view. We'll also - we're not going to be silent on members as well. We'll periodically update when we grow and we hit certain major milestones, we'll announce those. It's just not going to be part of our regular reporting. And we want to do all of this thoughtfully and give everyone time to adjust this transition. So we're going to continue to report subscribers until Q1 of next year, which links into our next annual revenue guidance for 2025. So we think that provides some long-range continuity. And we expect that will provide an effective bridge and transition. But ultimately, we think this is a better approach that reflects the evolution of the business and it more matches and is consistent with how we manage internally to engagement, revenue and profit.
Ted Sarandos: Yes. And on engagement, Greg, just a reminder, we currently report our engagement on our biannual engagement report, leading the industry in viewing transparency and granularity. And we're going to look into building on that both in granularity, which will be kind of tough. Our current report covers about 99% of the viewing on Netflix, but we'll look at the regularity in different ways that we can make it even easier to track our progress on engagement. And - but importantly, why we focus on engagement is because we believe it's the single best indicator of member satisfaction with our offering, and it is a leading indicator for retention and acquisition over time. So happy members watch more, they stick around longer, they tell friends, which all grows engagement, revenue and profit, our North Stars. And so - and we believe that those are the measurements of success in streaming.
Spencer Wang: Great. Thank you, Ted and Greg. I'll move us along to the next question from Ben Swinburne of Morgan Stanley who asked two years ago, Netflix stopped adding members. What changes inside Netflix and/or the broader industry explain the significant improvement in member growth we're seeing today, excluding the paid-sharing initiative? In other words, what are you doing better today as a company than in the first half of 2022?
Ted Sarandos: That's a great question. I would say, the thing we're doing is we're thrilling our members. That's the thing we set out there to talk about why we all bounce out of bed in the morning. I look at this last quarter, eight of the first 11 weeks of the year, we've had the number one film on streaming. Nine of the first 11 weeks, we've had the number one original series. And I'm talking about hits like Avatar: The Last Airbender, Griselda, Damsel, Love Is Blind, 3 Body Problem, all of that just in the last few months. So this consistent and dependable and expected drumbeat of hit shows, films and games, that's the business that we're in. And that's what we have to do every day and we have to do it all over the world. So if you think about that and how we're doing about kind of quality at scale in multiple cultures in multiple regions, I look at this last quarter, you see Fool Me Once, One Day, Gentleman, Scoop, The Super-Buzzy, Baby Reindeer, all that from the U.K., all in the last few months. Berlin, Society of the Snow, Alpha Males, all from Spain and all just in the last few months. So that's been one of those things that we just keep building and building and building on. And local unscripted, which is a fairly new initiative for us, and we're finding huge success with things like our second season of Physical 100 in Korea recently and Love is Blind, Sweden. These are all kind of hard to replicate things that we keep getting better and better at every day that we're really proud of the teams for doing that. So - and remember, engagement captures all of this and none of that's possible without great tech and product. We need to do both.
Greg Peters: Yes, I think that's right. The fundamental is all those amazing series, film, games, live events, but a key component of our success and something that we're seeking to get constantly better at is that ability to find audiences for all those great titles. Part of making that happen is just the number of people who look to us for entertainment. We mentioned over 0.5 billion people in this letter, but part of that is that, that product we do to effectively connect those folks with titles that they will love, which then enables us to find the largest audiences for those titles that we think that they could get anywhere. And I think as you mentioned, Ted, this applies globally to titles from all over the world, which is super-exciting. So - and then of course, we seek to maximize the fandom and the impact on the conversation and the cultural zeitgeist that all those titles have. And when we do that well, that just feeds positively into that cycle as we launch new titles. So in terms of what are we doing better, what do we do better, we seek to get better at all of those things. And if we can make that whole flywheel spin a little bit faster, then that's great for our members, it's great for our titles and it's great for our creators.
Spencer Wang: Thank you, Ted and Greg. Moving us along, we have Barton Crockett from Rosenblatt. There's a question about our revenue guidance. I will direct this question to Spence. Spence, can you please explain what drives the revenue deceleration for the full year, so 13% to 15% revenue growth for the full year compared with the 15% to 16% growth in the first and second quarters of this year? Secondly, he also has a question about second quarter subscriber growth. Will that be higher or lower than Q2 of 2023?
Spence Neumann: All right. Sure. Well, thanks for the question. So first, regarding revenue growth overall, full year outlook, I feel really good about where we are in our growth outlook. So I just want to be clear about that. We've done a lot of hard work over the past 18 months or so to reaccelerate the business and reaccelerate revenue through combination of improving our core service, which Greg and Ted just talked about and rolling out paid sharing, launching our ads business and that reacceleration really started in the back half of '23 and it built through the year. So our growth in the back half of '24 is really kind of comping off of those harder comps. And at the high end of our revenue forecast, our growth in the second half is consistent with our growth in the first half, even with those tougher comps. And it's still early in the year. We still got a lot to execute against. We also, as you see in our letter, there's been some FX that with the strengthening dollar, that's a bit of a headwind. So we'll see where that goes throughout the year. But we're guiding a healthy double-digit revenue growth for the full year, which is what we set out to deliver and that's what's reflected in the range. And I guess maybe it's in the question, I guess, seeded and this is a little bit of like what's really kind of the outlook for our growth of the business, not just the back half of this year, but into '25. And it's too early to provide real - specific guidance, but we're going to work hard to sustain healthy double-digit revenue growth for our business. And we really like the kind of the opportunity ahead of us. We're so small in every aspect. We're only 6% roughly of our revenue opportunity. We're lesser than 10% of TV share in every country in which we operate. There's still hundreds of millions of homes that are not Netflix members and we're just getting started on advertising. So the key is to, as you just heard from Greg and Ted, continually improve our service, drive more engagement, more member value. As we do that, we'll have more members. We'll be able to occasionally price in that value and also have a big highly engaged audience for advertisers. So more to come on '25 guidance, but that's - we feel good about the outlook. And then, I guess the second part of the question, I'm trying to remember Spencer. I'm sorry.
Spencer Wang: I can take - I'll be the bad guy on this one, Spence. So the second question was, do you expect Q2 subscriber growth to be higher or lower than Q2 of the prior year? So Barton, as you know, we don't give formal subscriber guidance. We did give an indication in the letter for you that we expect fairly typical seasonality. So paid net adds in Q2 of this year will be lower than Q1 of this year. And that's the limit of the color we'll provide there.
Spence Neumann: Thanks, Spencer.
Spencer Wang: No problem, Spence. So to follow-up on the revenue guidance question, we have Jason Helfstein from Oppenheimer, who is asking for some more color on the drivers of the full year revenue guidance with respect to subscriber growth versus ARM growth and how that - those two dynamics will play into the revenue forecast, Spence?
Spence Neumann: Yes. You want to take this one as well?
Spencer Wang: Yes.
Spence Neumann: Okay. I'll jump in. Others can chime in as well. But when you think about the outlook for the year, it's in terms of the mix of revenue growth. It's kind of pretty similar to - we expect it will be pretty similar to what you see in Q1 where it's primarily driven by member growth because of the kind of the full year impact of paid sharing rolling through the year and continued strong acquisition and retention trends. But you are - we are seeing some ARM growth as well. We saw it in Q1, about 1% on a reported basis, 4% FX-neutral. And what's - I just want to be clear, what's happening is that with ARM is price changes are going well. And that's why we're seeing those strong acquisition retention trends because it's testament to the strength of our slate, the overall improvement in the value of our service. But we've only really changed prices in a few big markets and that was U.S., U.K., France late last year. And only on some of the planned tiers in those markets, not even all the planned tiers. And since then, it's been mostly pretty small countries other than Argentina. And Argentina, as you can see, we're sort of pricing into the local currency devaluation and you see that in the difference between FX-neutral and reported growth in Q1. So mostly, what you're seeing in our growth profile this year is the fact that we haven't taken pricing in most countries for the past two years really. And we also have some ARM kind of headwinds in the near-term that you see in Q1. You'll probably see throughout most of this year, which is that one, we have some this planned mix shift as we roll-out paid sharing. So while it's highly revenue accretive, as you can see in our numbers and our reported growth - strong reported growth in Q1 and outlook for the year, that growth - as we spin-off into new paid memberships, they tend to spin-off into a mix of planned tiers that's a little bit of a lower-price view than what we see in our tenured members. And we're also growing our ads tier at a nice clip as you've seen. I'm sure we'll talk about it and monetization is lagging growth there. I'm sure we'll talk about that a bit as well. We also have some country mix shifts. So that whole combination of factors results in pretty modest ARM growth, still some ARM growth, but pretty modest in Q1 and probably throughout the year. But again, the key there is that this is all we're kind of managing this business transition in a way that's really healthy for overall revenue growth as you see with 15% reported revenue growth in the quarter, strong outlook for the year and we're building into a much more kind of durable and healthy foundation for revenue growth going forward across a larger base of paid members and a really kind of strong and scaled highly engaged audience to build into our advertising over time and a strong paid sharing solution and also to kind of penetrate into those households. So we'll increasingly kind of see that mix in our revenue growth and we start to see some of it this year.
Spencer Wang: Great. Spence, the next question comes from Kannan Venkateshwar from Barclays and it's for you, which is do you expect margin growth trajectory to continue being on the present path for a few years? Can you attain margins that are comparable to legacy media margins?
Spence Neumann: Well, thanks, Kannan. Our focus is on sustaining healthy revenue growth and growing margins each year. That's what we talk about a lot of we also talked about in the letter. And we feel good about what we've been delivering, 21% margins last year, that's up from 18% in the year before. And now, we're targeting 25% this year, which is up a tick from the start of year when we were guiding to 24%. So I'd say, just like we have in the past, we'll take a disciplined approach to balancing margin improvement with investing into our growth. We've managed that balance historically pretty well, growing content investment, growing profit, growing profit margin and growing cash flow. You should expect we'll continue to do that, but the amount of annual margin expansion in any given year could bounce around a bit with FX and other investment opportunities. But again, we're committed to grow margin each year. And we see a lot of runway to continue to grow profit and profit margin over the long term.
Spencer Wang: Thank you, Spence. Our next question comes from Alan Gould of Loop Capital. Which inning are we in with respect to enforcing paid sharing? Two years ago, you said 100 million subscribers were sharing passwords with 30 million in UCAN. How many do you estimate still borrow passwords? And I'll turn the floor over to Greg to answer that question.
Greg Peters: Yes. As we mentioned last quarter, we're at the point where we've operationalized the pay sharing work. So this is just now part of that standard mechanism that we've been building and iterating on over time to translate more entertainment value and great film, series, games, live events into revenue. And like we do with all of the significant parts of our product experience, we're iterating on that, testing it, improving it continually. So rather than thinking beyond sort of specific cohorts or specific numbers, we really think about this more as developing more mechanisms, more effective ways to convert folks who are interacting with us, whether they be borrowers or folks that were members before that are coming back, we call them rejoiners or folks that have never been a Netflix member. So we want to find the right call to action, the right offer, the right nudge at the right time to get them to convert. And just to be clear, we still see opportunities to improve this process. We've got line of sight on several improvements to this value translation mechanism that we expect will deliver and contribute to business growth for the next several quarters to come. But I also very much believe that just like for the last 15 years, we're going to - we've always found something to improve in this process. And even beyond those, for years and decades to come, we'll be working on this and making it better and better and better. So all of those improvements could allow us to effectively get more of that 500 million plus smart TV households to sign up and become members. Spence mentioned hundreds of millions yet to come. This is a way to effectively get at more of those folks and make them part of our membership base. And as we mentioned earlier on the call too, I think worth noting that while we're fully anticipating continue to grow subs, the overall business growth now has extra levers and extra drivers like plan optimization, including things like extra members, ads revenue, pricing into more value, which is important. So those levers are also an increasingly important part of our growth model as well.
Spencer Wang: Great. I'll move us on now to a series of questions around advertising. The first of which comes from Doug Anmuth of JPMorgan. What are the most important drivers of scaling your ad tier when you think about adjustments you could make to pricing and plans, partner bundles and marketing? How do you get people over the hump for a - that a few minutes of ads an hour can still be a very good experience at the right price. Greg, why don't you take that one?
Greg Peters: Yes, all the things mentioned in the question matter. And I would say we're generally taking our entire playbook, everything that we've learned about how do you grow members and we're applying it to our ads tier now. So clearly, that means partner channels, it means device integrations, bundles, integrated payments. Those are all important tools for growth just as they are and will continue to be in our non-ads offering, increasing awareness of the quality of our ads experience, especially relative to the linear TV ads experience, which in many countries is really quite poor. That's an important and iterative tool when we talk about sort of marketing and awareness building that's, that's going to be part of our growth mechanism. Low price, that's important to consumers. 699 is an example in the United States for multiple streams, full HD downloads. We think that's a great entertainment value, especially at the industry-leading low ad load that we've got. So that's critical as well. So I think you can see the results of leveraging all of these mechanisms and more and how our ads tier has been scaling over the last couple of quarters. So we're 65% up quarter-to-quarter this last quarter. That's after two quarters of about 70% quarter-over-quarter growth. For me, it's exciting to see that growth rate stay high even as we've grown the base so much because obviously, the numbers indicate. That means that there's more absolute additions each quarter. So we're making good progress there. But look, we've got much, much more to do in terms of scaling. We've got more to do in terms of effective go-to-market, more technical features, more ads products. There's plenty of work ahead for us on ads.
Spencer Wang: Great, Greg. Our next question on advertising comes from Rich Greenfield of LightShed. He has a three-part question. Part one, can you update us on your thinking around the optimal spread between the ad tier and the ad-free tier? Secondly, is your advertising ARPU, excluding the subscription fee, up meaningfully versus your original comments that it was in the $8 to $9 range last year? And then lastly, can you give us a sense of what ARPU would look like if supply was not outstripping demand?
Greg Peters: Yes. I'll take the first one and then maybe hand the ARPU/ARM points to Spence. We don't have a fixed operator position on sort of the optimal pricing spread. And much like we've done with price changes in general, we really use signals from our customers, things like plan take rate, conversion rates churn to guide us along an iterative path to get to that right pricing. And I think it's also probably worth noting that sort of right pricing is not really a static position. As we continue to evolve and improve our offering, that's going to change as well. But I think a good general guideline for us in the long term is that it would be healthy for us to land overall monetization between our ads and non-ads offerings in roughly an equivalent position. So it really comes down to what works best for any given member. And it's really a member choice about which plan they think serves them the best. And then I'll hand it over to Spence on ARM questions.
Spence Neumann: Sure. Thanks, Greg. So in terms of ARM and your question, Rich, in terms of how we're doing now relative to what we discussed when we first launched the business. And as Greg said, we've been growing our inventory at quite a fast clip. And so, monetization hasn't fully kept up with that growth in scale and inventory as we're still early in building out our sales capabilities and our ad products. But that is an opportunity for us, because we're still a very premium content environment, a very highly engaged audience that's at an increasing scale. So our CPMs remain strong and we're building out our capabilities, as Greg talked about. So the revenue is going to follow engagement over time and it's already kind of growing nicely, which is great just off a small base. So then really as Greg said, what that means for ARM is right now, it is a bit of a drag on our ARM because of we're kind of under-monetizing relative to supply. But over time, we expect to be similar in revenue on our ads tier, a combination of subscription as well as ads revenue with those kind of non-ads offering. So that's how to think about it, but we're building to it over time.
Spencer Wang: Great. Last question on advertising comes from Jon Hollick at UBS. How are you approaching this year's upfronts? And do you believe the base of ad-supported users is now of the scale that upfront commitments can drive a meaningful change in advertising revenue and be a contributor to ARM growth in 2025? So perhaps Ted, maybe you could start and then Greg follow after that.
Ted Sarandos: Yes, of course. Look, first and foremost, this is our second upfront. We're really excited to go and share with advertisers this incredible slate that we're very, very proud of. So they're going to get a look at some of the shows that are upcoming right away like brand new seasons of Bridgerton and Sweet Tooth and The '90s Show, some of our big unscripted events upcoming like our Tom Brady Roast by way of example and brand new shows like Dead Boy Detectives and Shane Gillis' new show Tires, Eric, a great new limited series out of the U.K. with Benedict Cumberbatch that we're super excited about. And then, they'll even get a longer look at what's all coming up in the second half of the year, which is again returning seasons at Cobra Kai, Emily in Paris, The Night Agent, Outer Banks and Squid Game, our big one and a brand new season of Monsters from Ryan Murphy, which is The Lyle and Erik Menendez Story this year, which is going to be really incredible thing to share with our advertisers. And brand new original series and limited series like American Primeval from Pete Berg, Heartburn with an all-star cast, Nicole Kidman and Liev Schreiber, Senna, which is this great limited series on the Great Brazilian Formula One Driver that we're really excited about. And also, I look at our early - at our movies coming up that we'll end the year with like Eddie Murphy in his most iconic role, Axel Foley and Beverly Hills Cop Axel Foley, Carry On, a big new animated feature, Spellbound. So we've got a lot of entertainment in store for the audience at the upfronts.
Greg Peters: Yes. I think this is an opportunity to reengage with advertisers and look at the fundamentals of what our offering is. I mean, first and foremost, that's an incredible list of titles that brands want to be connected with. It's just super exciting to hear that roster. We've got great engagement from our members on our ads tier. We've got an opportunity to grow that even further. We think that's connected again to the power of those titles. We're rapidly growing scale, as we mentioned. That's the number one request we've had from advertisers. So that's exciting. We're making progress on technical features like measurement, on ads products. So we're excited to get that out there. And really, this is just an opportunity to bring all of that progress in a package to advertisers and then of course, to get input from them because we know that they're going to have comments and they're going to have things that they're going to want us to continue to work on. And then really then just to continue that journey, because we know there's plenty more to go do to realize the potential we have in this space. And so, I would say, we're continuing to grow here. We're growing off of a relatively small base in terms of the impact against already big and substantial business. So even though it's growing quite quickly, it takes a while to grow that into the point where it's material. So we look forward to that increasing in '25 and then increasing further '26 and beyond.
Spencer Wang: Great. I'll now transition us to several questions around content. And this first one, I'll direct to Ted. It's a rare question around why don't we spend more. Given what seems like a very favorable current backdrop for Netflix to acquire and license content, why not lean in even more aggressively? Could it make sense to spend more than $17 billion in cash content this year?
Ted Sarandos: Yes. Look, independent of the availability of licensed content, you should look at it, I think we're - we've always been very disciplined about the way we invest in the business and how we grow it. And we can get a lot of bang for our buck by spending our money well and producing our shows really well and also by acquiring the right content. And the floodgates have opened a little more on licensing for sure. But again, we're very focused on the ones that we think will drive the business. So I think we're at our current level of spending at our current level - rate of growth and we're pretty comfortable spending just behind that anticipated rate of growth.
Spencer Wang: And Ted, Jason Helfstein's follow-up is also about licensed content or second-run content. And his question is, how would second - more second-run licensing impact your margins and free cash flow?
Ted Sarandos: Well, the budget is the budget. So it's all part of how we spend against the content and the free cash flow economics. We've gotten pretty close in our cash flow against P&L on our content spend generally. So I don't think it would have much - very much impact on that. Let's want to add some color to that, Spence.
Spence Neumann: I just love you talking about the discipline on our content budgets, Ted, it makes me happy. No, I agree with all of it. I mean, we spend the opportunity, but with I think, prudent constraints and discipline. And to be clear, like we as you say, there has been more licensed content opportunity. But the vast majority of our content spend is still into original programming. It's - and it is and is likely to continue to be. So we'll always complement it with great license content for that variety and quality for our members, but the original content is still our future too.
Spencer Wang: Yes. Great. Next question is from Michael Morris of Guggenheim. Specific about the Jake Paul, Mike Tyson fight for Ted, what are the characteristics of the upcoming Jake Paul, Mike Tyson fight that make this the type of sports programming you're interested in investing in? How does that content benefit your member base and advertising growth goals?
Ted Sarandos: And so, we're in the very early days of developing our live programming. And it's - I would look at this as an expansion of the types of content we offer, the way we expand it to film and unscripted and animation and most recently, games. On-demand and streaming have been unbelievable for consumer choice and control. And it's really put the controls of television back in the hands of consumers, which has been really phenomenal. But there's also something incredibly magic about folks gathering around the TV together in the living room to watch something all at the same time. We believe that these kind of eventized cultural moments like the Jake Paul and Mike Tyson fight are just that kind of television that we want to be part of winning over those moments with our members as well. So that for me is the excitement part of this. We have - beyond the fight itself, we have several nights of live comedy coming from the Netflix Is A Joke Festival next month and starting in January, we've got 52 weeks of live sports with WWE RAW that's going to be coming to our members every week on Netflix. And we think it's going to be a real value-add to watch those things in real time. And we're going to continue to try a lot of new things, but the core of it is, do our members love it? And judging from the early excitement around the Jake Paul, Mike Tyson fight, there's going to be a lot of people waking up in the middle of the night all over the world to watch this fight in real time.
Greg Peters: I think worth noting that just as what's relevant to members in terms of these large cultural events that Ted talks about, that's what has relevance to advertisers as well. So it's an opportunity for us to expand our advertising offering and give those brands access to these kind of culture-defining moments.
Spencer Wang: Thanks, Ted and Greg. And I'm personally looking forward to that event and my money is on Iron Mike Tyson. But as a follow-up on the sports. You still got it, I think. But as a follow-up to the sports question, for Ted, as you continue to scale Netflix and become bigger and bigger and potentially gain more leverage, how could your sports strategy change beyond what you're doing today around primarily sports entertainment?
Ted Sarandos: We've said this many times, but not anti-sports, but pro profitable growth. And I think that's the core of everything we do in all kinds of programming, including sports. So our North Star is to grow engagement, revenue and profit. And if we find opportunities we can drive all three of those, we will do that across an increasingly wide variety of quality entertainment. So when and if those opportunities arrive that we can come in and do that, which we feel like we did in our deal with WWE. If we can repeat those dynamics and other things, including sports, we'll look at them, for sure. So I think it's - we have the benefit of building an enormous business without a loss leader. And we continue to believe that we can grow on that path just as you've seen. So I think the core of it is, is that we're going to look at those opportunities with the same discipline that we do when we talk to movie producers and television networks about putting our content on the air.
Spencer Wang: Great. The next question comes from Rich Greenfield from LightShed about our film strategy. So for Ted, a recent New York Times article cited internal communications from new Netflix film, Chief, Dan Lin stating quote. The aim is to make Netflix's movies better, cheaper and less-frequent. Lin wants his team to become more aggressive producers developing their own material rather than waiting for projects from producers and agents that come to them unquote. Everyone wants to make better, cheaper films, but we find it hard to believe we being rich, find it hard to believe that there is a magic formula. Help us understand the strategy shift under Dan Lin versus Scott Stuber.
Ted Sarandos: Well, thanks for that question, Rich. I would send you back to that New York Times article because that was not a quote from Dan. And I would say that and nor did we participate in that article. I would say, just to be clear, there is no appetite to make fewer films. But there is an unlimited appetite to make better films always, even though we have made and we are making great films. We want to make them better, of course. We're super excited to have Dan join the company. He just joined a couple of weeks ago and he's joined us running 100 miles an hour. Bella has said this publicly that our strategy remains variety and quality. And she's doing an amazing job of bringing new fresh-thinking to our content and our content organization, bringing Dan on board is a great example of that. We want to have a lot of movies. We want them to thrill our audiences and they all have different tastes and we want them all to be great. And so, we take a very audience-centric view of what quality is. And Dan knows that from having produced for us as the CEO, Ride Back, he produced the Oscar-nominated film, the Two Popes. For us, he did Avatar, The Last Airbender for us recently. So he understands Netflix and the audience really, really well and his success in live action and animation is very hard to define in the business. So we're thrilled he's doing it here.
Spencer Wang: Great. Thank you, Ted. The next question comes from Kannan Venkateshwar from Barclays. Could you please provide an update on engagement trends now that paid sharing is mostly behind you. So I'll kick it over to Ted first and Greg, you can feel free to add-on.
Ted Sarandos: Well, it's important to note that we compete for every hour of viewing all the time, every day, everywhere we operate. And we think that engagement report is very important and that metric is important because again, it's the best indicator of customer satisfaction. I know I just said this 10 minutes ago, but I'm going to repeat it. Eight of the first 11 weeks of this year, we've had the number one movie and nine of the last 11 weeks of this year, we've had the number one series. And that's according to the Nielsen streaming data. And for us, that is what we're personally focused on. And we've actually seen in that Nielsen data, our share tick up a little bit even in this incredibly competitive space, where you've got a lot of folks competing for attention, for time and for money.
Greg Peters: Yes, Ted, I think you can repeat that eight, 11, 9/11 as many times as you want as far as I'm concerned.
Ted Sarandos: I'm going to close with that two.
Greg Peters: So as we have said, due to the work that we're doing on password sharing, we're essentially cutting off some viewers who are not payers and therefore, we're going to lose some viewing associated with that. So when you see our next engagement report, you are going to see some impact to our overall absolute view hours as a result of that. But despite that impact and despite the general pressure from strong competition that Ted noted, we think our engagement remains healthy. You can see it in the stat that Ted indicated in terms of the Nielsen ratings and our modest growth in TV time in the United States, but we also wanted to do an apples-to-apples view of engagement. So we looked at the population not impacted by paid sharing, it will be called owner households. And in Q1 of '24, the hours viewed per account were steady with the year-ago quarter. So that's a pretty good sign that our engagement is holding up and it sort of cuts through the noise around paid sharing. And again, I just want to reiterate, we think we have plenty of room to grow engagement, right? We're still less than 10% of TV hours, even in our most mature matrix markets. So there's tons of room of growth ahead of us.
Spencer Wang: Thank you, Ted and Greg. I'm going to move us along now to a series of questions around plans and pricing and pricing strategy. So from Steve Cahall from Wells Fargo. Greg, as you continue to expand, do you think there is a ceiling for pricing? If so, how close are we to that ceiling in mature markets? And do you envision Netflix having content here, so that you can continue to expand your content genres and further segment your customer base?
Greg Peters: Yes. We don't have a set position on a ceiling. I mean, I'm sure, you can look at pay TV as a potential markers for where people have spent before, but we really actually don't think of it so much as defined by that. We see it as an opportunity to continue the process that we've been working on, which is let's continue to try and invest wisely, add more entertainment value. And as we add more entertainment value, then of course, we can go back to our subscribers and ask them to pay a little bit more to keep that virtuous cycle moving. And really the markers for us in terms of the upside potential, more around the hours on TV that we are winning, how many moments of truth we call it that we are winning. Again, less than 10% in our even most mature markets, there's tons of room there. You can use total consumer spend on entertainment in the markets and categories that we compete in. That's between 5% and 6%. So there's just a lot of runway still ahead of us to go do a good job at making that investment happen, deliver more value and then ask folks to pay a little bit more.
Spencer Wang: Great. Next question on pricing comes from [Mark Shmulik] of Bernstein. Can you please share progress on how the retirement of the basic plan is going in the U.K. and Canada? And is there any color you can share on if when we could expect a similar rollout in the U.S.? Greg, why don't you take that one?
Greg Peters: Yes. As we shared in the Q4 '23 letter, we were planning on retiring our basic plan in some of our ads countries. We've now started that process in Canada and the U.K. and very similar to what you saw us do with paid sharing, we're going to work hard to make this a smooth transition. Part of that is listening to our members before we make any further moves. So we've got nothing more to announce and we really want to see how this goes. Yes. We know that this is a change for our basic members, but we think we've got a strong offering for them. They're going to get more for less, two streams versus one, we've got higher definition, we've got downloads, all at a lower price. And of course, it goes without saying hopefully that members can always choose our ads free plans as well if they prefer.
Spencer Wang: Great. Thank you, Greg. A couple of questions on overall capital allocation. So these would be for Spence, primarily from John Blackledge of TD Cowen. Excuse me, you mentioned evolving capital allocation strategy in your investor letter with the - with your new investment-grade status. Can you please talk about changes in how investors will see that change?
Spence Neumann: Yes, sure. Thanks for the question. It's really quite a modest evolution of our capital allocation strategy to better reflect our investment-grade status. And that's really what it is. We're still going to have the same financial policies and principles in terms of prioritizing profitable growth by reinvesting in our core business, maintaining a healthy balance sheet with ample liquidity and returning excess cash beyond several billion dollars on the balance sheet of minimum cash and anything that we use for selective M&A to return to shareholders through share repurchase. So really the only change is that now that we're solidly investment grade, we're going to - while we will hold still several billion dollars in cash on the balance sheet, we won't have the same marker of two months of revenue - the equivalent of two months of revenue on the balance sheet. So it allows us to be a bit more efficient there. We also upsized our revolver, which was announced today, up to $3 billion from $1 billion, which also gives us more access to capital and better cash efficiency. And then again, any cash beyond that, we'll return to shareholders. We've historically been mostly a build versus buy company with select strategic kind of acceleration through M&A. And that there's nothing right now planned, but that still is kind of our philosophy is to build predominantly. And we're also going to kind of refinance our existing kind of debt as those maturities approach, but we don't plan to kind of lever up through stock buyback. We want to - we really do value that balance sheet flexibility.
Spencer Wang: Great. Thank you, Spence. Last question on capital allocation for you. This comes from Vikram of Baird. What are your latest thoughts on the appropriate level of content spend for the business beyond 2024. Specifically, in the past, you have referenced a 1.1 cash content spend to amortization ratio. Is that still the case? And what would you need to see in an opportunity to meaningfully exceed that framework?
Spence Neumann: Yes. It still holds. It still holds. So still basically the short of it is we're really kind of managing to that. So as we said, we've been like - we've been focused on driving that acceleration of our revenue growth, continuing to grow our business, grow our profitability. As we do that, we would expect to continue to grow our content investment as we have historically into the highest impact areas, but also be quite disciplined there. So we want to grow our free cash flow. So we believe we can manage to that roughly 1.1 times of cash content spend relative to expense on the P&L and that leads to overall revenue growth, increased profit, profit margins, growing free cash flow. And that still gives us a lot of opportunity to spend into the all those kind of content and entertainment categories that Greg and Ted have been talking about.
Spencer Wang: Thanks, Spence. We have a few more minutes left. So we'll wrap-up with a few higher-level questions. The next one comes from Eric Sheridan of Goldman Sachs. And I think both Ted and Greg can tackle this one. The question is, what are your thoughts on the competitive impact from short form video consumption?
Ted Sarandos: So I look at how - what people watch and when they watch it, have a lot to do with one another. What are the choices and how much time do they have. So our version of short-form is more like giving our members the ability to watch 10 minutes of an episode of a series that they're binging right now if they only have 10 minutes. But some and those when I look at the short-form viewing on YouTube and TikTok, some of it is adjacent and quite complementary to our viewing. So our trailers or creators expressing their fandom for our shows like doing posting a Wednesday Dance or Ugly Crying, Watching One Day, all those kind of things that become viral sensations and actually increase the fandom of our shows. Now that being said, some of that viewing is directly competitive with us, the same as it is with other media companies who provide content to YouTube by way of example. The art of this has always been finding the right balance of both. So and also would point out that these platforms have been a way to have new voices emerge, and we've got our eye on them as well to try to develop them into the next-generation of great storytellers on Netflix.
Spencer Wang: Great. And I think for our final question, we'll take that from Dan Salmon of New Street Research. What is the opportunity for Netflix to leverage generative AI technology in the near and long-term. What do you think great storytellers should be focused on as this technology continues to emerge quickly. I'll turn that over to Greg, please.
Greg Peters: Yes, worth noting, I think that we've been leveraging advanced technologies like ML for almost two decades. These technologies are the foundation for our recommendation systems that help us find these largest audiences for our titles and deliver the most satisfaction for our members. So we're excited to continue to involve and improve those systems as new technologies emerge and are developed. And we also think we're well-positioned to be in the vanguard of adoption and application of those new approaches from our just general capabilities that we've developed and how we've already developed systems that do all these things. We also think that we have the opportunity to develop and deliver new tools to creators to allow them to tell their stories in even more compelling ways. That's great for them. It's great for the stories and it's great for our members. And what should storytellers be focused on. I think storytellers should be focused on great storytelling. It is incredibly hard and incredibly complex to deliver thrilling stories through film, through series, through games. And storytellers have a unique and critical role in making that happen and we don't see that changing.
Spencer Wang: Great. Thank you very much, Greg. And we are now out of time. So I want to thank you all for taking the time to listen into our earnings call. And we look forward to speaking with you all next quarter. Thank you |
ADBE | 1 | 2,024 | 2024-03-14 21:44:09 | Operator: Good day, and welcome to the Q1 FY 2024 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jonathan Vaas, Vice President of Investor Relations. Please go ahead.
Jonathan Vaas: Good afternoon, and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's first quarter fiscal year 2024 financial results. You can find our press release as well as PDFs of our prepared remarks and financial results on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, March 14, and contains forward-looking statements that involve risks, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call, we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant-currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's Investor Relations website. Adobe Summit is just around the corner in Las Vegas at The Venetian Convention and Expo Center beginning on Tuesday, March 26. Following the day one keynote, we will host an Investor Meeting at 2:00 PM Pacific Time. The event will be webcast live and the replay will be available on Adobe's IR website. More details about the summit are available at summit.adobe.com. I will now turn the call over to Shantanu.
Shantanu Narayen: Thanks, Jonathan. Good afternoon, and thank you for joining us. Adobe had a strong first quarter. We achieved $5.18 billion in revenue in Q1, representing 12% year-over-year growth. GAAP earnings per share for the quarter was $1.36, and non-GAAP earnings per share was $4.48, representing 18% year-over-year growth. Our performance reflects the essential role that Adobe products play in driving the global digital economy. We're delivering on our strategy to unleash creativity for all, accelerate document productivity and power digital businesses. Adobe Creative Cloud, Document Cloud and Experience Cloud are more critical than ever to the success of creators, communicators, students, entrepreneurs, and businesses of all sizes with AI serving as an accelerant for all. We are a leader in delivering generative AI across all our clouds. We're taking a highly differentiated approach across data, models and interfaces. Our proprietary data is built on decades of deep domain expertise across creative, documents and customer experience management. We leverage large language models, as well as have invested in building and delivering our proprietary models in the creative document and marketing domains. Our IP-friendly approach is a differentiator for creators and enterprises. In addition, we've innovated by delivering generative AI directly in products with releases in Adobe Photoshop, Illustrator and Express across both desktop and mobile. AI Assistant in Acrobat and Reader unlocks the tremendous value of the trillions of PDFs around the world. We're bringing generative AI to Adobe Experience Cloud and will demonstrate our AI Assistant for Customer Experience Management at Adobe Summit. Every student, communicator, creative professional and marketer is now focused on leveraging generative AI to imagine, ideate, create and deliver content and applications across a plethora of channels. Adobe is uniquely positioned through the combination of Express, Firefly, Creative Cloud, Acrobat and Experience Cloud to deliver on this immense market opportunity. The success we are already seeing with our GenStudio offering in the enterprise is validation of our leadership, and we expect that success to translate into other segments as we roll out these solutions throughout the year. We are driving strong usage, value and demand for our AI solutions across all customer segments. We're successfully monetizing our innovations with particular strength in Q1 in the Enterprise segment across our Digital Media and Digital Experience businesses. This strength is reflected in our strong RPO growth of 16% year-over-year. We're pleased with a strong Q1. We have a phenomenal product roadmap that we're executing against to bring AI innovation across our global customer base and we're just getting started. I'll now turn it over to David to discuss the momentum in our Digital Media business.
David Wadhwani: Thanks, Shantanu. Hello, everyone. In Q1, we achieved a net new Digital Media ARR of $432 million and revenue of $3.82 billion, which grew 13% year-over-year. The world's information whether it's an enterprise legal contract, a small business invoice or a personal school form lives in trillions of PDFs. We were thrilled to announce Acrobat AI Assistant, a massive leap forward on our journey to bring intelligence to PDFs. With AI Assistant, we're combining the power of generative AI with our unique understanding of the PDF file format to transform the way people interact with and instantly extract additional value from their most important documents. Enabled by a proprietary attribution engine, AI Assistant is deeply integrated into Reader and Acrobat workflows. It instantly generate summaries and insights from long documents, answers questions through a conversational interface, and provides an on-ramp for generating emails, reports and presentations. AI Assistant is governed by secure data protocols so that customers can use the capabilities with confidence. We are pleased with the initial response to the English language beta and look forward to usage ramping across our customer base as we release other languages later in the year. We will monetize this functionality through a monthly add-on offering to the hundreds of millions of Reader users as well as the Acrobat installed base across individuals, teams and enterprises. In Q1, we achieved Document Cloud revenue of $750 million, growing 18% year-over-year. We added $143 million of net new Document Cloud ARR, which was a Q1 record with year-over-year ending ARR growth of 23% in constant currency. Other business highlights include Acrobat Web continues to be an incredible source of customer acquisition with monthly active users up over 70% year-over-year and surpassing 100 million users in Q1. Acrobat extensions for Microsoft Edge and Google Chrome and our Acrobat Mobile offerings continue to accelerate free-to-paid conversion. Increased viral adoption through link sharing and stakeholder collaboration drove over 300% year-over-year growth in the number of PDF files sent. Key enterprise customer wins include Berkshire Hathaway, Merck Sharp & Dohme, Northrop Grumman, Porsche, and the U.S. Navy. On Creative Cloud, creativity is the currency of differentiation in our digital-first world. Every creator and business is focused on building their brand and engaging with their audiences through standout content. Creative Cloud remains the solution of choice for the world's creators, whether their medium is design, photography, video, illustration or 3D. Adobe Express is inspiring millions of users of all skill levels to design more quickly and easily than ever before. In the year since we announced and released Adobe Firefly, our creative generative AI model, we have aggressively integrated this functionality into both our Creative Cloud flagship applications and more recently, Adobe Express, delighting millions of users who have generated over $6.5 billion assets to date. In addition to creating proprietary foundation models, Firefly includes a web-based interface for ideation and rapid prototyping, which has seen tremendous adoption. We also recently introduced Firefly Services, an AI platform which enables every enterprise to embed and extend our technology into their creative, production and marketing workflows. Firefly Services is currently powered by our commercially safe models and includes the ability for enterprises to create their own custom models by providing their proprietary datasets as well as to embed this functionality through APIs into their email, media placement, social and web creation process. Early adopters like IBM are putting Firefly at the center of their content creation processes. IBM used Adobe Firefly to generate 200 campaign assets and over 1,000 marketing variations in moments rather than months. The campaign drove 26X higher engagement than its benchmark and reached more key audiences. In Q1, we achieved $3.07 billion in revenue, which grew 12% year-over-year. Net new Creative Cloud ARR was $289 million. Other business highlights include new the launch of the new Adobe Express mobile app beta brings the magic of Adobe Firefly AI models directly into mobile workflows. The first-of-its-kind integration with TikTok's creative assistant makes the creation and optimization of social media content quicker, easier and more effective than ever before. Express Web usage continues to ramp nicely with total exports more than doubling year-over-year and overall Express adoption is expected to accelerate even further, given the positive reception we're seeing from the mobile beta. Generative Fill in Photoshop continues to empower creators to create in new ways and accelerate image editing workflows. Q1 saw the highest adoption of Firefly powered tools in Photoshop since the release of Generative Fill in May 2023 with customers adopting these features across desktop, web and most recently, iPad, which added Generative Fill and Generative Expand in December. The beta release of AI-powered Enhance Speech and new audio workflows drove premiere beta usage to record highs. Adobe video tools were the go-to choice at Sundance Film Festival with over 80% of this year's entrants using Adobe software. The introduction of Behance Pro, a new offering to serve the rapidly growing Behance community empowers members to build their brand and find opportunities, and for businesses to hire talented creators through the Behance platform. The unveiling of new research like the preview of our music generation models and editing tools last month and our video auto dubbing models earlier today have inspired our Creative Cloud and Express customers. The introduction of Firefly Services for enterprises drove notable wins in the quarter, including Accenture, IPG and Starbucks. Other key enterprise wins include AECOM, Capital Group, Dentsu, IBM, Nintendo and RR Donnelley. Given the size of opportunity we see with generative AI, we continue to focus on driving innovation, adoption and usage of our AI solutions. In Q1, we saw strength across both clouds with record new commercial subscriptions in Creative Cloud for Q1, and strong product-led growth in Document Cloud. You can expect to see the product advances and Express with Firefly on mobile. Firefly Services and AI Assistant in Acrobat drive ARR acceleration in the second half of the year. We're excited about our product roadmap. The 6.5 billion assets generated to date include images, vectors, designs and text effects, and we can't wait to share the work we're doing on audio, video and 3D through research sneaks and product announcements in the coming months. I'll now pass it to Anil.
Anil Chakravarthy: Thanks, David. Hello, everyone. Experience Cloud business had a great first quarter, achieving $1.29 billion in revenue and was our strongest Q1 on record for new business. Subscription revenue was $1.16 billion, representing 12% year-over-year growth. Companies are prioritizing digital investments to improve marketing agility and customer engagement while driving growth and profitability. Adobe's holiday shopping report which analyzes trillions of data points, showed strong online spending during the 2023 holiday season, growing 4.9% year-over-year to $222.1 billion, a new record for e-commerce as well as mobile shopping, which surpassed desktop for the first time and drove 51.1% of online sales. Our Adobe Experience Cloud applications span the entire customer funnel from acquisition to monetization to retention. As the global leader in the Digital Experience Platforms category, Adobe offers businesses a single view of their customers' data across every channel, allowing them to create precise segments and deliver personalized experiences regardless of when and where the customer interacts with their brand. Over the last five years, our organic innovations in Adobe Experience Platform, Realtime CDP, Journey Optimizer, and Customer Journey Analytics have made us the leading platform for customer experience management given the scale of the profiles, campaigns and interactions we process, which now exceed 500 trillion segment evaluations per month. Today, rollout of personalization at scale has been limited by the number of content variations you can create and the number of journeys you can deploy. We believe harnessing generative AI will be the next accelerant with Creative Cloud, Firefly Services and GenStudio, providing a comprehensive solution for the current supply-chain, and generative experienced model automating the creation of personalized journeys. Adobe GenStudio is the generative AI first application that allows marketers to quickly plan, create, store deliver and measure marketing content in a single intuitive offering. With state-of-the-art generative AI powered by Firefly Services, marketers can create on-brand content with unprecedented scale and agility to deliver personalized experiences. Adobe GenStudio natively integrates with multiple Adobe applications across Creative Cloud and Experience Cloud, including Express, Firefly, Workfront, Experience Manager, Customer Journey Analytics, and Journey Optimizer. It can be used by brands and their agency partners to unlock new levels of creativity and efficiency in marketing campaigns. Business highlights include momentum with Adobe Experience Platform and native applications with the combined annualized book of business surpassing $800 million in the quarter. Demand for Adobe Experience Manager, Workfront and GenStudio to address the enterprise content supply chain. Global agencies, including Accenture, Havas, IPG, Omnicom, and Publicis have standardized on Adobe as their technology platform of choice for their own workflows and to optimize creative collaboration with the world's leading brands. Strength in Adobe Journey Optimizer on Adobe Campaign as companies look to deliver more personalized experiences across channels and surfaces. Adobe was recognized as a leader in the Gartner Magic Quadrant for Digital Experience Platforms for the seventh consecutive year, as well as the Forrester Wave for Digital Experience Platforms. Adobe Experience Manager assets was also named a leader for the fourth consecutive time in the Forrester Wave for Digital Asset Management. Key customer wins include Carl Zeiss, Comcast, Home Depot, NASCAR, Nestle, PayPal, Rogers Communications, Santander Group, Starbucks and Walgreens. Later this month, we are excited to host Adobe Summit, the world's largest digital experience conference in Las Vegas, where we will be joined by thousands of customers, partners, and developers from around the world. We look forward to showcasing a number of product innovations, including a new generative experienced model, advances in Adobe GenStudio, a new AI Assistant in Adobe Experience Platform, new capabilities in RT CDP for first-party data activation and expanded Firefly Services offerings. We will articulate our vision and playbook for brands to achieve a new level of personalization at scale in the era of generative AI. We look forward to sharing our exciting product roadmap and hearing from our customers and how Adobe is helping them transform their business. We were off to a fast start in Q1 and look forward to continuing the momentum and leadership in Q2 and beyond. I will now pass it to Dan.
Dan Durn: Thanks, Anil. Today, I'll start by summarizing Adobe's performance in Q1 fiscal 2024, highlighting growth drivers across our businesses, and I'll finish with financial targets. In Q1, Adobe delivered another quarter of double-digit top line growth with robust margins that result from product leadership, strong execution, and financial discipline. The pace of our product innovation across Document Cloud, Creative Cloud, and Experience Cloud is leading to customers making large multi-year commitments to Adobe. And you see the result of those customer investments in our RPO performance, which accelerated to 16% year-over-year growth. In the quarter, Adobe achieved record revenue of $5.18 billion, which represents 11% year-over-year growth, or 12% in constant-currency. Business and financial highlights included GAAP-diluted earnings per share of $1.36 and non-GAAP diluted earnings per share of $4.48. Digital Media revenue of $3.82 billion, net-new Digital Media ARR of $432 million, Digital Experience revenue of $1.29 billion, cash flows from operations of $1.17 billion, RPO of $17.58 billion exiting the quarter, and repurchasing approximately 3.1 million shares of our stock during the quarter. GAAP EPS came in lower due to the $1 billion payment resulting from the termination of the Figma transaction. Absent the termination payment, our cash flows from operations would have been $1 billion more, and GAAP EPS would have been $2.19 higher. The termination payment impacts both Q1 GAAP EPS and our full-year fiscal 2024 GAAP EPS. In our Digital Media segment, we achieved Q1 revenue of $3.82 billion, which represents 12% year-over-year growth, or 13% in constant currency. We exited the quarter with $15.76 billion of Digital Media ARR, up 14% year-over-year in constant currency. Adobe achieved Document Cloud revenue of $750 million, which represents 18% year-over-year growth as reported and in constant currency. We added $143 million of net new Document Cloud ARR in the quarter. Q1 Document Cloud growth drivers included demand for Acrobat subscriptions across all customer segments and geographies. Continued growth of Acrobat Web demonstrating the success of our flagship products across multiple surfaces, growing monthly active users in our Acrobat Reader Funnel driving free-to-paid conversion. New user acquisition resulting from our Microsoft Edge and Google Chrome partnerships. Strength in our Teams business with up selling our new Acrobat offering which includes integrated signed capabilities, and strong demand from businesses of all sizes, demonstrating the mission criticality of our Document Solutions. We achieved Creative revenue of $3.07 billion, which represents 11% year-over-year growth, or 12% in constant currency. We added $289 million of net new creative ARR in the quarter with ending ARR growing 12% year-over-year in constant currency. Overall CC pricing actions performed as expected in the quarter. Q1 net new Creative ARR grew more than 20% year-over-year, excluding the impact of pricing actions associated with both Acrobat CC and All Apps in the year-ago quarter and Creative Cloud in Q1 FY '24. Q1 Creative growth drivers included new subscription growth, including strong adoption of Creative Cloud All Apps across geographies and customer segments. Strong single-app customer demand in creative categories such as imaging and photography, and continued growth of stock and Frame.io. We again saw strength in emerging markets, which we continue to believe is a massive growth opportunity and outstanding performance of Creative Cloud in the enterprise including early traction of Firefly services. Turning to our Digital Experience segment. In Q1, we achieved revenue of $1.29 billion, which represents 10% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.16 billion, growing 12%year-over-year as reported and in constant currency. Q1 was a tremendous start to the year for our Experience Cloud business with growth drivers, including: success closing transformational deals across geographies and verticals with large enterprises that are choosing Adobe to be their end-to-end customer experience management platform, continued momentum with AEP and native applications with the annualized book of business growing more than 60% year-over-year, strong customer adoption of our content, campaign and Workfront solutions, and continued strength with customer retention and expansion across our products. Customer Experience Management remains an enterprise imperative. And as a leader in the category, we see a robust pipeline as we look into Q2 and beyond. Turning to the income statement and balance sheet. Adobe's effective tax rate in Q1 was 36% on a GAAP basis and 18.5% on a non-GAAP basis. The Q1 GAAP tax rate came in higher than targeted due to the Figma termination payment. RPO exiting the quarter was a record $17.58 billion, growing 16% year-over-year as reported and in constant currency. Our ending cash and short-term investment position exiting Q1 was $6.82 billion, and cash flows from operations in the quarter were $1.17 billion. In Q1, we entered into a $2 billion share repurchase agreement, which effectively exhausted our prior $15 billion authority. As a result of our strong trajectory of growth and profitability, we are announcing a new $25 billion share repurchase program, which demonstrates Adobe's continued commitment to returning capital to our shareholders. In light of the momentum across our business and factoring in the macroeconomic environment, for Q2, we're targeting total Adobe revenue of $5.25 billion to $5.30 billion; Digital Media net-new ARR of approximately $440 million; Digital Media segment revenue of $3.87 billion to $3.90 billion; Digital Experience segment revenue of $1.31 billion to $1.33 billion; Digital Experience subscription revenue of $1.165 billion to $1.185 billion; tax rate of approximately 18.5% on a GAAP and non-GAAP basis; GAAP earnings per share of $3.35 to $3.40, and non-GAAP earnings per share of $4.35 to $4.40. In summary, fiscal 2024 is off to a strong start. By combining the power of product innovation and executional excellence, Adobe is driving consistent profitable growth. We're delivering on our product roadmap, and we have the right strategy to monetize these innovations into the back half of the year and beyond. Adobe is incredibly well-positioned to capitalize on the secular trends that will shape the next decade. Shantanu, back to you.
Shantanu Narayen: Thanks, Dan. We're the leader in three large and growing categories and have delivered groundbreaking innovation across Creative Cloud, Document Cloud and Experience Cloud. We believe that AI augments human ingenuity and expands our addressable market opportunity. I'm proud of the pace and the responsible manner in which we have embraced and delivered generative AI capabilities across our product portfolio. As a result of our strategy and execution, we're confident in our ability to attract new users and deliver value to existing customers to drive growth and profitability. I'd like to thank our 30,000 employees for their continued dedication and unwavering focus on innovation and execution. It is particularly exciting to be named to Glassdoor's Best Places to Work, Fortune's Most Admired Companies, and he JUST 100. Thank you, and we will now take questions. Operator?
Operator: Thank you. [Operator Instructions] Our first question comes from the line of Kirk Materne with Evercore ISI. Go ahead.
Kirk Materne: Yeah. Thanks. Thanks very much for taking the question. I guess maybe this is for David or Dan. Obviously, you guys called out that new creative ARR was up more than 20% year-over-year when you exclude the pricing increases which infers a pretty major pricing headwind that we're seeing right now. Can you all just try to parse out how that's going to play out over the year? I know David you mentioned ARR will go up in the back half of the year, but that it’s just tough I think to reconcile what's going on in the business on a normalized basis, and when we might see that sort of translate more into the metrics that everybody follows. Thanks.
Dan Durn: Yeah. I'll start and others can go ahead and add on. First of all, we do -- as we look at the book of the business, it is a strong start to the year with Q1 coming in at a high watermark with $432 million across the entire business. As we look specifically at Creative Cloud, I just want to sort of make sure everyone takes a step back and looks at our strategy to accelerate the business because I think the growth drivers here are very clear. We are focused on expanding access to users with things like Express on mobile. We want to introduce new offers across the business with things like AI Assistant and also existing capabilities for Firefly coming into our core Firefly, our core Photoshop and Illustrator and flagship applications. We want to access new budget pools with the introduction of Firefly Services and GenStudio as we talked about. And the early signs, as you point out in Q1 results are really suggesting that those growth drivers are taking hold. As you talked about normalizing for FY '23, FY '24 pricing actions, we grew the CC business about 20% year over year. Other key things to look at is that we set another record for new commercial subscriptions in Q1, and the business growth remains stable at -- if you look back at revenue 12% -- if you look forward at ARR 12%. So the stability and the diversity of the business is strong. And as we enter the back half of the year, we have capabilities for Creative Cloud pricing with Firefly that have already started rolling out late last year, as we talked about, and we'll be incrementally rolling out throughout the year. We're ramping Firefly Services and Express and Enterprise. As we talked about, we saw a very good beginning of that rollout at the -- toward the end of Q1. We also expect to see the second half ramping with Express Mobile and AI Assistant coming through. So we have a lot of the back-end capabilities set up so that we can start monetizing these new features which are still largely in beta starting in Q3 and beyond. And as it relates to pricing, it's what we've talked about in the past. We had two pretty significant pricing actions that benefited FY '23, the first one being the Acrobat price increases that we had put out with the new value that we had introduced with sign capabilities, and also a CC price increase that we introduced in FY '22 that was rolling into FY '23. Both of those are rolling off as we have now introduced the new pricing for CC with Firefly, and overall, the roll-off of the prior pricing is more significant than the new pricing that we've introduced.
Kirk Materne: Thanks.
Operator: And we will take our next question from Brent Thill with Jefferies. Please go ahead.
Brent Thill: Thanks. Shantanu, the magnitude of the beat this quarter was -- there was roughly half the absolute beat you've had in past quarters and then the guide obviously, lower for next quarter. I think everyone is asking is this some type of AI headwind? Is this macro? Is this execution? Can you just comment on -- and maybe it's none of these things, but can you just comment on what you think you're seeing in the current quarter?
Shantanu Narayen: Yeah. Happy to, Brent. And again, I'll reiterate that as it relates to us taking our targets pretty seriously. I mean, when we guided to $1.9 billion for the year, I mean, we had factored in both, as David mentioned, what was likely to happen in the pricing and how that rolls off, as well as the product roadmap, and when AI Assistant and Acrobat would be available, when Express, which is now in beta, would be available. So I think it factored in all of those. I guess if you are looking at it from accomplishment, we look at it and say hey, we did $410 million. I think last year we did $432 million. If we look at the guide and we're on track as it relates to the $1.9 billion, and to hopefully exceed that guide. And so from our perspective, it's playing out. Maybe the other color, Brent, that I would provide is given the desktop products are still in beta, and there we look at value and there we look at utilization. And so I think we gave you some numbers on the $6.5 billion generations that we're seeing, the really positive feedback that we're getting in Acrobat that continue to give us optimism associated with how that is. I think where there's tremendous interest and where if you look at it from an AI monetization, the two places that we're monetizing extremely in line with our expectations. The first is as it relates to the Creative Cloud pricing that we've rolled out. And as you know, the generative packs are included for the most part in how people now buy Creative Cloud, that's rolling out as expected. And the second place, where we are monetizing it is in the entire enterprise as it relates to Content and GenStudio. And I'm really happy about how that's monetizing it. I mean, that's a combination, Brent, of when we go into an enterprise for creation, whether we provide Creative Cloud or a combination of Express, what we are doing with asset management in AEM, workflow, as well as Firefly Services to enable people to do custom models as well as APIs. We're seeing way more monetization earlier, but again, very much in line with expected. So again, I look at the quarter and I feel really good, both about the product delivery as well as the way monetization is turning out. I mean, it's clear, I guess, a little bit from sort of what we've seen that expectations were perhaps a little higher, both in terms of what we would guide for Q2, but I'm really optimistic about what we have done.
Brent Thill: Thanks, Shantanu.
Operator: Your next question comes from the line of Brad Zelnick with Deutsche Bank.
Brad Zelnick: Great. Thanks so much for taking my question. My question is for Dan. You're not raising the full-year guide, and I appreciate it's still early in the year, but I think we're all hoping you can at least affirm it for us. But you also -- you pushed out the enforcement of generative credit limits for some products beyond April that were originally expected sooner. What's the thinking behind this decision? And what are you seeing thus far in terms of credit consumption and purchasing patterns of those credit packs? Thanks.
Dan Durn: Yeah. Thanks, Brad. I'll jump in on the first part, then toss it over to David for the second. So we're not updating the targets. What the targets we provided for the full year, they're, as of the December call. What we did share on the call was the material change that we saw in Q1 as a result of the Figma termination payment. We talked about the GAAP EPS impact. It rolls through Q1 and it'll certainly have an effect for the full year. And it's $2.19 as a result of the $1 billion payment. And I think with that, I think you have everything you need relative to where we set our targets, but we're not going to be updating them on this call.
David Wadhwani: Yeah. And I'm happy to add a little bit. Yeah, in terms of the timing of the -- when we start enforcing credits, don't read anything into that other than right now, we are still very much in an acquisition mode. We want to bring a lot of users in. We want to get them using the products as much as possible. We want them coming back and using it. One thing I do want to state because I know there's a lot of energy around how do these credits play out over time. In the last few weeks, we've done a couple of sneaks that could also be instructive. Last month, we snuck music composition, where you can take any music track, you can give it a music type like hip hop or orchestral or whatever, and it will transform that initial track into this new type of music. Just this morning, we snuck our ability to do auto dubbing and lip-syncing, where you give it a video of someone talking and saying English, and then you can translate it automatically to French or Spanish or Portuguese or whatever. As you can imagine those actions will not take one credit. Those actions will be much more significant in terms of what they cost. So right now, Alex, the primary point is about proliferation and usage. We're going to be bringing in a lot more new capabilities throughout the tools that will drive more usage, and we're going to be bringing in more expensive capabilities as well. And as we've talked about, you should start to see that ramp through the year, and we feel very comfortable with the adoption we're seeing. Just one last thing to call out, as we mentioned on the call, highest number of users using generative AI in Q1 ever so we're very excited about the trajectory.
Shantanu Narayen: And maybe just to add a little bit more of how we're thinking about it as it relates to the monetization of AI. I think we're in early stages as it relates to experimentation. So we're looking at both what the value utilization is as well as experimentation. The value utilization is actually really positive for us. I think, as it relates to the monetization and the experimentation, we have the generative packs, as you know, in Creative Cloud. I think you will see us more and more have that as part of the normal pricing and look at pricing because that's the way in which we want to continue to see people use it. I think in Acrobat, as you've seen, we are not actually using the generative packs. We're going to be using more of an AI Assistant model, which is a monthly model. As it relates to the Enterprise, we have both the ability to do custom models, which depends on how much content that they are creating, as well as an API and metering that we've rolled that out and we've started to sell that as part of our GenStudio solution. So I think it's fair to say, and I certainly monitor what everybody else in the industry is saying. The good news about this is the interface integration that we've done in all our apps and the utilization, and I think the experimentation will enable us to determine how we best attract the largest number of customers that we can who are new to Creative Cloud. We've talked about that as it relates to Firefly attracting new customers. Certainly, I think the number of Q1 commercial subscriptions was another record. So we're absolutely doing everything that we intended to experiment as we roll this out, Brad. So I wanted to accentuate that as well.
Brad Zelnick: Thank you so much. Very helpful.
Operator: Your next question comes from the line of Michael Turrin with Wells Fargo Securities. Please go ahead.
Michael Turrin: Hey, great. Thanks. I appreciate you taking the question David, couldn't help but notice you led off your prepared remarks section with the Document Cloud. Can you speak to the enthusiasm you're seeing on the document side? And when we think about the mix of Digital Media growth for the year, should we expect it will continue to trend towards that Document side? Or is it more the second half where some of the creative enhancements start to layer on more meaningfully we could start to see that shift back a bit? Thanks.
David Wadhwani: Yeah. Happy to talk about that. We were very -- and continue to be very happy with the performance of Document Cloud. If you really look at trying to understand sort of how that plays out Document Cloud, the growth is a combination of both our go-to-market efforts and our product innovation. On the go-to-market effort side, think about the fact that Reader continues to be a top-of-funnel for us and we continue to see Reader monthly active user growth. So the potential of people we can convert over to paid subscribers continues to grow. We also talked about the fact that Acrobat Web has been a major contributor to our growth. So we're seeing 70% year-over-year growth in terms of Web MAU, and we crossed 100 million monthly active users for the first time on the website. And of course, we're doing a lot of work with product-led growth to drive the Journey users to some of that value that drives conversion. So that's all we're doing on the go-to-market side. On the side of product innovation, our strategy over the last couple of years has been to make PDF the starting point of a workflow, right? And so that's why we integrated Sign directly into that so that people could use their PDFs and start a transaction for their business. And that continues to grow very nicely, and it's a great selling point for an integrated service. We also introduced link sharing a few years ago for commenting and reviewing with groups and teams. We saw that link sharing grow 300% year-over-year so that's a huge point of value, but it's also a huge point of viral growth. That's also what when someone receives that, it's another opportunity for us to bring them into the value of the broader offering. And you can expect to see that with AI Assistant as well. So obviously, everyone is looking at AI Assistant in Acrobat. I certainly hope all of you are using it, should make your lives more effective. Not just for insight. We think that there's a lot of opportunity for monetization of insight for AI Assistant on our core base of Acrobat users, but also for the first time doing consumption-based value. So the hundreds of millions of monthly active users of Reader will also be able to get access to AI Assistant and purchase an add-on pack there too. So it's a really broad base to look at how we monetize that, but it's also the start of the ability to take your conversation and generate emails and presentations and continue that process. So the combination of all of that is a really potent combination of go-to-market efforts and product innovation. So we continue to be bullish about this. So the second part of your question, we are -- as we've said multiple times on the call, we are very excited about all the innovation that's coming out that's just starting to ramp in terms of monetization and/or still in beta on the Creative Cloud side. We expect that to come out in Q3 and we'll start our monetization there. So we continue to feel very confident about the second half acceleration of Creative Cloud.
Michael Turrin: I appreciate all the details there. Thank you.
Operator: Your next question comes from the line of Saket Kalia with Barclays.
Saket Kalia: Okay. Great. Hey, guys, thanks for taking my question here. Maybe for both David and Shantanu. Clearly, a lot of news around video creation using generative AI during the quarter, of course, with the announcement of Sora. Maybe the question for you folks is, can we just talk a little bit about how you think about the market impact that generative AI can have in the video editing market and how maybe Firefly can participate in that trend?
Shantanu Narayen: Sure. Saket. I mean, I'll start and then David can add. I mean, firstly, I think the advances, whether it's in OpenAI or our own models that certainly, David and I have the pleasure of looking at on a weekly basis, the advances are amazing because you have to -- when you're thinking about video solve some other fundamental problems like physics, right, I mean, if you have somebody walking on a street, how do you make sure that they don't go through a building or go through the floor? And so I think some of those video advancements that we have seen within Adobe have really addressed some of those hard problems. A big picture, though, video I think will be even more of an accelerant for editing applications. I think this notion that the next Oppenheimer will be done using a text-to-video prompt is just -- it's not going to happen for decades. And so I think actually more so in video, there's going to be an accelerant for people saying how do I get an on-ramp as it relates to using text to video and then edit that using our applications. And so I think I'm really particularly excited about what we can do with premiere as well as with After Effects as it relates to video. So net-net, I would say, Saket, the technology is impressive. We have our models, we have integrated into our interfaces. We're also partnering. I had a really great conversation with Jensen recently about what we can do as they are investing in video. Certainly, he would love to partner with us, and we're looking together to see how we can push the envelope on video as well using their models, whether it's Edify or Nemo. And so I think really early days, we're seeing a whole bunch. I hope -- and David mentioned this look at some of the lip sync stuff that we've done as well, which allows you to auto-dub and translate into languages. So we intentionally released a little bit of that demo. So really great advances. But net-net video is going to be even more of a need for editing applications in order to truly take advantage of generative AI.
David Wadhwani: Yeah. And maybe I'll just add a few things. First of all, as Shantanu mentioned, the research in the industry and certainly with Sora is very impressive and exciting. It's also very consistent with the models that we're developing. So we think that there is -- there will be, as there was with video -- sorry, imaging, there will be multiple models that come out, including the Adobe model later this year, and we should start to see a lot of innovation there like we've seen in imaging. We've already started to sneak a couple of things that Shantanu talked about. So you will see text-to-video capabilities from us later this year. But you'll also see it with transparency around the training data that we have, you'll see it with more tool ability and controllability. You'll see it integrated into our tools as well. Now, all of that said, I do want to be very clear with what Shantanu said, which is that we see the proliferation of video models to be a very good thing for Adobe. And we're going to work with OpenAI around Sora. You're going to see us obviously, developing our own model. You're going to see others developing model. All of that creates a tailwind because the more people generate video clips, the more they need to edit that content, right? So whether its Premiere or After Effects, or Express, they have to assemble those clips, they have to color-correct those clips, they have to tone match, they have to enable transitions. So we're excited about what we're building, but we're just as excited about the partnerships that we see with OpenAI and others coming down this path. And if you take a step back, you should expect to see more from us in the weeks ahead with imaging and vector and design, text effects, and in the months ahead with audio and video and 3D. We're very excited about what all of this means, not just for the models, but also for our APIs and our tools.
Saket Kalia: Super helpful. Thanks.
Operator: Your next question comes from the line of Alex Zukin with Wolfe Research. Please go ahead.
Alex Zukin: Hey, guys. Thanks for taking the question. And I just -- mine is going to be more of a clarifying question because it's clear that from a number of comments, whether it's outperforming Digital Media ARR in the quarter to accelerating Creative ARR in the second half to maybe doing better than $1.9 billion in the full year for Digital Media ARR. My question is very simple. Can you reiterate -- not update, but reiterate the guide that you gave in December for Digital Media ARR in net news specifically for this year, and maybe puts and takes around how we should think about to the question earlier, the second half versus first half tailwind, headwind around pricing?
Shantanu Narayen: Yeah. So we take our guide seriously. Q1 played out as expected. It was ahead of where we were last year. Our Q2 guide is ahead of where the guide was in Q2. We're talking about acceleration into the back half of the year. If I didn't feel like our full-year guide was achievable, we would have a different conversation. We're confident in the targets that we put out there, our ability to meet them. If there's an opportunity to do better, we certainly will. So we feel good about where we sit in the first half. And as we look forward into the second half, the momentum we see from an innovation standpoint integrating into our products, what we see going from beta to GA, we feel good about the momentum into the second half.
Alex Zukin: Perfect. Thank you, guys.
Operator: And your next question comes from the line of Karl Keirstead with UBS. Go ahead.
Karl Keirstead: Thank you. Dan, maybe I'll continue with this subject that Alex was getting at. So I think what's tough about modeling ARR of late is it's very difficult to see the impact of the price actions. It feels like a black box to us. So I'm wondering if you could help us get aligned for the second half, and offer some qualitative color on the extent to which the prior period price actions roll off. Is that more of a 3Q or 4Q phenomenon? Is there any way you could help size that impact, just to feel good about David's earlier comment about that roll-off being a big part of the second-half ARR acceleration? Thank you.
Dan Durn: Yeah. So there was two pricing actions that we had taken in 2022. In May of 2022, we pushed forward a pricing action, and then October of 2022, we pushed forward the Doc Cloud line optimization, where we integrated Sign. The one-year anniversary of those pricing actions from May of 2022 and October of 2023, or -- I'm sorry, October of 2022 will be behind us on the one year anniversary. So you will still see some Q3 impact from pricing actions in the year-ago period. Q4 will be a clean look for the company, at least two months in Q4 will be a clean look. The actions that we're taking right now from both a pricing and a product standpoint on the Creative side will be more apparent in the back half of the year into the end of the year.
Karl Keirstead: Okay. That's helpful.
David Wadhwani: I think the other way I would look at it, honestly -- sorry, go ahead.
Dan Durn: Go ahead, David.
David Wadhwani: Well, the way I would look at it, in terms of the rhythm of the numbers and how you've seen sort of what transpired in 2023, and how we look at 2024, and the path to $1.9 billion and beyond, the way I would look at it is we're ahead in Q1. We're ahead in Q1. We're giving you all the reasons why we think there's more product coming and more monetization coming in the rest of the year. And that's what gives us the confidence associated with the targets. I guess there's this question of every quarter, do we reiterate targets? Do we update targets? What does that mean? And the way we've always thought of it is, if it was a way -- if we didn't have confidence, we would give you that. We have confidence associated with the numbers, but we're not in the business of every quarter, looking at every number. And let's go down one other number, which was the GAAP EPS. Certainly, there's an impact, as you know, in the GAAP EPS associated with what we did as it related to the Figma sort of transaction, and therefore the impact to GAAP EPS in Q1. So I think, from my perspective, the quarter and the year is playing out just as we did, and I feel more confident now than I did when we gave you our annual targets. I'll leave it at that.
Karl Keirstead: Yeah. We got it. Thank you.
Operator: And we will take our next question from the line of Jay Vleeschhouwer with Griffin Securities.
Jay Vleeschhouwer: Thank you. Good evening. And with respect to Firefly, it's obvious that you are significantly ramping up your investments there, at least judging by the number of relevant open positions you're looking to fill for Firefly development, many of which are seemingly fairly senior. Could you comment on your pipeline of being able to bring in the requisite amount of developmental capacity to support everything you're doing with Firefly and everything else that David in particular talked about? And relatedly, on go-to-market in the last few months, you've been opening up the aperture for sales positions globally. Could you comment on what the thinking is behind that? And again, whether the population is there for you to bring in to meet your sales headcount needs? Thank you.
David Wadhwani: Yeah. Let me take the first one and then Anil can answer the question on sales. As it relates to the momentum we're seeing with Firefly, I think there are multiple layers of it. One is obviously, we're seeing the quality of the models. We're seeing a differentiated approach as it relates to the training data, as it approaches contribution of assets from our community and how we compensate those folks. And so that's not just an Adobe perspective, but it's playing out obviously, in enterprises as they look at what are the models that they can consider using for production workflows. We're the only one with the full suite of capabilities that they can do. It's a really unique position to be in, but it's also being noticed by the research community, right? And as the community starts looking at places as if I'm a PhD that wants to go work in a particular environment, I start to ask myself a question of which environment do I want to pick. And a lot of people want to do AI in a responsible way. And that has been a very, very good opportunity for us to bring in amazing talent. So we are investing. We do believe that we have the best -- one of the best, if not the best, research labs around imaging, around video, or around audio, around 3D, and we're going to continue to attract that talent very quickly. We've already talked about we have the broadest set of creative models for imaging, for vector, for design, for audio, for 3D, for video, for fonts and text effects. And so this gives us a broad surface area to bring people in. And that momentum that starts with people coming in has been great. The second part of this too is managing access to GPUs while maintaining our margins. We've been able to sort of manage our cost structure in a way that brings in this talent and gives them the necessary GPUs to do their best work.
Anil Chakravarthy: And regarding the sales positions in Enterprises. In Enterprise, we're in a strong position because what we -- I mean, this area of customer experience management, it remains a clear imperative for Enterprise customers. Everybody is investing in this personalization at scale, and current supply chain. These help drive both growth and profitability. So when you look at these areas, these from an enterprise perspective, these are a must-have. This is not a need to have. And that's helping us really attract the right kind of talent. We just onboarded this week a VP of Sales who have prior experience and a lot of experience in Cisco and Salesforce, etc. So that's an example of we're really bringing on some excellent enterprise sales talent.
David Wadhwani: And I don't know if Jay, you were asking for -- building your model, or if you were looking for a job? But if you're interested in any of these positions, let us know more.
Jay Vleeschhouwer: More the former.
David Wadhwani: Okay.
Jonathan Vaas: Hey, operator, we're coming up on the hour. Let's try to squeeze in two more questions. Thanks.
Operator: Thank you. We will take our next question from Kash Rangan with Goldman Sachs.
Kash Rangan: Hey, thank you very much. Looks like there is more trust in AI and Excel models than what you're actually saying qualitatively on this call. I just wanted to give you an opportunity to debunk this hypothesis that is going around, that AI, it is generating videos and pictures, but the next step is it's going to do the actual editing and put out Premiere Pro use or whatnot. So that is probably the existential threat that people are debating. So why don't you see if we could take a shot at why that scenario is very unlikely that right now it's about generation of images and then your tools pick up where the generation stops and you do the processing, right? So help us understand why this can coexist with AI. That's a philosophical question. And Dan, one for you. Besides the net new ARR that you've already reported on Creative and DM, what are the other indicators such as new business bookings that you don't quantify necessarily that you qualitatively saw in Q1 that makes you feel good about the year? Thank you so much.
David Wadhwani: Great. So maybe I'll take your first part, and Dan obviously, can take the second. So as it relates to generated content, I'm going to sort of break it up into two parts. One is around the tooling and how you create the content, and the second is around automation associated with the content. I think if you take a step back before we even get into either one of those, there is no question that there's a huge appetite because of personalization at scale, the need to engage users, the need to build your personal brand online. That content is going to explode in terms of the amount of content being created, and it's going to explode because of one of two things. The first is around the ability to create audio clips, video clips, images, vectors. These are things that get users started. It's a great for ideation. You'll see in a few weeks that some of the incredible work the team has been doing around ideation on Firefly.com. And once those things are created, they do flow into our tools for the production, work and process. We're clearly seeing a huge benefit from that because the more content that gets created, the more editing that's required, and that's what's driving more commercial CC subscribers this quarter than any other Q1 before. So that's the foundation of it. The second part of this, though, from an editing perspective is the controllability of -- and the editability of not just pixels and vectors and timelines, but also the editability of the latent space itself. The latent space being the core capability -- core model capabilities that actually generate the output. We have a lot of research that we've already started releasing, the first of which was Style Match, and you'll start to see more and more of that actually coming out at summit and beyond. But we are, in my mind, very, very clearly the leader in terms of creating models that can also be tooled on top of. So that combination of the models getting better and the controllability of those models, we're in a remarkable position for that. So we benefit from that. The second part, Kash, is around automation. So as people are generating more content, you clearly need to be able to automate that content and how it's created. And that's really where Firefly Services come in. First, it's built on the strength of our Firefly models, say for commercial use integrated into our tools, but it also adds the ability to have custom models so control what kinds of information or brand and content it's trained on for both brand styles and product replica, and it's also part of an ecosystem of API services, not just generate something which is a core part of it like text to image, or Generative Fill or Generative Expand, but also process. So once you generate some images through APIs and automation, you want to be able to remove the background, you want to be able to blur the depth, you want to auto tone, you want to apply actions to that image. And then the last is you want to be able to assemble that for delivery. Firefly services don't just generate something, but they let you have that entire ecosystem, and then you can embed that using low code, no code environments into your flows, and we are already embedding it into GenStudio and all of the capabilities that we're shipping. So I think the core part of this is that as more of this content creates, you need more tool ability. The best models are going to be the models that are safe to use and have control built in from the ground up. And I think we have the best controls of anyone in the industry, and they need to be able to be done in an automated fashion that can embed into your workflow. So I think all three of those vectors point to benefits for Adobe.
Kash Rangan: That's very convincing.
Dan Durn: And then as we think about the forward-looking, a couple of points I would turn to, just think about cash flow in Q1. Strength of our cash flow, once you normalize for the $1 billion termination payment, that's up 28% year-over-year. When you think about RPO, 3 point acceleration sequentially, and when I break that up on deferred revenue, unbilled backlog, you saw that acceleration in each of those subcomponents, which as you look through that acceleration, the near-term underscores the strength of the business and it underscores the longer term strength we have around the momentum of the business. When I think about individual product commentary, we talked about it a lot on this call. You see record commercial subscriptions in the Creative business. In Q1, you see engagement going up on the products. Usage of Firefly capabilities in Photoshop was at an all-time high. In Q1, Express exports more than doubling with the introduction of Express Mobile in beta now going to GA in the coming months, AI Assistant Acrobat, same fact pattern. You can see that momentum as we look into the back half of the year. And from an enterprise standpoint, the performance in the business was really, really superb in Q1, strongest Q1 ever in the enterprise. So there's a lot of fundamental components that we're seeing around performance of the business that give us confidence as we look into the back half of the year.
Kash Rangan: Super. Thank you so much, Dan.
Operator: We'll take our next question from Keith Weiss with Morgan Stanley. Please go ahead.
Keith Weiss: Excellent. Thank you, guys, and I appreciate you squeezing me in. I'm going to take one last crack at this. Shantanu and team, we definitely, hear your confidence in the business, but obviously, the stock market reactions reflecting investors are worried about something. And the two things that worry investors more so than anything is uncertainty number one, and number two is back half ramps, right? And so I think what investors would really love to hear is Dan Durn actually say we still expect to do $1.9 billion in net new Digital Media ARR, and get some certainty there, and then also have a little bit more certainty or a little bit more explanation of what are the building blocks to that second half ramp? Which products are expected to go GA? Are we including stuff like document intelligent -- intelligence? Is there new monetization avenues that we're putting into the back half? Or is there just some mechanism within sort of the Creative Cloud pricing that's going to turn on in the back half of the year? Any further specifications in there, I think would help sort of close the gap between your confidence and sort of the lack of confidence exhibited by the after-hour reaction.
Shantanu Narayen: And let me tackle that, Keith, and maybe I'll just tackle it by taking a couple of the other questions as well, summarizing that and ending with your question associated with the financial results. I think the first question that I hear across many folks is, hey, with the advent of AI and the increase in the number of models that people are seeing, whether they be image models or video models, does that mean that the number of seats, both for Adobe and in the world, do they increase or do they decrease? To me, there's no question in my mind that when you talk about the models and interfaces that people will use to do creative content, that the number of interfaces will increase. So Adobe has to go leverage that massive opportunity. But big-picture models will only cause more opportunity for interfaces, and I think we're uniquely qualified to engage in that. So that's the first one. The second one, I would say, is that does Adobe innovate, and when we do that, do we only leverage the Adobe model, or is there a way in which we can leverage every other model that exists out there? Much like we did with plugins, with all of our Creative applications, any other model that's out there, we will certainly provide ways to integrate that into our application. So anybody who is using our application benefits not just from our model creation, but from any other model creation that's out there. The way we first started to execute against that is in the enterprise because for us, the enterprise and the ability to create custom models so people can tweak their models to be able to do things within Photoshop that are specific to a retailer or a financial service was where we focus. But long term, certainly, as I've said with our partnerships, we will have the ability for Adobe in our interfaces to leverage any other model that's out there, which again, further expands our opportunity. I think as we play out the year, when we gave our targets for the $1.9 billion in ARR and the $410 million in Digital Media ARR for Q1, it factored in both our product roadmap and how things would evolve in the year. All of the product roadmaps we knew whether it was Acrobat, whether it was Express, whether it was Firefly, whether it was Creative Cloud, or whether it's GenStudio that brings all of these together, we knew the product roadmap, which we're executing against. In the first half of the year, a lot of that was beta, and in the second half of the year, a lot of that's monetization. It's playing out as expected. If anything, I would say the excitement around that, and in particular, the enterprise is faster than expected. And so I think our ability to monetize it just -- not just through new seats but also through these new Firefly services is expanded as it relates to what we are doing. And then as it relates to your question around financial results and the go-forward execution, we gave a Q1 target, we beat the Q1 target. And that gives us confidence that the financial target that we gave at the beginning of the year, we're ahead of that. And that's how I'll play it out. You're right. You have to model it. You can look at last year's model and look at last year's model and say, hey, they got to $1.913 billion. If they're ahead, does that fundamentally change Adobe's thesis on why we get to $1.9 billion and beyond, and in my mind it doesn't. And so that's the way I would answer that question. We have to go execute against the opportunity that we have. I look forward to those who are at Summit. I'm sure we'll have a little bit more conversation. But Q1 was a strong start. It was a strong start against product execution. It was a strong start against the financial metrics that we outline, and we're going to go do it again, Keith. So that's how I'd answer your question. So thank you all for joining.
Keith Weiss: Excellent. That's super helpful.
Shantanu Narayen: And with that, I'll hand it back to Jonathan.
Jonathan Vaas: All right. Thanks, everybody. I look forward to speaking with many of you soon. And this concludes the call. We look forward to seeing you at Summit. |
AVGO | 1 | 2,024 | 2024-03-07 22:18:06 | Operator: Hello, and welcome to Broadcom's Inc. First Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, for opening remarks and introductions, I will turn the call over to Ji Yoo, Head of Investor Relations of Broadcom Inc. You may begin.
Ji Yoo: Thank you, operator, and good afternoon, everyone. Joining me on today's call are Hock Tan, President and CEO; Kirsten Spears, Chief Financial Officer; and Charlie Kawwas, President, Semiconductor Solutions Group. Broadcom distributed a press release and financial tables after the market closed, describing our financial performance for the first quarter of fiscal year 2024. If you did not receive a copy, you may obtain the information from the Investors section of Broadcom's website at broadcom.com. This conference call is being webcast live and an audio replay of the call can be accessed for one year through the Investors section of Broadcom's website. During the prepared comments, Hock and Kirsten will be providing details of our first quarter fiscal year 2024 results, guidance for our fiscal year 2024 as well as commentary regarding the business environment. We'll take questions after the end of our prepared comments. Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. In addition to U.S. GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results. I'll now turn the call over to Hock.
Hock Tan: Thank you, Ji, and thank you, everyone, for joining us today. In our fiscal Q1 2024, consolidated net revenue was $12 billion, up 34% year-on-year as revenue included 10.5 weeks of contribution from VMware. Excluding VMware, consolidated revenue was up 11% year-on-year. Semiconductor solutions revenue increased 4% year-on-year to $7.4 billion, and infrastructure software revenue grew 153% year-on-year to $4.6 billion. With respect to infrastructure software, revenue contribution from consolidating VMware drove a sequential jump in revenue by 132%. We expect continued strong bookings at VMware will accelerate revenue growth through the rest of fiscal 2024. In semiconductors, AI revenue quadrupled year-on-year to $2.3 billion during the quarter, more than offsetting the current cyclical slowdown in enterprise and telcos. Now let me give you more color on our two reporting segments. Starting with software. Q1, software segment revenue of $4.6 billion was up 156% year-on-year and included $2.1 billion in revenue contribution from VMware. Consolidated bookings in software grew sequentially from less than $600 million to $1.8 billion in Q1 and is expected to grow to over $3 billion in Q2. Revenue from VMware will grow double-digit percentage sequentially, quarter-over-quarter, through the rest of the fiscal year. This is simply a result of our strategy with VMware. We are focused on upselling customers, particularly those who are already running their compute workloads with vSphere virtualization tools to upgrade to VMware Cloud Foundation, otherwise branded as VCF. VCF is the complete software stack, integrating compute, storage and networking that virtualizes and modernizes our customers' data centers. This on-prem self-service cloud platform provides our customers a complement and an alternative to public cloud. And in fact, on a VM Explore last August, VMware and NVIDIA entered into a partnership called VMware Private AI Foundation, which enables VCF to run GPUs. This allows customers to deploy their AI models on-prem. And wherever they do business without having to compromise on privacy and data -- in control of their data. And we are seeing this capability drive strong demand for VCF, from enterprises seeking to run their growing AI workloads on-prem. And reflecting all these factors for the full year, we reiterate our fiscal 2024 guidance for software revenue of $20 billion. Turning to semiconductors. Before I give you an overall assessment of this segment, let me provide more color by end markets. Q1 networking revenue of $3.3 billion grew 46% year-on-year, representing 45% of our semiconductor revenue. This was largely driven by strong demand for our custom AI accelerators at our 2 hyperscale customers. This strength extends beyond AI accelerators. Our latest generation Tomahawk 5 800G switches saw through Ethernet mix refinements, DSPs and optical components are experiencing strong demand at hyperscale customers as well as large-scale enterprises deploying AI data centers. For fiscal 2024, given continued strength of AI NAND working demand, we now expect networking revenue to grow over 35% year-on-year compared to our prior guidance for 30% annual growth. Moving on to wireless. Q1 wireless revenue of $2 billion decreased 1% sequentially and declined 4% year-on-year representing 27% of semiconductor revenue. As you all may know, the engagement with a North American customer continues to be very deep strategic and, of course, multiyear. And in fiscal 2024, helped by content increases, we reiterate our previous guidance for wireless revenue to be flat year-on-year. Next, our Q1 server storage connectivity revenue was $887 million or 12% of semiconductor revenue, down 29% year-on-year. We are seeing weaker demand in the first half, but expect recovery in the second half. Accordingly, we are revising our outlook for fiscal '24 server storage revenue to decline in the mid-20 percentage range year-on-year compared to prior guidance for high teens percent decline year-on-year. On broadband, Q1 revenue declined 23% year-on-year to $940 million and represented 13% of semiconductor revenue. We are seeing a cyclical trough this year for broadband as telco spending continues to weaken and do not expect improvement until late in the year. And accordingly, we are revising our outlook for fiscal '24 broadband revenue to be down 30% year-on-year from our prior guidance of down mid-teens year-on-year. And finally, Q1 industrial resales of $215 million declined 6% year-on-year. In fiscal '24, we continue to expand industrial resales to be down high single digits’ year upon year. And in summary, with stronger-than-expected growth from AI more than offsetting the cyclical weakness in broadband and server storage, Q1 semiconductor revenue grew 4% year-over-year to $7.4 billion. Turning to fiscal '24. We reiterate our guidance for Semiconductor Solutions revenue to be up mid- to high single-digit percentage year-on-year. I know we told you in December, our revenue from AI would be 25% of our full year semiconductor revenue. We now expect revenue from AI to be much stronger, representing some 35% of semiconductor revenue at over $10 billion. And this more than offset weaker-than-expected demand in broadband and service storage. So for fiscal 2024 in summary, we reiterate our guidance for consolidated revenue to be $50 billion, which represents 40% year-on-year growth. And we reiterate our full year adjusted EBITDA guidance of 60%. Before I turn this call over to Kirsten, who will provide more details of our financial performance this quarter, let me just highlight that Broadcom recently published its fourth annual ESG report available on a corporate citizenship side, which discusses the company's sustainability initiatives. As a global technology leader, we recognize Broadcom's responsibility to connect our customers, employees and communities. Through our product and technology innovation and operational excellence, we remain committed to this mission. Kirsten?
Kirsten Spears: Thank you, Hock. Let me now provide additional detail on our Q1 financial performance, which was a 14-week quarter and included 10.5 weeks of contribution from VMware. Consolidated revenue was $12 billion for the quarter, up 34% from a year ago. Excluding the contribution from VMware, Q1 revenue increased 11% year-on-year. Gross margins were 75.4% of revenue in the quarter. Operating expenses were $2.2 billion and R&D was $1.4 billion, both up year-on-year primarily due to the contribution from VMware. Q1 operating income, including VMware, was $6.8 billion and was up 26% from a year ago, with operating margin at 57% of revenue. Excluding transition costs of $226 million in Q1, operating profit of $7.1 billion was up 30% from a year ago, with operating margin of 59% of revenue. Adjusted EBITDA was $7.2 billion or 60% of revenue. This figure excludes $139 million of depreciation. Now a review of the P&L for our two segments, starting with Semiconductor. Revenue for our Semiconductor Solutions segment was $7.4 billion and represented 62% of total revenue in the quarter. This was up 4% year-on-year. Gross margins for our semiconductor solutions segment were approximately 67%, down 190 basis points year-on-year driven primarily by product mix within our semiconductor end markets. Operating expenses increased 8% year-on-year to $865 million, reflecting a 14-week quarter resulting in semiconductor operating margins of 56%. Now moving on to our infrastructure software segment. Revenue for infrastructure software was $4.6 billion, up 153% year-on-year, primarily due to the contribution of VMware and represented 38% of revenue. Gross margins for infrastructure software were 88% in the quarter, and operating expenses were $1.3 billion in the quarter, resulting in infrastructure software operating margin of 59%. Excluding transition costs, operating margin was 64%. Moving on to cash flow. Free cash flow in the quarter was $4.7 billion and represented 39% of revenues off a higher revenue base. Excluding restructuring and integration spend of $658 million free cash flows were 45% of revenue. We spent $122 million on capital expenditures. Days sales outstanding were 41 days in the first quarter compared to 31 days in the fourth quarter on higher accounts receivable due to the VMware acquisition. The accounts receivable we brought on from VMware has payment terms of 60 days unlike Broadcom standard 30 days. We ended the first quarter with inventory of $1.9 billion, up 1% sequentially. We continue to remain disciplined on how we manage inventory across the ecosystem. We ended the first quarter with $11.9 billion of cash and $75.9 billion of gross debt. The weighted average coupon rate and years to maturity of our $48 billion in fixed rate debt is 3.5% and 8.4 years, respectively. The weighted average coupon rate and used to maturity of our $30 billion in floating rate debt is 6.6% and three years, respectively. During the quarter, we repaid $934 million of fixed rate debt that came due. This week, we repaid $2 billion of our floating rate debt, and we intend to maintain this quarterly repayment of debt throughout fiscal 2024. Turning to capital allocation. In the quarter, we paid stockholders $2.4 billion of cash dividends based on a quarterly common stock cash dividend of $5.25 per share. We executed on our plan to complete our remaining share buyback authorization. We repurchased $7.2 billion of our common stock and eliminated $1.1 billion of common stock for taxes due on vesting of employee equity, resulting in the repurchase and elimination of approximately 7.7 million AVGO shares. To help you with modeling share count, the weighted effect of the 54 million shares issued for the VMware acquisition resulted in a sequential increase in Q1 to $478 million. With the Q2 non-GAAP diluted share count expected to increase to approximately $492 million as the shares issued are fully weighted in the second quarter. Now on to guidance. Regardless of the updated dynamics of our semiconductor and software segments as Hock discussed, we choose to reiterate our guidance for fiscal year 2024 consolidated revenue of $50 billion and adjusted EBITDA of 60%. With regard to VMware, in February, we signed a definitive agreement to divest the end-user computing division with the transaction expected to close in 2024, subject to customary closing conditions, including regulatory approvals. The EUC division has been classified as discontinued operations in our Q1 financials. We have decided to retain the Carbon Black business and merge Carbon Black with Symantec to form the enterprise security group. The impact on revenue and profitability is not significant. That concludes my prepared remarks. Operator, please open up the call for questions.
Operator: [Operator Instructions] Our first question comes from the line of Harsh Kumar with Piper Sandler.
Harsh Kumar: Yes, thank you, Hock. Once again, tremendous results and tremendous activity that you guys are benefiting from in AI. But my question was on software. I think if I heard you correctly, Hock, you mentioned that your software bookings will rise quite dramatically to $3 billion in 2Q. I was hoping that you could explain to us why it would rise almost 100% up, if my math is correct, in 2Q over 1Q. Is it something simple? Or is it something that you guys are doing from a strategy angle that's making this happen?
Hock Tan: As I indicated, with the acquisition of VMware we're very focused on selling, upselling and helping customers, not just buy but deploy this private cloud what we call virtual private cloud solution or platform on their on-prem data centers. It has been very successful so far. And I agree it's early innings still at this point. We just have closed on the deal -- well, we closed on the deal late November, and we are now March, early March. So we had the benefit of at least three months, but we have been very prepared to launch and focus on this push initiative on private cloud, VCF. And the results has been very much what we expect it to be, which is very, very successful.
Harsh Kumar: Thank you, Hock.
Operator: Our next question comes from the line of Harlan Sur with JPMorgan. Your line is open.
Harlan Sur: Good afternoon. Thanks for taking my question. Hock, on the AI outlook being revised from greater than $7.5 billion, I think, last quarter to $10 billion plus this quarter. As you mentioned, AI compute pulls your ASICs, but it also pulls your networking, optical, PCIe, connectivity solutions as well. So can you just help us understand like of that $2.5 billion increase in outlook? Is it stronger AI ASIC demand, stronger networking, stronger optical, et cetera. But more importantly, are you also seeing a similar acceleration in your forward ASIC design win pipeline as well?
Hock Tan: There's a lot of questions, a lot of information you want me to disgorge. Let's take them one at a time, shall we. Yes, the increase, as we have said before as we shown before, it's roughly two-thirds, one-third or 70-30, which is AI celebrators which are custom ASIC AI accelerators this. We've a couple of hyperscalers compared to the other components, which are collectively considered as networking components. And it's about 70%, 30% mix. And that increase of almost $3 billion that you mentioned, it's a similar combination.
Harlan Sur: And then are you seeing a similar acceleration on the forward design win pipeline and customer engagements?
Hock Tan: I have indicated that I only have to really only have to say, I don't count anybody. I do not go into production as a rail customer at this point.
Harlan Sur: Okay. Thanks, Hock.
Operator: Our next question comes from the line of Vivek Arya with Bank of America Securities. Your line is open.
Vivek Arya: Thank you for taking my question. Hock, on, again, on the over $10 billion for AI, is this still a supply constrained number? Or do you think that this is kind of a very project-driven number, so it's not really supply that gets it. So if you were to get, let's say, increase supply, could there be upside? And then kind of part B of that is, on the switching side, have you already started to see benefits from the 51 terabit per second switches? Is that something that comes along later? Like what is the contribution of 51T to the switching upside that you mentioned for this year?
Hock Tan: Yes. No, our Tomahawk 5 is going great guns. Now it's not driven unlike in the past, Tomawak 3, Tomawak 4 by traditional scale-out in hyperscalers on their cloud environment. This is all largely coming from a scaling out of AI data centers. The building of larger and larger clusters to enable generative AI computing functionality. And you're going for bigger and bigger pipes. Hence, the Tomahawk 5 51 terabit is a perfect solution, and we're seeing a lot of demand. And in many cases, we are basically, they are surpassing the rate of adoption that we had previously thought. So it is a very good solution in connecting GPUs. And with respect to AI accelerators where I think you are focusing on, is that a constraint on supply chain? We do get enough lead time out of our hyperscale customers that we do not have a supply chain constraint.
Vivek Arya: Thank you.
Operator: Our next question comes from the line of Stacy Rasgon with Bernstein Research. Your line is open.
Stacy Rasgon: Hi, guys. Thanks for taking my question. I had a question on the core software business. So you said VMware for the two months that was in there was $2.1 billion, which would put the rest of the software, CA Symantec and Brocade at like 2.5 almost could be up like 25% sequentially and almost 40% year-over-year. I guess do I have my math right? And if so, like how can that be? What's going on in the core business? And how should we be thinking about the growth of the core business in VMware as we go through the year? Is the VMware still $12 billion or just -- how do we think about that?
Hock Tan: Yes, don't get too excited over that. I think it's certain products, contracts we obtained and -- but it's very strong contract renewals in the older -- from old Broadcom contracts, especially in mainframes were very strong, as was some of our other distributor software platform. So that has also accelerated, but that's not the star of this show, Stacy. Star this show is the accelerating bookings and backlog we are accumulating on VMware.
Stacy Rasgon: Okay. So VMware is still running at like an $11 billion to $12 billion run rate benefit. So that sounds like that should accelerate. So the overall for VMware should be more than the $12 billion that you talked about. So the core business, the strength this quarter that was kind of a onetime we could model that kind of like falling off because you've shown at the overall software at 20?
Hock Tan: Correct.
Stacy Rasgon: Got it. Okay. Thank you.
Operator: Our next question comes from the line of Aaron Rakers with Wells Fargo.
Aaron Rakers: Yes. Thanks for taking the question. I wanted to ask kind of continuing on the VMware discussion a little bit. Hock, now that you've had the asset for a little while, I'm curious of how you how the go-to-market strategy looks with VMware relative to the prior software acquisitions that you've done. What I'm really getting at is kind of like how have you kind of thought about the segmentation of the customer base of VMware? Are you -- I know there's been some discussion around your channel engagement, VM legacy VMware channel in the past. So I'm just kind of curious of how you've been managing that go-to-market.
Hock Tan: I think now we haven't had it for that long, to be honest. It's like three months, about three months. But yes, it's what -- and it seems to be that things to work out, but things seem to be progressing very well as we had hoped it would. Because where we are focusing our go-to-market -- and more than go to market, where we are focusing our resources on don't just go to market but on engineering a very improved VCF stack, which we have and selling it out there and being able to then support it and in the process that help customers deploy and start to really make it stand up in your data centers. All that focus is on the largest, I would say, 2,000 strategic customers. These are guys who want to still have significant distributed data center on-prem. Many of our customers is looking at a hybrid situation, not trying to use the word too loosely. Basically, a lot of these customers had some very legacy but critical mainframe. That's an old platform not growing, except it's still vital. Then what they have in modernizing workloads cut today and in the future, is they really have a choice, which they are taking both angles of running a lot of applications in data centers on-prem distributed data centers on-prem, which can handle these modernized workloads while at the same time to -- because of elastic demand, to be able to also put some of these applications into public cloud. Today's environment, most of these customers do not have an on-prem data center that resembles what's in the cloud, which is very high availability, very low latency, highly resilient, which is one we are offering with VMware Cloud Foundation of VCF. It's exactly replicate what they get in a public cloud. And they love it. Now three months. But we are seeing it in the level of bookings we are generating over the last three months.
Aaron Rakers: Thank you.
Operator: Our next question comes from the line of Chris Danely with Citi. Your line is open.
Chris Danely: Thanks, for letting me ask question. I have just a question on the AI upside in terms of a customer perspective. How much of the upside is coming from new versus existing customers? And then how do you see the customer base going forward? I think it's going to broaden. And we know how you like to price. So if you do get a bunch of new customers for these products, could there be some better pricing and better margins as well? Hopefully, they're not listening to the call.
Hock Tan: Chris, thanks for this question. Love it. Because perhaps let me try to perhaps give you a sense how we think of the AI market, the new generative AI market, so to speak, using it very loosely and generically as well. It's really -- we see it as two broad segments. One segment is hyperscalers, especially very large hyperscalers with huge, huge consumer subscriber base. You probably can guess who this few people are, very large subscriber base and very -- an almost infinite amount of data. And their model is getting subscribers to keep using this platform they have. And through that, be able to generate a better experience for not only the subscribers, but a better advertising opportunity for their advertising clients. It's a great ROI as we are seeing ROI that comes very quickly. And the investment continues vigorously with those -- with that segment, comprising very few players. But we will choose subscriber base, but with the scale to invest a lot. And here, ASICs custom silicon, custom AI accelerators makes plenty of sense and that's where we focus that attention on. They also buy as a scale out those AI accelerators, through clusters increasing large clusters because of the way the models are running, the foundation models run and large language models need to generate those parameters. They buy a lot of networking together with it. But in comparison, obviously, to the value of AI accelerators we sell. Now the network working side, while growing its small percentage compared to the size, the value of the accelerators. That's one big segment we have. The other segment we have, which is smaller is the enterprise, what I broadly call enterprise segment in AI. Here, you're talking about companies, large not so large, but large who wants to do -- who have AI initiatives going on. All these big news and hype about AI being the savior to productivity and all that gets all these companies on multiple on their own initiatives. And here, short of going to public cloud, they're trying to run it on-prem. If they try to run it on-prem, they take standard silicon for an AI accelerators as much as possible. And here, in terms of the AI accelerator, we don't have a market. That's the merchant silicon market. But in the networking side as they tie it together with their data centers, they do buy all those are -- our networking components beginning with switches, routers even through people like Arista 7800 but switches for sure, and the various other components I mentioned. And that's a different sense market that we have. So it's an interesting mix, and we see both.
Chris Danely: Thanks a lot, Hock.
Operator: Our next question comes from the line of Karl Ackerman with BNP Paribas. Your line is open.
Karl Ackerman: Yes, thank you. Hock, weakness in broadband, server and storage customers is understandable given what your peers have said this earnings season. But perhaps you could speak to the backlog visibility you have with your customers in those markets that would indicate those markets could begin to order again and see sequential growth in the second half through the calendar year? Thank you.
Hock Tan: You're correct. We are -- as I say, we are almost like near the trough. This year, '24, first half, for sure, will be the trough. Second half 24, don't know yet. But I tell you what, we have 52-week lead time, as you know. We are very disciplined in sticking to it. And based on that, we are seeing bookings lately, significantly up from bookings a year ago.
Karl Ackerman: Thank you.
Operator: Our next question comes from the line of Christopher Rolland with Susquehanna. Your line is open.
Christopher Rolland: Thanks for the question. So Hock, this one is for you on optical. So, our checks suggest that you're vertically integrating there. You're now putting in your own drivers, TIAs, you're starting to get traction in PAM4 DSP. And I think you kind of had an early lead in 100-gig data center lasers as well. And this is -- a lot of this should be on the back of AI networking that appears to be exploding here. So I was wondering if you could help us size the market and then also talk about how fast this is growing for you. I think there may have been some clues in that one-third number the AI you gave us, but perhaps if you can kind of double click or square that for us, it would be great. Thanks.
Hock Tan: Okay. Before you get carried away, please, and those in the other categories outside AI accelerators, all those things that PAM-4, DSPs, optical components, retirements. They are small compared to Tomahawk switches and Jericho routers using AI networks. And also being in an environment where, as you all know, traditional enterprise networking is kind of also in a bit of a slowdown now. So always think, it's demand driven very much by AI. And that tends to push us in a line of thinking that could be very biased because what it is showing is that the mix and the content on networking relative to compute, is very skewed very different from -- in an AI data center compared to a traditional CPU-based data center. So I don't want to get you guys all in the wrong way. But you're right, in the AI data center, there's a lot of -- there's quite a bit of content on DSPs, PAM4s, optical components and retirements and PCI Express switches. But they are still not that big in the overall scheme of things compared to what we sell in switches and routers. And compared to AI accelerators, they are even small, I think in that ratio. As I said, AI revenue of $10 billion plus this year, 70% would be AI accelerators. 30%, everything else. And within that everything else, 30% or so, I would say more than half of that 30%, more like 20% are the switches and routers. And the rest are other various retirement DSP components because we are not -- unlike what you said, we're not vertically integrated in the sense we do not do the entire transceiver the optical transceiver. We don't do that. Those are manufactured typically by OEM contract manufacturers like in online, Eoptolink guys in China. Where those guys are much more competitive, but we provide those key components we talk about. So when you look at it that way, you can understand the kind of the weighting of the various values.
Christopher Rolland: Super helpful. Thank you, Hock.
Operator: Our next question comes from the line of Toshiya Hari with Goldman Sachs. Your line is open.
Toshiya Hari: Hi, thank you for taking the question. Hock, I think we all appreciate the capabilities you have in terms of custom compute. I asked this question last quarter on the group call back. But there is one competitor based in Asia, who continues to be pretty vocal and adamant that one of the future designs at your largest customer, they may have some share and we're picking up conflicting evidence, and we're getting a bunch of investor questions. I was hoping you could address that and your confidence level in sort of maintaining, if not extending your position there? Thank you.
Hock Tan: You know, I can't stop somebody from trash talking, okay? It's the best way to describe it. Let the numbers speak for themselves, please, and leave it that way. And I add to it like most things we do in terms of large critical technology products. We tend to always have, as we do here, a very deep strategic and multiyear relationship with our customer.
Toshiya Hari: Understood. Thank you.
Operator: Our next question comes from the line of Vijay Rakesh with Mizuho. Your line is open.
Vijay Rakesh: Yes, hi, Hock. Just on the custom silicon side, obviously, you guys dominate that space. But you mentioned two customers, only two major customers. But just wondering what's really holding back other hyperscalers from ramping up their custom silicon side. And on the flip side, you're hearing some peers talk about custom silicon road maps as well, so if you could hit both? Thanks.
Hock Tan: Well, number one, we don't dominate this market. I only have two. I can’t be dominating it, too and number one. Number two, the second point is very -- it takes years. It takes a lot of heavy lifting to create that custom silicon because you need to do more than just hardware of silicon to really have a solution for generative AI or even AI in trying to create those AI capabilities in our data centers. It's more than just silicon. You have to invest a lot in creating software models that works on your custom silicon that matches. You've got to match your business model in the first place, which leads to and create foundation models which then needs to work and optimize on the custom silicon you are developing. So it's an iterative process. And it's a constant evolving process even for the same customer we deal with. I mentioned that in the last call. So it takes years to really understand or to be able to basically reach a point where you can say that, hey, I'm finally delivering production worthy -- and it's not because silicon is bad. It's because it doesn't work well with the foundation models that the customer put in place and a software layer that works with it, the firmware, the software layer that translates into it. All that has to work you are almost like creating an entire ecosystem on -- in a limited basis, which we are recognized very well in x86 CPUs, but in GPUs, those kind of AI accelerators is something still very early stage. So it takes years. And for our two customers, we have engaged for years. With one of them, we have engaged for eight years to get to this point. So it's something you have to be very patient, persevere and hope that everything lines up because ultimate success, if you are just a silicon developer, it's not just dependent on you, but dependent as much even more on your partner or customer doing it. So just got to be patient guys. I got the two only so far.
Vijay Rakesh: And on the peers getting into that market?
Hock Tan: Who is getting to the market, please repeat?
Vijay Rakesh: You talked about some of your peers like I think NVIDIA has been talking about entering the custom silicon market. Just your thoughts around that, yes.
Hock Tan: Oh, custom silicon market. I have no comment to be made on it. All I do say is I have no interest in going into a market where -- we have a philosophy in running our business, Broadcom. And maybe other people have a different philosophy. Let me tell you my simple philosophy, which I've articulated over time, every now and then, which is very clear to my management team and to the whole Broadcom. You do what you're good at. And you do -- you keep doubling down on things you know you are better than anybody else. And you just keep doubling down because nobody else will catch up to you if you keep running in of the pack. But do not do something that you think you can do, but somebody else is doing much better job than you are. That's my philosophy.
Vijay Rakesh: Thanks, Hock.
Operator: Our next question comes from the line of Matt Ramsay with TD Cowen. Your line is open.
Matt Ramsay : Thank you very much for squeezing me in guys. Just kind of a 2-part thing on the custom silicon stuff. I guess, Hock, if some of the merchant leaders in AI who are interested in some custom networking stuff from you either in switching routing would you consider it? And the second question is for Kirsten. The business model around custom silicon for most folks is taking our e-payments upfront and sell the end product at a lower gross margin, but a higher operating margin and you guys have wrapped this massive custom business with no real impact to gross margin. So maybe you could just unpack the philosophy and the accounting about the way that you guys approach the custom silicon opportunities just from a margin perspective? Thanks guys.
Hock Tan: I'll take that, because you're asking business model, you're not asking really number crunching. So let me try to answer in this way. No, there's no particular reason shot of what constitutes an AI accelerator. An AI accelerator, the way it's configured now, whether it's a merchant or its customer has a -- for AI accelerator to run foundation models very well needs not just a whole bunch of loads of floating point multipliers to do matrix multiplication, matrix analysis on regression. That's the logic part, compute part. It comes -- you have to come with access to a lot of memory, literally almost cash memory tied to it. The chip is not just a simple multiplier. It has -- it comes attached to memory. It's almost a layer 3-dimensional chip, which it is. Memory is not something we -- any of us in AI accelerators are super good at designing or building. So we buy the memory from very specialized high-bandwidth memory, you all know about that, from key memory suppliers. Every one of us does that. So you parted combine the two together, that's what an AI accelerator is. So even if I get very good net corporate silicon gross margin on mine compute, logic chip on multipliers. There's no way I can apply that kind of add-on margin to the high-bandwidth memory, which is a big part of the cost of the total chip. And so naturally, by simple math, it will -- that hold an entire consolidated AI accelerator brings a gross margin below on a traditional silicon product we have out there. No going away from that because you are adding on memory, even though we have to create the excess, the IOs that attach in, we do not and could not justify adding that kind of margin to memory, Nobody could, for us. So it brings a natural lower margin. That's really the simple basis to it. But on the logic part of it, sure, with the kind of content with the kind of IP that we develop cutting edge to make those high-density floating point multipliance [ph] on 800 square millimeters of advanced silicon we can command the margin similar to our corporate gross margin.
Operator: Our next question comes from the line of Edward Snyder with Charter Equity Research. Your line is open.
Edward Snyder: Thanks a lot. First, a housekeeping one, if I could, Hock. You mentioned the second customer as customer, but you also mentioned that it takes years of work iteratively. I mean you can -- anybody has looked at the TPU history, I guess, understands that. So -- and you've said before that it takes time to ramp it up. But maybe you could give us a little bit of color of phenomenal growth in your custom silicon products. Is much or a material part of that coming from your second customer and taking into account the low revenue number, is the growth rate, generally speaking, fairly comparable? And then I had a question about VMware.
Hock Tan: You better go on to VMware customers. And because on the first -- I don't tell about my customer individually, sorry.
Edward Snyder: Okay. Okay, never mind. That's a waste of time. So closing VMware held kind of a significant shift in your software strategy from focus on the largest 1,000 or so customers to hundreds of thousands now. Why should we expect once you get through, I don't say, the low-hanging fruit of selling into the, like you mentioned, the first 1,000 customers with the VCF product that your OpEx is a share of sales, firstly, in sales and marketing would start to increase because that's the big leverage Broadcom has had over almost all your acquisitions in software, and that seems to be changing now?
Hock Tan: We have a shift here. And it's interesting. You're right, now we've got. We are spending more on go-to-market and support because we have a lot of customers with VMware. They are 300,000, but we stratify. So we have the strategic guys. We sell, upsell VC private cloud very good. But the long tail of what we call smaller commercial customers, we continue to support and sell improved versions of just vSphere compute virtualization to improve productivity on their service. We don't attempt to say, go build up your whole VCM. They don't have the skills, don't have the scale to do it. But only it adds up you're right, costs of my spend, OpEx spend, be it support services, go-to-market will increase. But the difference between that and, say, CA, under acquisition we did is we're growing this business very fast. And you don't have to increase your spend growing this business. So we have operating leverage through revenue growth over the next three years.
Edward Snyder: Great. If I could squeeze one more in. You'd mentioned several times actually in the last quarter that there were two divisions you're going to divest including Carbon Black, and that's changed. What has changed? Is the market outlook kind of softened and you just wait and see? Or did you change your strategy and how you're going to integrate? I'm just curious why last quarter, you said you probably get rid of it in months and now you're keeping it.
Hock Tan: Well, we find now that we could generate more value to you, the shareholders. I assume you are -- I'm just kidding, but we would generate more value to our shareholders by taking Carbon Black, which is not that big and integrating it, Symantec, that by doing it, we would generate much better value to our shareholders than taking a one-shot divestiture on this asset, not particularly large to begin with.
Edward Snyder: Great. Thank you.
Operator: Ladies and gentlemen, just in the interest of time, I would now like to turn the call back over to Ji Yoo for closing remarks.
Ji Yoo: Thank you, operator. In closing, we would like to highlight our Broadcom enabling AI an Infrastructure Investor Meeting on Wednesday, March 20, 2024, at 9:00 a.m. Pacific 12:00 p.m. Eastern Time. Charlie Kawwas, President of Broadcom's Semiconductor Solutions Group and several General Managers will present on Broadcom's merchant silicon portfolio. The live webcast and replay of the investor meeting will be available at investors.broadcom.com. Broadcom currently plans to report its earnings for the second quarter of fiscal '24, after close of market on Wednesday, June 12, 2024. A public webcast that Broadcom's earnings conference call will follow at 2:00 p.m. Pacific Time. That will conclude our earnings call today. Thank you all for joining. Operator, you may end the call.
Operator: Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. |
COST | 2 | 2,024 | 2024-03-07 21:10:34 | Operator: Ladies and gentlemen, thank you for standing by. At this time, I would like to welcome everyone to Costco Wholesale Corporation's Fiscal Second Quarter 2024 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] I would now like to turn the conference over to Richard Galanti, CFO. Please go ahead.
Richard Galanti: Thank you, Debbie, and good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include but are not limited to those outlined in today's call, as well as other risks identified from time-to-time in the Company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made and the Company does not undertake to update these statements, except as required by law. Comparable sales and comparable sales excluding impacts from changes in gasoline prices and foreign exchange are intended as supplemental information and are not a substitute for net sales presented in accordance with GAAP. In today's press release, we reported operating results for the second quarter of fiscal 2024, the 12 weeks ended February 18th, as well as February retail sales for the four weeks ended this past Sunday, March 3rd. Reported net income for the 12-week second quarter came in at $1.743 billion or $3.92 per diluted share, up from $1.466 billion or $3.30 per diluted share in the 12-week second quarter last year. This year's results included a tax benefit of $94 million or $0.21 per diluted share due to the deductibility of the $15 per share special dividend to the extent received by our employee 401(k) plan participants. Net sales for the second quarter was $57.33 billion, an increase of 5.7% from the $54.24 billion in the second quarter last year. Net sales were negatively impacted by approximately 1.5% in the US and worldwide from the shift of the fiscal calendar as a result of the 53-week 2023 fiscal year. The following comparable sales reflect comparable locations year-over-year and comparable retail weeks. For the -- in the US, we reported a 4.3% comparable. Excluding gas, deflation, and FX, the 4.3% would have been a 4.8%. Canada reported comp of -- for the quarter 9.2%, 9.0% ex-gas and FX. Other International 8.6%, and 8.2% ex-gas and FX. Total company 5.6% reported for the quarter, and a 5.8% excluding gas, deflation, and FX. E-commerce was an 18.4% reported, and an 18.2% excluding FX. In terms of second quarter comp sales metrics, our traffic or shopping frequency increased by 5.3% worldwide and 4.3% in the US. Foreign -- our average transaction or ticket was up three tenth of a percent worldwide and up one tenth of a percent in the US. And foreign currencies relative to the US dollar positively impact sales by approximately two tenth of a percent. While gasoline price deflation negatively impacted sales by approximately four tenth of a percent minus. Moving down the income statement to membership fee income. We reported membership fee income of $1.111 billion, up $84 million or up 8.2% year-over-year in the quarter. In terms of renewal rates, at second quarter end, our US and Canada renewal rate came in at 92.9%, which is up one tenth of a percent from Q1 and 12 weeks earlier. And the worldwide rate came in also at 90.5%, similar to the last quarter. Membership growth continues. We ended the second quarter with 73.4 million paid household members, up 7.8% versus last year, and 132.0 million cardholders, up 7.3%, with continuing growth throughout the quarters. At Q2 end, we had 33.9 million paid executive members, an increase of 646,000 during the 12-week second quarter. Executive members represent a little over 46% of paid members and a little over 73% of worldwide sales. Moving down the income statement line, next, to the gross margin. Our reported gross margin in the second quarter was higher year-over-year by 8 basis points, coming in at 10.80% compared to 10.72% last year in the quarter, and at 4 basis points excluding gas deflation. Writing down the little matrix that we usually do with two columns, both reported and excluding gas deflation. First line item is core merchandise, plus 5% -- plus 5 basis points year-over-year on a reported basis, and plus 2 basis points ex-deflation -- gas deflation. Ancillary and other, plus 7 basis points and plus 6 basis points. 2% reward, minus 7 basis points and minus 7 basis points. LIFO, plus 3 basis points and plus 3 basis points. And all told, total reported, again, gross margin year-over-year up 8 basis points and up 4 basis points excluding gas deflation. In terms of the core margin on their own sales, again, while the number I just read you was a plus 5% -- plus 5 basis points and plus 2 basis points ex-gas deflation. In terms of core margin on their own sales, our core-on-core margins were up 25 basis points year-over-year, with food and sundries and non-foods being positive year-over-year and fresh being negative. Ancillary and other businesses, gross margins were higher by 7 basis points and higher by 6 basis points ex-gas. The increase year-over-year was driven largely by e-comm and partially offset by gas. 2% reward, again higher 7 basis points -- lower by 7 basis points both with and without gas deflation, with higher sales penetration coming from our executive members. LIFO, plus 3 basis points. We had a $14 million LIFO credit in the second quarter of this year compared to no LIFO charge or credit in the second quarter of last year. Moving to SG&A. Our reported SG&A in the second quarter was higher year-over-year by 3 basis points or minus 3 basis points would be higher, coming in at -- this year at 9.14% compared to last year's 9.11%. And the higher 0.3% would have been lower by 1 basis point excluding gas deflation. In terms of Q2 year-over-year, the operations component of SG&A, doing the matrix, was 11 basis points higher, or minus 11 basis points. Ex-gas deflation, minus 8 basis points, so 8 basis points higher. Central, plus 4 basis points and plus 5 basis points. Stock compensation, plus 4 basis points and plus 4 basis points. And total would be 3 basis points higher year-over-year and plus 1 basis point or 1 basis point lower year-over-year or better. And with regard to the operations component being higher by 11 basis points reported and 8 basis points excluding deflation. As compared to a year ago, since -- during the past year, we included two last March's extra top-of-scale increase in wages, which was about a 2 basis point hit to the SG&A line. As well, in the first quarter of this year we raised the starting wage in the US and Canada. We estimate the impact of that new wage also was a roughly 2 basis point. So, about 4 basis points of that 8 basis points or 4 basis points of that 11 basis points were related to those two wage increases, more than normal. Below the operating income line, Central I mentioned was better by 4 basis points or 5 basis points, and the rest was pretty much straightforward. Below the operating income line, interest expense was $41 million this year versus $34 million last year and interest income and other for the quarter was higher by $102 million year-over-year. This was driven by an increase in interest income due to higher interest rates and higher average cash balances, as well as FX which was favorable versus last year. We'll see less benefit from interest income going forward following the January payment of the $6.7 billion special dividend. In terms of income taxes, our tax rate in the second quarter came in at 22.1% compared to 26.1% in Q2 last year. As discussed earlier, this year's rate benefited from the tax deductibility of a special dividend paid to 401(k) participants. The fiscal 2024 effective tax rate including discrete items is currently projected to be in the 26% to 27% range. And excluding the special dividend tax benefit in Q2, our Q2 tax rate instead of being -- coming in at 22.1% would have been 26.3%. Overall, reported net income was up 18.9% in the quarter on a reported basis. And again, excluding the special dividend-related income tax benefit, it would have been up 12.5% year-over-year. A few other items of note. In terms of openings in the second quarter, we opened four net new warehouses, including three new locations in the US. Actually, two of them were Costco business centers, and one new Costco Wholesale warehouse, and one unit in -- our sixth in China in mid-January in Shenzhen. That's our six in China. There's been a lot of press about it. We have an estimated 10,000 people who were at opening and there are just under 200,000 members currently, including more than 20,000 members who signed-up from Hong Kong. And we've seen all kinds of things over there from tour agencies doing bus trips over to shop. For the full year 2024, we estimate 30 total openings, including two relo's, so for a net increase of 28 new units. And that puts the remainder of fiscal 2024 for Q3 and Q4, we plan on opening a total of 15 net new locations, 11 in the US, two in Japan, and one each in Korea and in China. Regarding CapEx, fiscal second quarter spend was approximately $1.03 billion. And for the year, it remains in the north of $4.4 billion to $4.6 billion, in that range. One additional comment on China. This past Monday, we launched in our Pudong, China location, the ability for our members to order online about 400 items from our -- of our items to be delivered that day. This -- and the delivery will be within about an eight kilometer radius of the warehouse itself. That's getting a lot of social media attention over there and we plan to launch it in the other four Shanghai area locations by month-end, as well as in Shenzhen sometime the following month. In terms of e-commerce, e-commerce sales in Q2 ex-FX increased 18.2%. E-com showed strength in several areas, led by sales of gold and very recently silver. As well, appliances were very, very strong, as was gift cards and e-tickets. As well, Costco Logistics enjoyed record-breaking deliveries. Much of that -- many of those items are sold via e-commerce. In Q2 of 2024, we completed over 1 million deliveries, up 28% versus Q2 a year ago. In terms of e-commerce sales over the past few months, we believe we've done a much better job explaining to our members the significant value propositions we offer compared to traditional competitors in several big-ticket categories. Under the Why Buy At Costco banner and The Price You See Is The Price You Pay banner, we share with our members what's included in the price of appliances, tires, televisions, computers, and mattresses. You can see these online on our website of Why Buy At Costco. Just to give you one example. If you take a four-set of high-end tires compared to a traditional retailer, we include, of course, installation, rotation, balancing, a five-year road hazard warranty. Typically that's a lot less road hazard warranty than other places, or you'd have to pay for it extra, ongoing flat repairs, nitrogen, and disposal of the prior tires. So, just one of the examples where the price of the tires itself might be very close to us. When you put in all the differences of those additional items, it's anywhere from a 15% to 25% savings on any of these items. Next on my list, talk about costconext.com, a couple of comments on the seller platform. This allows -- costconext.com allows our members to exclusive asset -- access to direct-to-consumer sites for top-quality brands at Costco value pricing. Currently, there are about 70 -- there are 70 Costco Next brand sites, with 15 additional sites in development. We will likely end this calendar year with about 90 sites and continue to grow from there. Costco Next offers everything from home improvement to apparel to pet to home to kitchen to electronics to accessories, as well as sports, bicycles, and toys. You should check it out, it's a pretty good site. Progress continues to be made in our e-com, mobile, and digital efforts. A couple of recent enhancements. In February, we rolled out our new native mobile application homepage on iOS. The native homepage now loads in less than 2 seconds compared to 8 seconds previously. Needless to say, that's important when about 60% of our e-com business, both visitors and orders, are now done via our mobile app and browser. And last week, we rolled out Apple Pay to all members online, both web and mobile, on February 28th. App downloads during the quarter were up 2.8 million and currently total around 33 million. On the product side, a couple of other new items to comment on. In our food courts, we recently replaced the churro with an awesome freshly baked 5.5-ounce chocolate chip cookie for $2.49. It is awesome. It's a great-tasting -- and a great-tasting turkey sandwich for $6.99, with the rollout of the latter being completed this week. In addition, we recently opened our first fully operated sushi offering in Issaquah, Washington, across the street from our headquarters, with two more planned to open in the very near future. This operation is what we have successfully done for years -- for many years, and throughout our Asia Costcos and several countries over there. The sushi program has proven to be a category where we can be successful in both quality and price, and we're looking forward to seeing more of that in the future. A couple of comments about inflation. In the last quarter, in the first quarter, we estimated that year-over-year inflation was approximately zero to 1%. We'll now say that in Q2, it was essentially flat. And notwithstanding essentially flat, we're taking price reductions where we can. Anecdotally, everything from simple items like reading glasses from $18.99 to $16.99, the 48 count of Kirkland Signature batteries from $17.99 to $15.99, a 24 count of Pellegrino from $16.99 to $14.99, and even a four pounds of frozen three berry fruit blend from $14.99 down to $10.99 with new crop pricing. So, we continue to do that. We always want to be the first out there trying to lower prices. Many new items in sporting goods and lawn and garden are being set with lower prices year-over-year, and overall, mostly due to reduced freight costs and lower commodity costs versus a year ago. And overall, our inventories and SKUs are in good shape across all channels. Overall, we've had good seasonal sell-through during the quarter. In terms of shipping and supply chain issues, we've been asked about that often of late. There are some delays, generally just a couple to three weeks, but mostly now planned for. First, there was an issue a while back with the Panama Canal challenges. Then, of course, the Red Sea challenges. A lot of that has to do with changing the way ships are being routed. No meaningful pricing issues because a lot have been placed contracts. Finally, turning to our February sales results, the four weeks ended this past Sunday, March 3rd, compared to the same retail calendar weeks last year. As reported in our release, that sales for the month came in at $18.21 billion, an increase of 6.9%, versus $17.04 billion for the same four retail weeks last year. Again, just to announce what we did in the announcement earlier today, the US reported comp of 3.4% for February, ex-gas and FX, 4.1%. Canada, 8.4% and 8.3%. Other international, 10.8% and 11.3%. For our total Company, a 5.0% reported and a 5.6% ex-gas and FX, with e-com coming in at a 16.2% reported and a 16.0% ex-FX. Our comp traffic or frequency for February was up 6.2% worldwide and up 5.0% in the US. Foreign currencies year-over-year relative to the dollar negatively impacted total and comparable sales as follows: Canada by about one tenth of a percent negative; other international by approximately 0.5%; and total Company by approximately one tenth of a percent. Gasoline price deflation negatively impacted total reported comp sales by approximately 0.5%, and the average worldwide selling price per gallon of gas was down approximately 3.5% versus last year. Worldwide, the average transaction for February was down about 1.1%, which includes the negative impacts from FX and gas deflation. In terms of regional and merchandising categories, the general highlights are as follows: US regions with the strongest comps were Midwest, Southeast, and Northeast. In terms of other international in local currencies, we saw strength in Mexico, Australia, and Korea. Moving to merchandise highlights, food and sundries were positive in the mid-single-digits. Fresh foods were up high-single-digits, and non-foods were positive mid-single-digits. And ancillary businesses were up in the low-single-digits. Food court, pharmacy, and optical were top performers, with gas down low-single-digits on a lower price per gallon. In terms of upcoming releases, we will announce our March sales results for the five weeks ending Sunday, April 7th on the following Wednesday, April 10th after market close. And lastly, before I turn it back to Demi for Q&A, I'd like to take a moment to say thank you to many of you who have turned in to each quarter, some for many years, to allow me to share with you Costco's results, both our ups and our downs, and thankfully many more ups than downs, and provide some fun and informative color on how we're doing along the way. Since going public in December of 1985, I have hosted all but one call and it's been an absolute privilege and honor to do so. So, thank you all. As you know, in early February, it was announced that I will be ceding the role of CFO to Gary Millerchip effective March 15th after our second quarter 10-Q is filed, and retire, including from our Board, next January. It's a bit surreal of late, but what a wonderful journey it has been with such a great Company and great people, including many of you on the call today. I have certainly been very fortunate. The good news, Gary joined Costco last week, and along with David and Josh, will continue to provide to you all with the transparency and straightforwardness that we are known for. It will be a positive and seamless transition. With that, I will be happy to turn it back to Demi to open it up for Q&A.
Operator: The floor is now open for your questions. [Operator Instructions] We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Simeon Gutman with Morgan Stanley. Your line is open.
Simeon Gutman: Hi, everyone. Hey, Richard, best wishes to you. Thank you for all your guidance. That's a metaphor since you don't give guidance. My first question is on the -- this is like a parting question on membership, and I want to make sure this framework sounds right. I know you said it's if, not when. And as part of the thought process is, there are enough levers in the business, product savings, cost savings, to be able to drive an appropriate level of profit growth from the business. And when that no longer presents itself, that's when the membership price increase can come through. And that can come through earlier than that, but that was one framework we were thinking in this, as we wait to hear when it happens.
Richard Galanti: Sure. And by the way, it's when, not if, still. And but really, joking aside, we're not that smart in terms of figuring out exactly why. I mean we know that all the factors that we believe, if we wanted to do it, would we feel comfortable in terms of renewal rates, new member signups, loyalty, all those things are continuing in the right direction. It really is a function. And I don't think it would be done simply because, hey, things have slowed down a little bit, let's do it now. We like the fact that we're performing well. We like the fact that almost all metrics are going in the right direction in our business right now. We've got plenty of runway left. And given the economy and given everything else, it's us, it's Costco, so I think it is simply still not trying to be accede about it, it's not some big analytical formula, it's simply a measure of we will at some point, I'm sure, do it. And I've been joking with Gary, it'll be on his watch, not mine.
Simeon Gutman: And then maybe one more, Richard, is another question. You used to -- the business has comped very consistently over time and you used to say, I regret when it won't comp north of 4% to 5% because that's where it may be tougher to leverage our expenses. If you think about that framework, does it still apply? And then as you hand the baton to Gary and even Ron, do you spend more or are there ways where you -- the cost structure of the business can actually be altered to lower that leveraged threshold point?
Richard Galanti: Right. Well, I would say it's probably more likely to go up a little bit down just because of whatever goes on in life with inflation that happened. But I got to look back at the last few years. We were -- we and others were helped through the crisis of COVID. And we haven't given a lot of that back. If I look at our SG&A, I remember when in fiscal 2019, it came in at a $10.04 billion. I'm looking at these numbers here. And even in 2020, it was at a $10.30 billion in the first quarter before COVID. And then in fiscal 2021, it was at $9.65 billion and then down to an $8.88 billion. And now it's up to fiscal 2023, it was a $9.08 billion. So, notwithstanding that, I remember when it was slightly above $10 billion, we said, well, it's never going to get below $10 billion again. And a lot of factors continue to change. But just the sheer high productivity that we have is frankly higher than we thought. Some of that was gained through COVID because of everything else going on. But we haven't given it back. The good news is, we haven't given it back. And the good news continues to be that we seem to continue to be able to take market share. I think the fact that on big-ticket items, there's less SG&A. We continue to change the pack sizes of things for less freight, whatever it is. Although freight would be, that would be SG&A. But it is still a lot about sales at the end. And if you ask the rhetorical question, if comps went to zero, what would that mean? That would be tough on SG&A, but we'd figure other things out.
Simeon Gutman: Yes. Okay. Best wishes. Thanks, Richard.
Operator: Next question comes from the line of Chuck Grom with Gordon Haskett. Your line is open.
Chuck Grom: Hey, good afternoon. Richard, congrats on a great career, for someone who started on basically day one at the Company. My question is on culture. You've always said it was customers first, employees second, shareholders third, and that philosophy's clearly played out. So, looking at it, I'm curious how the new team is going to keep this culture intact and resist pressure from some of the non-founders of the Company going forward.
Richard Galanti: Well, first of all, nothing has changed. It's not unlike the same question I think that was asked of Jim Senegal after 28 years before he retired, and before we knew who his successor was going to exactly be. And I remember the Board asking, if you're 100 in terms of extreme value and extreme taking care of the customer and the employee and everybody else, whoever takes your place, what will they be? And he paused for a minute and said, I have no doubt they'll be at least in the mid-90s if not higher. And frankly, after Craig was made that, in my view, whatever that number was, it increased towards a 100 just because that's what we do. That culture is so ingrained here. And we talk about changing management. I always joke when people ask me as CFO how I'm important -- am I important to the strategic whatever of the Company? The fact is, is we're run by merchants and operators, and we're there to serve and help them and certainly add our voice. But the fact of the matter is, and Craig for 12 years and now in Ron, you have people that have been here for 35, 40 years and were born and raised and have grown up in this culture. And it is so intact. Just last week when Gary joined us, he had to go through the required two-hour Costco orientation, which includes the obey the law, to take care of your customer, to take care of your employee, to respect your supplier. And then if you do that, you can reward the shareholder. It is -- that's the one thing I can sleep very well at night.
Chuck Grom: That's great. Thanks, Richard. Enjoy your retirement.
Richard Galanti: Thanks.
Operator: Next question comes from the line of Michael Lasser with UBS. Your line is open.
Michael Lasser: Good evening. Thank you so much for taking my question and best of luck, Richard. You mentioned previously that most of the metrics are moving in the right direction. Could you highlight which metrics are not moving in the right direction, especially from a membership per club standpoint? Are there any signs that some of the more mature locations are either reaching a saturation or starting to see a peak in that metric?
Richard Galanti: No. First of all, when I said most, I was just trying to be human, that nobody is perfect. Everything is working in the right direction right now. And actually, I wasn't talking just about membership metrics, but in general, knock on wood, things are working pretty well. When I -- when we sit in at our monthly budget meeting, more times than not, we get pretty excited about what's going on from a new merchandising standpoint, newness, buying with conviction, and being aggressive and assertive out there. I mean, what we saw with just even that simple example I gave you with changes to big ticket items and why buy them at Costco, we saw great changes in numbers. So, we know that we've got a lot of levers to be able to pull to make this thing work. And so no, I just said, honestly, I said most because nobody is perfect. I didn't have any particular examples.
Michael Lasser: Understood. My follow-up question is on what seems like an inflection in the discretionary business. To what degree is Costco experiencing improvement in the GenMerch categories as a result of aggressive changes, either like you had cited with the way you're communicating with the customer or the member, or aggressive actions to take down prices? And if you are pulling those levers hard, is there an opportunity to move even more aggressively to drive the discretionary business? Because it does seem like Costco is experiencing a rebound in some of these areas more so than the rest of retail. Thank you.
Richard Galanti: Yes. And no, and absolutely. When -- what is it? It's called -- it used to be NPD, it's Circana, which is that industry that shows you how you are on different product -- non-food product categories versus the industry. When we look at something like appliances in the last several weeks or a couple of months, the industry is flat and we're up north of 20%. Same thing with tires, more than that percent. And so, now that you can't say, let's do everything and everything will be up 20% or 30% because that's not going to happen. But at the end of the day, the focus of the buyers, as an example, is coming up with new ways to do things, to have great pricing, and to constantly improve that pricing and figure out how to do that with our global buying power with -- every time there's a commodity price increase. Given an item business, we have buyers that are in charge of 20 and 30 items, if not less, not 200 and 300 items in a category. They know a lot more, in our view, about every cost component of that. And I think -- I feel very good that we do a very good job, and I'm not suggesting others don't, but I know we do a very good job of getting on the phone immediately and working those issues. And as soon as we can get a savings, we're out there first passing it on. And that's just our religion. Now, we're able to do that partly because our sales have been relatively strong, and we've lapped some things from last year that have helped.
Michael Lasser: Thank you very much.
Operator: Next question comes from the line of Peter Benedict with Baird. Your line is open.
Peter Benedict: Sure. Thanks for taking the question, and my congratulations as well. Well done. It's been a pleasure. Wondering if you can maybe talk about Kirkland, the penetration, what's going on there, any member shopping behavior around kind of private brand versus branded, and maybe what some of the branded packaged good companies are doing to maybe get some volumes up. Just curious about your view on that.
Richard Galanti: There's not a lot of trade down, although when we -- we sometimes have more control over certain private labeled CPG items that we're able to drive more business, and so we're seeing an increased penetration of that versus some of the brands sometimes. But then that gets the brands to the table to work to provide more value on the branded as well. We want to be both. But we haven't really seen -- that was a question that happened as "the economy was" -- the question is, are we going into a recession, a couple of years ago, and inflation was peaking at 7%, 8%, and 9%, and are we seeing a difference? So, we did see a -- if you look back over the last 20 years, and without looking at the exact numbers, it seems like every year we'd grow a 0.25% to a 0.5% of increased Kirkland Signature penetration. And then there was one year when we were asked a couple of years ago, it seemed like there was 1% to -- 1.5% to 2% -- even 2% change in penetration. So, people were, in my view, switching a little bit out, but that's changed. We don't see that as much anymore.
Peter Benedict: Got it. And then just on Costco Logistics, you gave some delivery numbers there. Just maybe step back a little bit. The penetration of Costco Logistics within the business, how meaningful is that at this point? What's left in terms of maybe growing that? Is that just going to go with the big ticket trends, or are there, I don't know, internal initiatives to kind of drive further penetration of Costco Logistics?
Richard Galanti: What is done strategically, I hate to overuse that word, it's allowed us to be much better in value and delivery times and quality, and brought the delivery costs down on big ticket items, particularly appliances and big screen televisions, mattresses, and furniture, indoor and outdoor patio and mattress and patio furniture and indoor furniture, some sporting goods. And before we bought Innovel, we're now called Costco Logistics in the spring of 2020. And the year before that, in the US, we did about 2.2 million drops. And a drop is anything from dropping off a sofa to delivering and installing a new refrigerator, freezer, or washer, dryer, and taking the old one away for disposal. Both of those are a drop, recognizing their extreme difference there. But we did about 2.2 million drops in the US, none of which we did ourselves. With the acquisition of Innovel, I think for the - probably over the last -- with this million this quarter, a rough number of 4 million drops, which I believe about 70% of them -- over 4 million drops, and about 70% of them is us. We've reduced the delivery times. We've just introduced in some categories like two-hour windows where you can -- or three-hour windows where you can choose, two-hour windows where you can choose. So, we're constantly getting better, and we've greatly improved the value. And when you look at something, a category like appliances, we're still a very low percentage of the industry. And, the fact that it was up, 20%-plus last month or last quarter, is a function of some of the things we're doing in terms of shouting out how good of a deal it is and doing a better job of that. But we think we have an opportunity to continue to grow those categories, recognizing they're all meaningful categories, but they're all small percentages of our total. That's one of the nice things about us that we have lots of different categories.
Peter Benedict: Got it. Great. Well, thanks again, and best of luck, Richard.
Richard Galanti: Thank you.
Operator: Next question comes from the line of Rupesh Parikh with Oppenheimer. Your line is open.
Rupesh Parikh: Good evening, and thanks for taking my question. And Richard, I also want to offer my congratulations on your retirement. So just going back to the core on core margins, they're up, I think, 25 basis points this quarter. Just curious what drove that strong performance, if there is anything in particular driving that?
Richard Galanti: Well, on the non-food side, the biggest thing is -- well, not the big -- a piece of it is comparing to last year when we had extra markdowns. I think we probably talked about it last time that non-food was -- a year ago had been down year-over-year because of some of the supply chain challenges we had when such things were coming in late after the season in case some of the big ticket items from overseas containers. So, that was probably a chunk of it. On the Fresh food side, I said it was down year-over-year a little. Fresh is competitive, and we're being ever competitive on it as well. And -- but again, I don't view any of that as being terribly meaningful in terms of, is that a big change that is coming. There's always something that's up a little bit, and there's another thing that's down a little bit.
Rupesh Parikh: Great. And then maybe just one follow-up question. On the expense side, you guys did have better expense controls this quarter. So, just curious to what changed sequentially, because the growth rate did decelerate by a few percentage points.
Richard Galanti: I can't think off the top of my head other than I -- actually, someone across the table has just said the word focus. At our budget meetings, which happen every four weeks with 150-plus people in town from all over the world, those are the kind of things we look at. And I think the operators are doing a better job of budgeting. And one of the things I think that came out at the last budget meeting in terms of budgeting, if you budget sales a little higher and they came in a percentage -- a percent lower, you've got to your labor costs. And so a lot of it has to do with focus and being meaningful about it. We certainly don't try to control expenses by not doing a wage increase when we think we need to, and we certainly have done that.
Rupesh Parikh: Thank you. Best of luck.
Richard Galanti: Thanks.
Operator: Our next question comes from the line of Scott Mushkin with R5 Capital. Your line is open.
Scott Mushkin: Hey, thanks. Hey, Richard, I feel like we should be, like, raising your jersey to the Rafters like a superstar is retiring here. I never came without you, to tell you the truth. So, congratulations.
Richard Galanti: Thank you.
Scott Mushkin: So, here you are. So, yes. So, we'll have to see that The CFO Hall of Fame. So, a couple of things, some of your comments that you made. You're doing this delivery in one hour in China. I think you started going from one club to three. Is that something you envision that can expand outside of China? And how should we think about that, maybe even vis-a-vis the US?
Richard Galanti: Well, in a way, we're doing the same thing here with a few people, most notably Instacart. And a little bit was shipped down in the Southeast. And I think we've got a test in Texas with Uber. But at the end of the day, we had that same-day delivery already as function. Over there, it is a third-party that's doing it, like Instacart or these other ventures here. So, it's just -- it's new. It's not something that's new to the warehouse club industry in China. You could look elsewhere and find it too. But it's certainly something that makes sense. And again, in part because of social media, there's been a lot of publicity and just, I mean, from the day it launched three days ago, it's gone nuts in terms of how many page hits it's getting and all that stuff. But it's just part of the business.
Scott Mushkin: Got it. And then we've talked about this over the years, and I think you said you're going to do 28 net new clubs this year. What's the capacity of the organization? Where do you go? Do you envision that going to 35 and 40? Like, how should we think of it as we move out three to five years? Is it something that's going to trend up?
Richard Galanti: I think, who knows, but I think generally it probably trends up a little. There was a few years there, excluding the year when COVID hit, that we only did like 13 because there were shutdowns in certain countries of construction and as well as the US. But if you look back, excluding that year over a three or five-year period, plus or minus a couple of years there, it was about 23 a unit. Without looking at numbers, about 23 units a year. At the time, you said, what do you see over the next 10 years? What we saw collectively was is somewhere in the, hopefully, targeting, let's say, 25 for the next five years per year, and then going up to 25 to somewhere in the high-20s, if not 30. I think that's generally the sense that we feel. Could we do more? Yes. Are we comfortable doing it this way? Yes. I think part of that is it's such a hands-on business. I get to say that from sitting here in headquarters most of the time, not traveling like my colleagues do in operations. But, Ron is a great example. I mean, he and several regional executives in operations, if there's an opening somewhere, or not an opening, they're out visiting, usually at least two, if not three weeks a month, or out for three or four days, jumping around, visiting locations, not only existing locations, but new sites. And so, I think from a standpoint -- and the other thing is, particularly in newer countries, you want to get the first one open so you can train 50 or 80 people that want to move to the next location in that city that'll help that one go. And we were very fortunate a few years back in the first Shanghai, in Minhang in China, where we had a number of employees from Taiwan that wanted to move and be promoted into new locations, new jobs over there. So, that helps us when we have one, then two, then four, then whatever. So we take it slow. All I know is, we're all very busy, and, particularly the operators and merchants as well. And so that's kind of the paradigm that I think that we're going to continue to work at. Something in the 25 range, and then heading up. Just a month -- just a quarter ago, I think our budget for this year was 32, and now -- or 31, now it's 28. And that's simply timing. There is two or three that are pushed, that for whatever, construction delays, or you found something in the soil delays, or whatever it might be, they might have moved from mid to late summer to early fall, which is the new fiscal year. So, I'm feeling pretty good that we're going to open 25-plus for the next couple of years, and then probably 28-plus, and go on from there.
Scott Mushkin: Perfect. Thanks, Richard.
Operator: Next question comes from the line of Greg Melich with Evercore ISI. Your line is open.
Gregory Melich: Hi. Thanks, Richard. You mentioned the word surreal, the feeling of retiring. I'd say it's almost as surreal as a $4.99 chicken. So, thank you for all the help over the years. I would say, I guess two things I want to touch on. One is ticket pressure. It looks like just in the most recent sales, with traffic growing more and more, that you're seeing some AUR pressure. Is that 0% inflation turning to deflation, as the merchants are seeing into March and April?
Richard Galanti: Well, I think that, again, the inflation number is a calculation based on costs and mix. I think it's probably -- I wouldn't look too closely if the average ticket was up a couple of -- a few tenths in the quarter, and then it was down a percent, down in February by a tenth. That's still relatively close. Some of it's a mix change, I'm sure, and some of it is -- some of the examples I gave you about lower pricing. Even if the underlying cost hasn't changed, some of it may be in terms of how we package, and we take advantage of that. So -- and that's on the sales side and not on -- not the exact cost from yesterday.
Gregory Melich: So, looking ahead, that number of flat looks pretty good from what the merchants are seeing today.
Richard Galanti: Yes. I think when I go to the last budget meeting two weeks ago, I think there's -- in the presentations, there's a lot of -- I used the phrase a few minutes ago, upscaling. I didn't use that phrase, but then buying with conviction. I mean, I think the buyers are looking ahead right now in an offensive way and a positive way. Hopefully, we'll be right, but we feel so far we're being right.
Gregory Melich: I wanted to follow up with my second question on the Instacart side of e-commerce penetration. What would e-commerce penetration be now in the US if you included the Instacart delivery and the other deliveries?
Richard Galanti: Yes. Instacart is 1.5% to 2% percent, something below 2%, but more to 1.5%, which is still on a $200 billion retailer, it's a lot. And we don't include that because that -- the Instacart person comes in, buys it, and checks out at the front end, so we don't include that. So, you'd add -- depending on rounding, you'd add 1% to 2% to the top-line number.
Gregory Melich: Got it. Well, thanks. Thanks for everything, and enjoy retirement.
Richard Galanti: I hope to see you all.
Operator: Next question comes from the line of Kelly Bania with BMO Capital. Your line is open.
Kelly Bania: Good evening. Thanks, Richard, and I have to add my congratulations to you. It's been a pleasure. Just wanted to ask where Costco stands with retail media and advertising dollars. I think the last update I had was in the range of a few hundred million. Just curious if you're willing to share with us where that stands today, what kind of growth that is experiencing, and just the Company's thought process on investing in that down the line.
Richard Galanti: Well, without giving numbers out, we know there's an opportunity there more than we've done in the past. In the last six or eight months, we've brought on people that are seasoned in this business to help us, and it's a point of focus. We know that there's money out there. We've always been very successful in other forms of vendor buckets, whether it's end caps or advertising in our own Costco connection. And, of course, over the last several years, some advertising online or banners or placement, but there's a lot more that can be done there. Rest assured, whatever it is, we're going to use it to -- just like when we always said if we can save a dollar on buying something, we're going to give $0.80 or $0.90 to the customer. I think that mantra will continue on this side as well. So -- but there's certainly ability for more dollars out there. Some of our big retail competitors have talked about doubling in five or six years what they have. I think, again, it's a lower market share for us, so there's a little more opportunity for us to continue to grow that.
Kelly Bania: Thank you. And maybe just can I just follow up with the decision to roll out Apple Pay? Costco is pretty notorious for being strict on the payment method you can use. So just maybe the thought process on that, what you expect that to do for your e-commerce business, and any economics you can share.
Richard Galanti: Yes, on e-commerce, there's not as many stored cards for our members. And as we're doing more with a digital wallet, that'll help as well. So, it's something that should help.
Kelly Bania: Fair enough. Thank you.
Operator: Next question comes from the line of Oliver Chen with TD Cowen. Your line is open.
Katy Hallberg: Hi there, this is Katy on for Oliver. And, of course, best wishes to you in your retirement. Just wanted to talk a little bit about the Kirkland price gap versus national brands. I know you touched on the Kirkland brand a little bit earlier on the call. But how has that price gap changed, especially year-over-year? And how has there -- has there been any impact to unit elasticity given that price discrepancy? Thank you.
Richard Galanti: Well, we definitely have seen an impact from it. I think historically, the view was it has to be at least as good, if not better quality than the leading national brand, and at least a 20% savings as compared to what we sell the national brand for. And those metrics continue in that regard. I think what we've seen when we look at some of the items that have risen greatly in price, like paper products, on a percentage basis over the last several years because of freight costs, because of pulp prices, because of energy, all those things have dramatically increased. And what used to be -- I don't know the exact numbers, but for an 18-pack of -- a 24-pack of toilet tissue or a 15-pack or 18-pack of paper towels, you've got price points in the high $20s, if not low-to-mid $30s. And where we can show a dramatic savings on that, we've seen dramatic changes in unit market share towards Costco -- towards Kirkland Signature. But that's something that's been an iterative process over many years, probably goes up and down a little bit. I'd say it's gone up a little bit in terms of a little more of a penetration in the last couple of years.
Katy Hallberg: Great. Thank you. And then just to follow up on the store discussion and unit growth, can you just provide a little bit of color on how the international store openings are performing just from a productivity angle? How is that versus the more tenured stores as well as the domestic stores?
Richard Galanti: I don't think there's a big difference. In new markets, it's always a little slower. So, like when we opened originally in Iceland or Sweden or Auckland or some of those or France several years ago, you're always going to start -- or frankly, Japan 20 years ago, you tend to start out lower. In some cases, it's also a question is, some local vendors may not want to -- local country vendors may not want to sell you because they want to upset all the big traditional that have all the market share before we enter. And once we get two or three open, they talk to you a little more. And so I think all those things help us as we grow. Certainly, it's changed a little bit in the last few years. China being the most recent example, when we opened the first one in Minhang in Shanghai, what, about four years ago? It made international news based on just the sheer number of members we signed up and everything. So we have a lot faster start, I think. Each year, we have a lot faster start than the year before. And so I don't see a big difference there. We certainly -- if you look in the US, I mean, I think one thing that's interesting is this fiscal year, we're going to open, whatever, 28 units. Let me get my page here. And, I think of the 28, 20-plus are in the US, which is -- some people have asked, has it slowed down internationally? No, international takes a little longer to do. But what's interesting is, is we have a lot more runway than we ever thought possible. If you had asked us five years ago, by now, how many would we be putting in this year in the US? We would not have said 20-plus. It's got to slow down at some point. But the volumes that we're now doing in these locations, we've got to bleed some of that off. And so that's one good point. And then we've still got plenty going on overseas. And you'll see that continue to ramp up as well.
Katy Hallberg: Excellent. Thank you so much, and best wishes again.
Richard Galanti: Thanks.
Operator: Next question comes from the line of Scot Ciccarelli with Truist. Your line is open.
Scot Ciccarelli: Thanks for the time, guys. It seems like you guys are doing some things to cut down on membership sharing, food court usage from nonmembers, etc. Richard, are you seeing something in the business that gives you concern that there's a growing issue from things like membership sharing?
Richard Galanti: No, I think part of it is -- first of all, I think the storyline sometimes is a little greater than the reality. During COVID, we did a little bit more. There was a little bit more membership sharing. You had individuals where one family member, maybe not the one that had one of the two memberships, was coming into shop with mom or dad's credit card. And we allowed it. And then with the advent of self-checkout over the last several years, when you walk in the front door and you just flash your card and do they look at it or not, who knows, you would -- people would get in. And if you're going through self-checkout, you're not having to show your membership card to the cashier. And so there's probably an increasing but still small level of abuse of that privilege. And -- but we also had complaints from members saying, I pay, why shouldn't they? So, the view was -- is we needed to just shore that up a little bit. And we did. We did it over a period of six months, I think about six months, where we -- first there was warnings, and then ultimately changed. Are we getting some new signups from it? Absolutely. But it's relative to the 60 million or 70 million members, it's not terribly meaningful. But it's more fair and the right thing to do.
Scot Ciccarelli: Yes, I mean, that was actually -- you started to answer it. So, like you've seen some acceleration in membership. Should we kind of expect to see that in the future, like what we've seen with Netflix, for example, as they cut down on their sharing?
Richard Galanti: Right. Well, it seems like Netflix had a much bigger issue or the ability to share was much easier because, first of all, it's electronic. In this sense, you still have to show a card when you walked in. And we're actually doing testing on that too, in terms of having your card be scanned and reviewed when you walk in. And we've done that in the UK, I believe, for a few years. And so it's all about -- just I would say it's as much hygiene as anything else. And it'll be slightly profitable to the extent that we make sure everybody -- I think we signed up more members than there were non-members then lost the small sales that that non-member did.
Scot Ciccarelli: Makes sense. Thanks again. And enjoy the next stage.
Richard Galanti: Thank you.
Operator: Next question comes from the line of John Heinbockel with Guggenheim Securities. Your line is open.
John Heinbockel: Congratulations, Richard. Enjoy your retirement. You'll be missed. So, when you think about -- you don't have many pain points in your in your clubs. But when you think about kind of throughput and things like, I know you tested BOPUS and cost really didn't make sense there. Things like that and/or scan and go, what -- do you think there are some unlocks here to do more volume and/or reduce any pain points?
Richard Galanti: I think the biggest challenge with pain points, first of all, is full of merchandise and pallets through the system, which we continue to work on and improve. Never -- if you'd asked us 10 years ago, will you ever have 150 of your 600 US locations doing over $300 million and 40 of them doing over $400 million? The answer would be no, no way, even with inflation. The fact is, is we're doing a lot more volume than we've ever thought we would do. And so the biggest answer of not only making it a little more efficient, but driving more sales is cannibalizing. We find existing members that sometimes will say, I don't want to go there. It's too busy today. And by opening up that third or fourth unit in that city, we're seeing not an increase of by a third or fourth of the membership base, but a significant increase in sales. And I can't think of anything specifically. We're always doing things with -- Oh, David mentioned something here. One of the things we're in -- we should be doing shortly is having warehouse inventory online. So when you go online to -- now, I say that a couple of people in the room are smiling and says it may be a few months or a few more than a few months, but it'll be soon. But at the end of the day, if you look at something to buy online and we have it in the location or two in the zip code where you typically shop -- in the location you would shop physically, we'll let you know you can buy it there. And in many cases, it'll be cheaper if you go pick it up yourself because the online cost might be higher. It's typically higher, particularly on the non-food items. So, I think that's something that'll help that as well.
John Heinbockel: And secondly, is there any way to tell you think about email outreach. I mean, it seems to be getting better and more call to action. I try to think about the seven days of spring, which are in the middle of now. Is there a way to tell the productivity of that outreach? And is that driving some of the e-com pickup?
Richard Galanti: Absolutely. And yes, there is a way to tell. We're looking at it. Again, without going into a lot of detail, a couple of years ago, we brought in a new person in charge from IT in terms of all digital. He's built a team. They're working closely with merchants and operators, but mostly with merchants in terms of doing these types of things. And we've seen, again, lots of improvements with our app, with our desktop. It's getting less clunky by the day and more ability to do some items to drive sales and some promotions like that.
John Heinbockel: Okay. Thank you.
Operator: Our next question comes from the line of Chris Horvers with JP Morgan. Your line is open.
Chris Horvers: Good evening and we'll miss you, Richard, and welcome aboard, Gary. So, on the MFI, can -- did you mention how much the FX impacted total MFI growth year-over-year? And more broadly, it seems like it's becoming more competitive to acquire customers in the club channel. Couponing amongst your peers has really accelerated over the past year. Is that what you've observed? And do you think it's still escalating? And how are you responding?
Richard Galanti: I got to tell you, we in the last 12 months, we opened like 3% new locations. We had a 7%-plus increase in new members. So we're not finding -- we do a few promotional things, but I would say we have not increased the types of things we do at all. And you're right. At other places, there's not a day that goes by you can't get a deep discount, much deeper than we've even ever done on an ongoing basis. And so, no, we're not doing anything different. We're -- I mean, are we pleasantly surprised by the rate of new signups? Yes. It's nice to hear and have. And I think the fact that things like social media has helped us with the value proposition. And so, no, we're not doing a lot of things in that regard.
Chris Horvers: And just from a technical question, what are your peers talks about tenure renewal rate? The 93% that you quote, does that include like the year-one renewal or anyone that comes to the door on one of those digital coupons?
Richard Galanti: Yes. It does. And we've been doing the same way forever.
Chris Horvers: Got it. Thank you very much and best of luck.
Richard Galanti: Thank you.
Operator: Next question comes from the line Robby Holmes with Bank of America. Your line is open.
Robert Holmes: Oh, hey, Richard. My congrats as well. You will be missed very much. Listen, just a quick question. I love the credit card rewards program. It's amazing. It's like the best thing that's ever happened to me. The Citi Card you guys do. Is there any issue or change with the late fees or anything going on that could change the rewards program or anything there?
Richard Galanti: Well, that's the new recent headline of that's happening and we'll have to wait and see. Look, at the end of the day, it may change the economics. There are other levers that we've talked to them in the past, our issuing bank about what we could do, but nothing is done at this point.
Robert Holmes: Got it. Thanks again and congrats on your retirement.
Richard Galanti: Thank you.
Operator: Next question comes from the line of Laura Champine with Loop Capital. Your line is open.
Laura Champine: Thanks for taking my question and wish you a long and happy retirement, Richard. It is -- I'm going to go out on a nitpick on the renewal rate. If renewal rate is flat overall, but 10 bps better US and Canada, that seems to imply it's not as good in international markets. Is that just some of the sampling that went on in China or what do you think might be driving that?
Richard Galanti: Well, that's exactly what it is. When -- first of all, if you think -- if you just take the total number of members divided by total number warehouses, I think we're about close to 70,000 households per location. When we open a unit in, not only China, but other countries in Asia, we'll have anywhere from 80,000 to 150,000 members that sign up, many of whom we are looking to lose and a year later don't renew. We will start in some new countries with -- once the first batch renew for the first time, you might have a renewal rate in the 50%s or at best low-60%s. And then it just -- over the next four or five years, it continues to grow to something that's higher than that that's higher than that. That's more extreme than we saw 30 years ago in the US and Canada. But nonetheless, that's exactly what you see. So, when you're just opening the one unit in Shenzhen or whenever we open [Technical Difficulty] a year and a half ago in China, that's going to affect the international renewal rate. When we look at all other countries, when we look at the 13, the 11 other operations outside of US and Canada, their renewal rate generally ticks up a little bit every year, like the US and Canada. And US and Canada, by the way, has been helped also with increased penetration of executive members. We have that in several countries, but not all countries. The smallest countries, we don't have it in a number of units. And also with auto renewal, which has helped us in the last several years. And that's I don't believe everywhere.
Laura Champine: Got it. That's helpful. Once those clubs mature, the clubs in China, other clubs, new clubs in Asian markets, etc., do they tend to -- can you serve a higher number of households there? Meaning, would you expect them to be sustainably above that 70,000 or so households that you have in an average club?
Richard Galanti: Well, the answer is it is and it does. So, the answer is yes. Yes, I was at an open -- I was at -- two months after it opened in Osaka, Japan, back in October, and on a Sunday, a random Sunday was not there on business, but a random Sunday went over there. You couldn't move in the place. And it was -- and it was great. It was a wonderful picture to see. So, yes, I think that despite the fact that not everybody has cars and despite the fact that people have smaller housing arrangements, value plays well.
Laura Champine: Got it. Thank you.
Operator: Our last question comes from the line of Corey Tarlowe with Jeffries. Your line is open.
Corey Tarlowe: Hi. Good afternoon. Thanks for taking my question. And congrats Richard on your retirement. As it relates to big ticket discretionary items, it seems like that category has improved a little bit. Just wanted to get a little bit of understanding as to what you've seen that's underlying that improvement in trend. And then secondarily on AI, just curious with the recent technology enhancements that the business has made, how you see that impacting the business on a go-forward basis?
Richard Galanti: Sure. Well, in terms of big ticket discretionary, I think we completely believe that it's some of the things we're doing on our side to better explain the value. I mean, we -- it was almost like you did that and sales skyrocketed, 20% and 30% increases in some of those big ticket categories just over the last couple of months. Even if a piece of it is a year-over-year comparison, which I don't even know if it is or it isn't, at the end of the day, it was very evident to us. And the other comment I mentioned, particularly like on appliances, we're still a very, very small percentage of the total industry. And so it's easier to take market share when you're such a small percent of something. So, I think that'll continue. As regards to AI, we're just in the early innings of that. We've had third-party AI companies, large companies, including ones that are headquartered in Seattle, come out and talk to us. We -- where there's a whole list of things that we're doing with working with IT and our CEO and our heads of operations and merchandising to see where and how it might fit. So, that'll be a question for Gary in the future.
Corey Tarlowe: Great. Thank you very much, and best of luck.
Richard Galanti: Well, thank you, everyone. Again, it's been fun. The thing I miss most about the job is talking to everybody because I like talking. It's been a great story to tell, but it's been an absolute privilege and I appreciate it. So, have a good day and I'm sure we'll be speaking to some of you shortly over the next few days with additional questions. Have a good day.
Operator: Ladies and gentlemen, this concludes this conference call. You may now disconnect. |
MELI | 4 | 2,023 | 2024-02-22 22:15:22 | Operator: Hello, everyone and welcome to the MercadoLibre's Earnings Conference Call for the quarter ended December 31, 2023. Thank you for joining us. I’m Richard Cathcart, MercadoLibre’s Investor Relations Officer. Today we will share our quarterly highlights on video, after which we will begin our live Q&A session with our CEO, Marcos Galperin, Chief Financial Officer Martin de los Santos, Fintech President, Osvaldo Gimenez and Commerce EVP Ariel Szarfsztejn. Before we go onto discuss our results for the fourth quarter of 2023, I’ll remind you that management may make or refer to and this presentation may contain forward-looking statements and non-GAAP measures. So please refer to the disclaimer on screen which will also be available in our earnings materials on our investor relations website. With that, let’s begin with a summary of our results. Hello everyone. I’m delighted to share that MercadoLibre delivered solid results in Q4 marking a strong conclusion and outstanding year. Overall, 2023 highlighted their strength of our financial model and it’s future potential as well as a powerful impact of compounding of several years of investment in technology. For our commerce business it was a year of accelerated growth and market share gains in most countries. We achieved this but continued to make improvements and the value proposition to buyers and sellers in our marketplace. I would like to highlight three important initiatives that contributed to our success in commerce. We continued to invest in having the widest product assortment in order to offer the best buying experience to consumers. A key contributor to this was the acceleration of our first-party business, particularly in Brazil, where it grew by 81% in 2023. We continued expanding our logistic network with record fulfillment penetration of almost 50%, which provided an improved user experience to our buyers. This resulted in faster shipping and fewer late deliveries, particularly around the Christmas season. Our ads business continues to deliver impressive results, growing revenues at an accelerated pace. In 2023, we on boarded almost 50,000 new advertisers who appreciate the value of promoting their products on our parent regional platform. On the Fintech front, Mercado Pago maintained strong momentum as users and merchants continued to adopt our services. In acquiring business, we delivered solid TPV growth and gained market share in most countries where we operate, both in online as well as in-store payments. We made improvements in approval rates and deployed new features that enabled us to move up market, enhancing the value proposition to SMBs. In Fintech services, we have expanded our product offering and made improvements to user experience. The increased engagement with our products resulted in Mercado Pago achieving the milestone of surpassing for the first time 50 million active users in a single quarter. The credit business continues to be an important piece of our Fintech strategy, and it delivered another quarter of strong results with accelerated growth and solid spreads as we continue to cautiously manage risks. During Q4, Meli delivered strong financial results. Revenues grew by 42%, accelerating both in Fintech as well as commerce due to the strong execution during the peak season and investments we made throughout the year. For the quarter, we delivered a 13.4% EBIT margin, excluding one-off expenses from previous years as explained in the letter to share folders. This represents margin improvement from Q4 of 2022 while we continue to invest in building a logistic infrastructure, supporting our MELI+ loyalty program as well as expanding our credit card offering. Following our strong financial performance in 2023 it’s a good time to reflect on the journey over the past six years. During that time frame, we multiplied our revenues by 10x while achieving significant improvements in profitability, culminating in nearly $2 billion of operating income in 2023. In recent years, we have increased our investment in technology, which enabled us to launch multiple products and services and make significant improvements in user experience. We have grown our development team by more than 10,000 in the last three years alone and currently have 16,000 engineers who are constantly working to create the best experience for our users. We remain committed to our technology-led strategy in order to continue delivering sustainable results for Meli. We enter 2024 with optimism about our growth opportunities and confidence in our capacity to continue to execute on our strategy. Now, back to Richard to share some product initiatives from 2023.
Richard Cathcart: As a technology company with more than 15,000 developers, launching products and features is at the heart of our business as we continue to innovate. Innovation is about new products and businesses, but it's also about being attentive to and passionate about detail and solving multiple small customer pain points that compound into a great user experience. 2023 was no different. We've launched several new products and services such as the MELI Mas loyalty program, Meli delivery day, credit cards for consumers in Mexico and businesses in Brazil, amongst many other things. We've also vastly improved our core products with several new experiences that build onto our value proposition as we continue to strive to offer our users the best experience. Today, we want to share some of this year's highlights. In commerce, we continue to look at the specific needs of each vertical to improve the user experience as we believe this will drive offline consumption online. In 2023, we considerably improved the navigation in fashion, apparel and sports with standardized filters across brands and sellers. This enables consumers to find what they need more quickly. On the product pages, users can also see the more like this section to find similar items to a product that the user has clicked on rather than simply going back to the search results. This feature is powered by artificial intelligence. AI-based features are already an integral part of the Meli experience with many innovations launched in 2023, including a summary of customer reviews on the product pages that concentrates the main feedback from buyers of that product. On beauty product pages, a summary of products, functions and characteristics is automatically created that facilitate buyer’s choices. Push notifications about items left unpurchased in shopping carts are now highly personalized and remind users why they may have chosen to buy a particular product. We have also added an AI feature that helps sellers to respond to questions by preparing answers that sellers can send immediately or edits quickly. To deliver a better experience to our sellers, we launched a new version of the seller hub where they can see all of the promotional campaigns available for them to participate in. A new pricing tool also enables sellers to easily compare prices with competitors and or similar products and receive insights and recommendations on how to boost sales. In 2023, we also re-launched our ads tech stack. An automated buying platform was launched for display ads accompanied by live reports and unique insight analysis. We enhanced our bidding algorithm for product ads and introduced new placements on search and product pages that give more visibility to sponsored products. Our brand ad solution was also launched as a mid-funnel campaign option to enhance consideration for brands. Our platform also now includes a feature for agencies to be able to manage different brands through the platform. Brands, sellers and official stores can delegate certain products or even the whole assortment to a specific agency. The agencies are now available to manage all accounts delegated to them in one place. And to expand the possibilities given to advertisers, a new pool of custom audiences was launched and later expanded enabling advertisers to use filters to create an infinite combination of audiences for their campaigns. Finally, in advertising, MELI Play was launched as an ads-based streaming platform. Through a revenue share model with studios, we were able to offer free content to our users across the region enabling us to explore a new revenue stream for ads. In logistics, most of the technological improvements were behind the scenes and were crucial in helping us to maintain costs broadly stable as a percentage of GMV whilst expanding fulfillment penetration. We optimized routes from first to last mile, fulfillment-centered processes and demand prediction. On the UX front, buyers are now notified that their package is being delivered and can follow it through their app. And for sellers that adopt fulfillment, an enhanced tool to manage inventory brings more technology to the process flagging products that need to be replenished, how many units should be sent to us, amongst other things. At Mercado Pago, we continue to innovate as we consolidate our position as one of the region's leading Fintechs. In the acquiring business, the launch of the Mercado Pago tap brings a free POS option to merchants by turning their cell phones into a tool to receive payments via NFC technology. We also improved the pairing process of mobile POS devices with merchants' cell phones and worked behind the scenes to reduce processing times, which had a positive impact on NPS and helped to improve the experience of merchants and buyers. With more personalization in the Mercado Pago app, our seller homepage now prioritizes the features that merchants most need on a day-to-day basis. In Fintech services, we continue to search for ways to facilitate financial inclusion. We expanded our credit card offer to Mexico and launched our collateralized credit card solution in Brazil where the user receives a credit limit equivalent to the value of funds deposited into their account. These products enable consumers to start building a credit score and take advantage of the possibilities that a credit card brings for many for the first time ever. Innovations in credit enabled us to attract new users. For merchants, we now offer a business credit card using Open Finance to contribute to scoring. For consumers in our lower-risk cohorts, a new product enables them to opt for larger, longer-duration loans in our app, personalizing the loan to their needs and expanding the use cases of our credit product. As our product stack expands, we have focused on facilitating and simplifying navigation around all of the different products available on Mercado Pago. Our digital account homepage combines the most used features, such as transfers, credit limits, investment positions and insurance, adapting to the user's profile. We have seen increased traffic to all of our key digital account products as a result. Digital account users in Brazil can now see a summary of their monthly activity on a personalized report, an enhancement that brings more information to the user about their finances. The report also highlights new offerings that may be useful to the user, such as our certificates of deposit and investment funds, alongside credit products and our remunerated account. All of the innovations offered by MercadoLibre and Mercado Pago continue to have a deep, intrinsic impact in Latin America by generating economic and financial inclusion for entrepreneurs and individuals. A recent report in partnership with Euromonitor shows that MercadoLibre is the main source of income for 1.8 million families in the region and that for 54% of users in the region, Mercado Pago was the first digital payment method available to them. This was just a snapshot of the innovations delivered by our teams in 2023. In 2024, our users can expect even more because there's always a MercadoLibre. The best is yet to come.
Operator: Thank you. [Operator Instructions] Our first question comes from a line of Andrew Ruben of Morgan Stanley. Your line is open.
Andrew Ruben: Thanks very much for the detail and for the question. I'd like to dig in a bit on the logistics network. We see that the net shipping fees and some of the shipping costs looks like it was a bit more of a drag than in recent quarters. So I was wondering if you could help with what changed sequentially, whether it was more seasonality or if there's been, let's say, sequential changes in investment areas such as shipping campaigns or DC builds in the quarter. And then perhaps zooming out a bit on the logistics network, how you think about the state of the network, where you are for shipping fees, and how you think about the intensity of investment in those areas for the year ahead versus 2023. Any comment there would be very helpful. Thank you.
Ariel Szarfsztejn: Okay. Through compared to last year, lower delay rates, more fulfillment penetration, particularly in Brazil, and more free shipping coming from Melimise together with a network that has expanded over the year and particularly in Q3. So going to your specific question about margin compression or sequential margin compression, we also experienced some cost pressures during Q4 that you will see reverted in early Q1. And basically those headwinds in Q4 come mainly for the following reasons. Number one, this is the first quarter in which Melimise has been fully operating. And that means that we have increased the level of free shipping offered in Brazil and Mexico. I think we've discussed before Melimise is a strategic and long-term investment that we think will continue increasing loyalty and driving incremental orders and GMB. So it's a conscious investment on our part. Second, I think the growth of 1P in our business, who’s GMB was 50% higher quarter-over-quarter in dollars also acts as a headwind basically because there are no sellers paying for shipping revenues given that we are the sellers in the case of 1P. I think that's going to point number three. In previous quarters, we flagged that some of the shipping gains in terms of take rates were due to the negotiated postponement of cost increases from our suppliers after already having passed through higher prices to seller at the start of the year. And those costs are now hitting our P&L as we were expecting. And on the fourth, I think Argentina also added some pressure as we decided not to fully pass inflation through to our prices on the spot in an environment with accelerated inflation and a lot of uncertainty in the market. Of course, then you have peak season, which is the biggest component of the sequential compression of shipping costs. There is ramp up in capacity to be able to attend demand coming from our buyers. There is also an increase in unit costs coming from labor hours and bands and truck drivers, etcetera. And that is the biggest component of the sequential compression, which you will see probably reverted in early Q1 in 2024. Finally, and just to wrap up on this first part of the question, it's also important to note that we were expecting most of these increases in cost, and that is one of the reasons why we decided to increase our flat fees. So the charge that we make to the sellers when they sell items below the free shipping threshold. If you recall, we increased that fee in Brazil in approximately July or August, and we did the same in late Q3 in Mexico. And this is one of the levers we have used to manage our shipping P&L as well. And it's a good example of how we manage the profit and loss of the company in a consolidated manner and not on a line-by-line basis. So to your second part of the question, I think, as we've been saying many times, in the long run there will be opportunities for us to continue monetizing our logistics network. We are not desperate for that. We think long-term not only in monetization, but also in remaining competitive in terms of prices to our buyers and to our sellers, and we are conscious on how to execute around that opportunity.
Andrew Ruben: Very helpful, color. Thank you.
Operator: Thank you. One moment, please. Our next question comes from Irma Sgarz of Goldman Sachs. Your line is open.
Irma Sgarz: Hi. I hope you can hear me well. Connectivity has been a bit patchy. I have two very quick questions. Firstly, on Mexico, sequentially the margin was a little bit lower into the fourth quarter, which is obviously to be expected given the seasonality. But 1P, I think, plays less of a role here. So I was wondering if you could just elaborate on the drivers here. I imagine some of the logistics capacity ramp-up has to do with that. But is there anything else that we should be mindful of? And then on the commerce take rate, this builds a little bit on the earlier question, but we also noticed that there was a sequential decline quarter-over-quarter. And it is just basically sort of a reflection of and I'm excluding 1P here but is that just mostly really a reflection of category mix and logistics? And is there anything else at play that we should – in the revenues and shipping revenue dynamics that you just described – that we should be mindful of, especially as we look into 2024 and think about this line, whether there should be further compression coming into the commerce take rate? And maybe, sorry, if you can also add to that the influence that lower funding cost of rates that should be positive for the take rate. But I don't think we saw much of an effect, if I'm not mistaken. So if you could just also speak to that. Thank you.
Ariel Szarfsztejn: Hey, Irma. Ariel here again. So on Mexico's sequential compression, I think you were spot on with some of your hypotheses. And it relates to what I was explaining before. So everything that I just described about operating in peak season with building capacity before the event and increasing unit costs is actually more complex in Mexico for two reasons. On the one hand, in Mexico, during Q4, we opened three fulfillment centers and one cross-docking station, big cross-docking station. As we've been pointing out over the last few quarters, we have a capacity constraint there that we need to fix. And of course, whenever you open new warehouses such as these ones, the ramp-up process is a bit costly. And that's part of what has happened over the quarter. Secondly, our existing warehouses were operating at maximum capacity. And that also puts an extra pressure in terms of productivity for our fulfillment operations. So in the end, there's nothing that we were surprised about. We are managing the cost and the performance of the network. But we think we are in good shape for the future. So no comments on the second part of the question on some things that you should expect or that we should call out there.
Martin de los Santos: Irma, it's Martin here. Regarding the funding cost being lower, it should benefit the credit business, of course, because it lowers the cost of funding for that operation. So that should improve NIMAL. And it also should help us on both the commerce side as well as the Fintech side, because it lowers the cost of discounting coupons. So that should result in improvements in margins.
Ariel Szarfsztejn: So probably, let me be clear on that, Martin. Probably, you will see more of an impact with regards to the marketplace, where the fee we charge for including installments is fixed on the Fintech side of business, on the acquiring side of business. Many times when the funding cost is lower, we end up passing some of those savings to consumers. And that is not as straightforward in the marketplace. Thank you, Irma.
Operator: Thank you. One moment, please. Our next question comes from the line of Robert Ford of Bank of America. Your line is open.
Robert Ford: Good evening, everybody, and congratulations on the quarter. I was curious, how should we think about service transfer pricing and the recurring tax impact on profitability? And when it comes to advertising, how should we think about ad penetration rates in 2024 and the receptiveness of the product stack with larger display advertisers now that they've had time to really understand the product and maybe build their budgets coming into this year?
Martin de los Santos: Hi, Bob. I think you're referring to the withholding, the incremental withholding tax that we started booking this quarter, as we explained on the short-hold letter. I think if you, obviously, it's a big charge, and this is the reason why we excluded from the results, to explain results, because it generated a big distortion in Q4 results. That's to put in perspective a full charge of roughly $350 million. Only 6% of that corresponds to this particular quarter. The way to look at that is by roughly, I would say, $20 million incremental cost per quarter will resolve for this incremental tax that we're going to be starting to provision from now on. Just to complement that, keep in mind that the $350 million one-off charge were fully funded because throughout the last 10 years, we're funding a judiciary account with those amounts. So if in the event that we lose this case, we will continue disputing it, the event that we lose it, it will not have a material cash impact on our results. So in summary, I think it's about $20 million per quarter, the impact going forward.
Ariel Szarfsztejn: Bob, this is Ariel. So going back to your question on advertising, I think, start by saying that we are extremely pleased with the ad result from the quarter. Our revenues grew 72% year-over-year on an FX neutral basis. It's the seventh consecutive quarter going above 70%, and that's driven mainly by Brazil and Mexico. I think as we mentioned in our shareholder letter, we added 53,000 new advertisers this year, and this is a great achievement and shows how strong the level of interest in our product is today, and we expect to build on that in the coming quarter. On sequential penetration, I think while ads continue to grow at a very fast pace, GMV accelerated at an even faster pace this quarter, and it is the case that ad revenue does not necessarily follow one-to-one the growth pattern of our GMV. Particularly during Q4, our GMV accelerated from 59% growth in Q3 to 79% in Q4, and it's worth maybe highlighting the case of Argentina, which represents 20% of our GMV, but only around 10% of our ad revenue. That's the main offender for sequential penetration. In such a high inflation context, the lack of stocks in the seller hands disincentivized some of the ad investments, and simultaneously, advertisers were not necessarily updating their investment amounts together with their item prices, and for that, we did already deploy some features that automatically update ad budgets whenever there is an inflationary context in item prices. So, as I was saying before, we remain extremely confident in our product stack, and we see ample opportunities for growth in the coming years. Regarding display, it's been not so long for our current product format to be live, and we are going through the learning curve in terms of go-to-market strategies, as well as the brands are still learning about branding possibilities in MercadoLibre. So, we believe in the product that we have, in the value proposition we are offering with display ads as an awareness tool for one of the largest audiences in Latin America, but we need to be patient, and we think that we can continue building on the product we have to gain even more traction and make a display an even bigger business for MercadoLibre and for our sellers.
Robert Ford: A very helpful idea. Thank you so much.
Operator: Thank you. One moment, please. Our next question comes from the line of Kaio Prato of UBS. Your line is open.
Kaio Prato: Hey. Good evening. Thanks for the opportunity. So, I have one question on the credit portfolio, please. I saw your origination was much higher this quarter, and you mentioned that your own credit card is one of the most used in your platform, I think among the five most used. So, I just would like to have a sense about how much of this origination is coming from the credit card, and how are you seeing the contributions specifically of the credit card in your GMV today? In other words, what's the level of GMV penetration today versus one year ago? And finally, what makes you comfortable with the credit card origination today? Because we are already seeing some spike in short-term NPLs, which is attributed to this product. Thank you.
Ariel Szarfsztejn: Hi, Kaio. Let me start by the end, and then I'll go back to the first questions. With regards to what makes us more comfortable, we first launched credit cards in Brazil three years ago, and we have been iterating the models we use to score grades. We have done many iterations, several every year. And each iteration we do, we get better results. We saw the credit situation overall in Brazil worsened a year and a half ago, two years ago. So we were more cautious. And now, throughout last year, we started feeling more and more comfortable, and we have been increasing the amount of origination in Brazil. And also, we launched a credit card in Mexico, and we've been, I would say, aggressive in rolling it up. When we look at, as we say in the shareholder letters, when we look at total payment volume for our credit card, year-over-year, it has grown well above 100%. So we have been aggressive with regards to that. In terms of portfolio, there has been high origination. We have not disclosed the origination amount, but we have disclosed the total portfolio. And you can see how the chunk coming from the credit card is growing. It has reached $1.2 billion, which is nearly 100% growth versus a year ago. And on top of that, I would say that the credit card is growing in exactly the way we expected it to grow. We are expanding in the lower segments and also starting to have a little more traction in the higher segments. And the penetration we see in the marketplace is growing in Brazil and in Mexico. And most importantly, when we look at the total penetration of credits in the marketplace, which adds our consumer loans and our credit card is growing significantly. So it's not that we are cannibalizing consumer loans with a credit card, which has probably lower profitability per transaction, but rather that we are adding to that number.
Kaio Prato: Okay, thank you. Can you share the level of penetration nowadays in your platform?
Ariel Szarfsztejn: I would say this is, we have not disclosed the precise level. We can disclose that this is the largest means of payment we have today in Mexico.
Kaio Prato: Okay, thank you very much.
Ariel Szarfsztejn: Credit, I mean, no total payments. All of the credit products available are on credit and credit card is the largest one.
Operator: Thank you. One moment, please. Our next question comes from the line of Maria Infanto. Your line is open. Pardon me, Maria Clara Infanto. Your line is open.
Maria Clara Infantozzi: Hello, everyone. Good evening. Thanks for taking my question. So I would like to explore the profitability of the 1P operations in the release you mentioned that you achieved better profitability trends, despite the seasonality of the business in the fourth quarter. So can you please give us more granularity on how the contribution margin of the business has been evolving lately? We feel that the accelerated growth of the category has been allowing you to have better negotiations in terms of suppliers. And how do you feel about the growth potential of the channel going forward? How far are we from reaching an optimum stability level in the division? Thank you.
Martin de los Santos: Hi, Maria. Thank you for your question. Yes, we have made significant progress in the 1P business throughout the year, and we feel that we are a much more sustainable footing today than we were a year ago. As you say, we made improvements on margins. We look at our product purchase margin has improved a few percentage points in 2023, and we expect to continue improving that. That gave us confidence to grow our business, and we did grow it in Q4 by 60% year-on-year in dollars and 85% in local currency, taking advantage of the obviously the peak season that we had in Mexico as well as Black Friday. So we are making significant progress. As I mentioned, one way of looking at the 1P business is obviously we don't share the actual profitability of the business, but I can give you some guidance in terms of how we're doing. If you were to look at the 1P business now, it is profitable before considering fixed costs and including all variable costs, that is shipping as well as financing. So one way to look at it is the more volume we have, the better we dilute the fixed cost of that business. So we are at a point where we feel that we can scale the business and should start to contribute to lower the deficits that we have in terms of area. Finally, we think we have plenty of room to continue to attach more advertising into that business, and that creates a big opportunity to continue improving profitability of 1P.
Ariel Szarfsztejn: Ariel here, just to complement Martin. So we continue to think that 1P is strategic in order for us to sustain our competitive position, to gain market share, and more importantly, to satisfy customer demands through better selection and price competitiveness. So we continue to be strategic in deciding which categories and products we serve with 1P while simultaneously optimizing our consolidated P&L. So while we don't have a specific target regarding 1P penetration for the future, we are encouraged by the progress we've made in terms of profitability, in terms of supplier relationships and operating processes. And the more confident we feel about that, the more confident, the more probability that we could scale in the future, and the bigger we get, the more benefits of scale we will capture, as Martin was saying just before. Having said that, there is seasonality in terms of category demand and the role that 1P plays in the different categories, particularly consumer electronics was a high demand category during big season, and it's one category where 1P plays an even more strategic role for us. So to wrap up, we have many initiatives in place to continue improving our retail business, both in terms of economics as well as in terms of selection, price management, and supplier relationships, and we'll continue to work on that.
Maria Clara Infantozzi: Perfect. Very clear. Thank you.
Operator: Thank you. One moment, please. Our next question comes from the line of Trevor Young of Barclays. Your line is open.
Trevor Young: Great. Thanks. First one, just to build on the earlier question on advertising, can you remind us where we are in terms of penetration on a geographic basis? I think to your earlier comments, advertising may be remaining softer in Argentina and perhaps stronger in Mexico and Brazil. Just any numbers to help kind of frame the progression there, particularly as the GMB growth in Argentina is probably optically making that ad penetration look weaker. And then secondly, in Argentina, items growth accelerating for the second straight quarter up 22%, I think. How much of that is related to kind of the worsening inflation dynamic in that market and more of that pull forward of consumption versus maybe some improvement in consumer demand? And just appreciate that you don't give any guidance, but at a high level, do you think that degree of unit growth is durable? Thank you.
Ariel Szarfsztejn: Hey, Trevor. Ariel here. I think we don't disclose specific numbers in terms of penetration by country, but we have shared that while the overall ad revenue penetration as percentage of GMB was 1.6% in Q4, if you were to exclude Argentina from that equation, you would get something like 1.9. So Argentina is definitely a big detractor in terms of measuring ad revenue as percentage of GMB.
Martin de los Santos: Yes, and the successful item sold that you mentioned in Argentina is just like you said, we saw the first half of the year where items were flat year-on-year, mainly because of the recession that we faced in the first half of 2023. Then the second half was a government put more money in people's pockets. We saw a pickup in volume, both in terms of GMB and item sold, which increased 12% in Q3 and accelerated to 21% in Q4. And that part of that is inflation, is like advanced purchases ahead of expected devaluation towards the end of the year, which eventually happened in December with the new government and towards the second half of December. We saw a slowdown of those volumes. But that's correct, your assumption about our consumption.
Trevor Young: Great. Thank you both.
Operator: Thank you. One moment, please. Our next question comes from the line of João Soares of Citi. Your line is open.
João Soares: Hi, thank you. Yes, just one more one question on my end. I just wanted to get, I'm just trying to understand the different moving parts for the operating profit margin thinking about 2024. I think you mentioned that we should see some reversion in terms of the logistics cost pressure rating in the first quarter. And of course, we have, structural growth, the 1P business, of course, affected by naturally, there's going to be seasonality, but on a more on a year, we should see an increase in penetration of the 1P. So just want to try to understand, different moving parts, also taking into consideration that you're growing, again, your credit portfolio within credit cards, which should come with increasing provisions. So I know it's, I don't want to see a forward looking statement, but just trying to understand what should we have in mind for different moving parts for your operating profit margin. Thank you.
Martin de los Santos: Thank you, João for your question. First of all, I will discuss a margin. Let me verify that all the numbers that we'll be discussing, contemplate the adjustment for the $351 million of one-offs, given the size of it, we felt that it was easier to explain and taking those, that one-off out and obviously, including the appropriate cost corresponding to this particular quarter. I would say that if you look at margins on a year-on-year basis, excluding the one-off that I mentioned before, we improved margins by 270 basis points because of expanding the business and basically growing the business and diluting our fixed costs, while at the same time, we continue to invest behind the many growth opportunities. One of them is credit cards, as you mentioned, but also fulfillment and several other things that we're doing at the company. This is something that we plan to continue. We think that we run a business that should scale very nicely in the long term and we'll continue to focus on managing costs very efficiently and as we continue to grow the business, we should be able to continue scaling in the long term. Q4 in particular is a quarter with seasonality in terms of lower margins because of investments that we make in commerce, particularly behind the special events of Black Friday and Blue Wednesday. Furthermore, during Q4, we intensified certain investments, as Ari mentioned before, such as fulfillment, 1P, and free shipping. If you were to look at the sequential compressions of margins, we have roughly four and a half points of compressions in margins. That compression comes mainly from 1P and shipping, which affects our cost of goods sold. In terms of our 1P business, two-thirds of the compression comes from the 1P business, as Ari mentioned. The revenues of 1P grew from 9% to 12% of total revenues. You can see that in our disclosures. And as you know, 1P has a different margin structure than 3P because almost 100% of the GMB is booked as revenues compared to just the take rate of the 3P business. So although there was pressure on the margin, the incremental negative impact on EBIT due to 1P was only $20 million during the Q [ph]. On the other hand, we generated more than $220 million incremental GMB from 1P, which resulted in market share gains of almost 10% of points on consumer electronics category, as Ari was mentioning before. The other part of the compression comes from shipping. As Ari mentioned, there is a seasonality factor in shipping during Q4, which comes with higher costs associated with peak seasons. It happened this quarter, and we expect this trend to revert back to normal the following quarters. And then finally, investments that we're making, and we have been flagging over the last few quarters to the market, investments on a value proposition, which includes the launching of more fulfillment centers. We launched three. We implemented three new fulfillment centers this quarter. The increased adoption of Melimise, which resulted in higher levels of free shipping. We put all those together. That explains the compression that you see quarter-on-quarter.
Ariel Szarfsztejn: Let me add to that your question regarding credit portfolio and provisions. Throughout this year, we have been able to expand our credit portfolio and furthermore, gain share in credit cards. Despite that, we have been able to increase our net interest margin after losses and also decrease NPLs, which have pierced 30% for the first time in quite some time. Again, we don't guide, but we are confident with how the credit business is evolving.
João Soares: Perfect. Thank you so much.
Operator: Thank you. One moment, please. Our next question comes from the line of Deepak Mathivanan of Wolfe Research. Your line is open.
Deepak Mathivanan: Hey, guys. Thanks for taking the questions. I apologize if this was asked already, but one big picture question and then one tactical one. If you think about logistics, what are the big initiatives for 2024, maybe with respect to expanding the fulfillment centers or the middle mile and last mile operations? How should we think about the CapEx levels as we progress through the year? Then second one on competition, e-commerce players from China have cost pretty significant shifts and moved into the U.S. It is anticipated in several Latin markets. Can you share any color on your thoughts and how you're positioning the business for any sort of potential competitive intensity growing? Thanks so much.
Ariel Szarfsztejn: Hey, Deepak. How are you, it’s Ariel. In terms of logistics, I think we don't guide and we don't disclose future numbers in terms of performance, etcetera. But just to reiterate what I said and Martin tried to explain. So most of the sequential compression on logistics was coming from peak season cost, which has been reverting during early Q1. So that's important. Having said that, we have many, many projects on hand to execute during 2024, none of which we think should drastically change the way we manage our P&L. We will invest in faster delivery. We will continue investing in slower delivery simultaneously. We will continue testing more automation and robotics as we have been doing so over the last few years. We will continue working with our technology team. We have thousands of developers fully dedicated to improving the processes and the experience of our customers with logistics and the way we operate inside our warehouses and processing stations. So all-in-all, we will focus in becoming more efficient, in serving our customers better, in improving our delivery promises and execution, and to support the business of the marketplace with more categories and better services. Regarding the Asian competition, I'd say we've seen Temu in particular more present in Mexico over the last few months. But still, as you can see from our results, we grew 32% year-over-year in items sold in Mexico. So we are extremely pleased with how we are executing in the countries. All categories in Mexico are showing good year-over-year GMB growth. While we see some of the Asian players focused on apparel and home and mostly focused on low ASP items, we see our growth in those segments extremely healthy. So in the end, we are confident that our competitive advantages, particularly logistics and payment, remain strong. We have a unique logistics network. We have a unique buy-now-pay-later and credit card offering in Brazil, Mexico, etcetera which we think will continue helping us drive our business and our market share gains in those markets. So to wrap up, in the past several years, we have been successful in competing against Asian players who were executing strategies similar to the ones that current players are executing. So we expect to continue doing so in the future, building on our strengths and successfully competing against whoever is operating in each of the markets where we are.
Martin de los Santos: Just on your question on CapEx, obviously we don't guide future expenditures, but this year, 2023, was roughly $500 million invested on CapEx, which was fully funded with our own cash flow generation.
Deepak Mathivanan: Okay, thank you so much.
Operator: Thank you. One moment, please. Our next question comes from the line of Marcelo Santos of JPMorgan. Your line is open. Pardon me, Marcelo Santos, your line is open.
Marcelo Santos: Thank you. Sorry for having a bad line. Thanks for taking my question. My first question is about MELI Mas. Is MELI Mas net negative in terms of P&L? I understand it has recurring benefits and has a lot of loyalty benefits, but when you think about the P&L impact, is it negative now and should it remain negative in the future? That's the first question. The second question is, did you also see this seasonal, this peak cost last year, or was something that you had stronger this year because you were running at fewer capacities? Thank you.
Operator: Thank you. One moment, please.
Ariel Szarfsztejn: Thank you for your question. The first part of the question was related to MELI Mas. Okay, sorry. We don't look at MELI Mas as an individual P&L. We look at this as a way to generate incrementality in our marketplace. You break it down between content. Content is basically cost neutral because we pass on the benefits that we get. Basically, the cost that we pay for the content, we pass it on to our consumers. And then the shipping, obviously, we provide more free shipping, but that generates incremental volume that then in turn should finance that operation. In the short term, we are investing behind this initiative because we're also investing in advertising, but it shouldn't be looked at as an individual P&L and more so as part of the critical part of our strategy for commerce.
Martin de los Santos: And then regarding the peak season, if we saw a particular peak, a special peak in terms of cost, probably this quarter, the incrementality of cost due to peak season was a little bit higher than we saw last year. But again, as Ari mentioned, this is something that we'll revert in the following quarters. And I was expected to have a peak in incremental cost during peak season.
Marcelo Santos: Thank you very much.
Operator: Thank you. One moment, please. Our next question comes from the line of Soomit Datta of New Street Research. Your line is open.
Soomit Datta: Hi there. Yes, thanks very much for taking the question. Just one at this stage, please. On Argentina and the Fintech business, as we kind of contemplate entering a recessionary environment in Argentina, how should we think about the Fintech business? The e-commerce business is a bit more kind of logical to me in that sort of environment in terms of thinking about consumer demand, et cetera, units sold. But just on the Fintech side, it's not clear to me kind of what the drivers will be exactly under that scenario. If you could kind of help me with that, that would be great. Thanks.
Ariel Szarfsztejn: I would say, let me try to split the question between the different businesses we have. With regards to acquiring, I would say it's a business that also is very much independent of there being a recession. No, obviously, the volumes are impacted, but we are growing so much by gaining share, and the impact tends to be, could be smaller. Let us not get into what will happen in the future, but it's a business that people still continue to sell and process payments. So it will come by a little bit, is basically the growth rate, but no more than that. Where we've been more cautious is on the Fintech services side of the business on issuing credit. We don't have yet a credit card in Argentina, and we have been more cautious throughout the fourth quarter, even before the elections, knowing that there could be an evaluation and there could be increased NPLs. And that's why we were already more cautious towards the end of last year, and most of the volume growth you saw is coming from Mexico and Brazil and not from Argentina. And then we'll see what happens with the other Fintech service products. What we're seeing today is an inflation that in Q4 and even today has peaked and is higher than it was, and that is a further incentive, and we have seen that for people to bring money from their bank into the Mercado Pago account, which is currently remunerating 80% year-on-year, and it's a huge advantage versus zero at most banks. So we saw throughout the fourth quarter an increase in asset under management. You don't see that in total numbers because the evaluation at the end of the year, but in local currency, we grew assets in our account by 6x year-over-year. So I would say that I'm comfortable with the impact we saw towards the end of last year. We cannot predict what we don't forecast what will happen in the future.
Martin de los Santos: And if I may complement, the credit business in Argentina continues to have the lowest NPL compared to all other markets, and it continues to be extremely profitable.
Soomit Datta: Great, thank you.
Operator: Thank you. One moment, please. Our next question comes in line of Neha Agarwala of HSBC. Your line is open.
Neha Agarwala: Hi, thank you for taking my question. A quick one. I noticed that the ticket size for your credit card loans across the segment have been coming off. Is this a conscious decision, or is this a trend based on the demand that you're seeing from your client? And any color on the credit uptake in Mexico, what kind of products are working in Mexico? How is the response on the credit card? That would be very helpful. Thank you so much.
Ariel Szarfsztejn: Let me start with the first part of the question, and then take on the second one. The first one, I would say, with regard to the credit card loans, they have been falling. It has been totally been a conscious decision. What we have been doing is reaching out to more consumers who did not have a credit card in the past with micro lines, what we say that is typically 100 or 200 [Indiscernible] lines. So it's really small lines. And also with what we call warranted cards, where we ask people to deposit 100 or 200 or 300 reais in their account and offer a card that is warranted by that amount. So definitely, that has been part of our strategy in order to be, for many of these people, the first time they get a credit card. And with regards to, you mentioned credit uptake in Mexico. I would say that basically, we have been growing a lot. First, the credit card, which is the latest product we launched, and has been a quite successful launch. And when you look at the combined volume we are loaning to consumers, adding the consumer loans to the credit cards that business has also been growing nicely.
Neha Agarwala: Just in terms of the asset quality trends that you are seeing in Mexico.
Ariel Szarfsztejn: Sorry, could you repeat the question, please?
Neha Agarwala: Asset quality trends for both the consumer lending and the credit card book in Mexico. Is it better than Brazil? Has it been improving? Or are you cautious there? Thank you.
Ariel Szarfsztejn: It has been, remained fairly stable. The profitability has continued to be good.
Neha Agarwala: Thank you so much.
Operator: Thank you. One moment, please. Our next question comes from the line of Marvin Fong of BTIG. Your line is open.
Marvin Fong: Excuse me, did you say Martin Fong? I thought you cut out there. But thanks for taking my question. Two, if I may. First, I think maybe you touched on this earlier, but the Fintech take rate, I think there was some compression there, part of which was related to financing costs. And I think in prior quarters, we had thought that perhaps the take rate would fall kind of in step with funding costs. You see some spread compression there. Any thought about how you should think about that going forward? And then second question, just to touch again on the credit portfolio, the consumer loan balance fell a little bit quarter-by-quarter. So was that a function of what you were saying about Argentina and pausing there? Or was it some currency issues or any kind of highlight there? Is it sort of you're focusing more on credit card and maybe the consumer book won't have as much growth for the time being?
Ariel Szarfsztejn: I would say on the Fintech take rate, part of the impact is larger portion of our credit book coming from credit cards, which have the portion of those loans that are interest bearing are lower than in the other kind of loans. That has some impact to that. Also, on the other part of the Fintech business, when you look at our acquiring business, as we move into SMBs, they typically have slightly lower take rate, albeit with significantly larger volume. I would say those have an impact on the overall take rate. The second one you mentioned, if I got it right, was there was an impact in the credit portfolio because of the Argentina devaluation, right?
Marvin Fong: It's sort of a part of the question. I was just noticing the consumer loan kind of fell very, very slightly quarter-by-quarter. I was hypothesizing that perhaps there might be some currency impact or just or there's something else behind that.
Ariel Szarfsztejn: Yes, there was some impact for two reasons. The first one is in the fourth quarter before the elections, we were more conservative in issuing credit in Argentina. The second one is more direct, which is the currency devaluation. Since we take the portfolios at the end of the quarter, the devaluation happened throughout December and the forwarded loans portfolio we're showing in Argentina is devalued already.
Marvin Fong: Okay, understood. Thanks so much.
Operator: Thank you. I'm showing no further questions at this time. Let's turn the call back over to Martin de los Santos, CFO, for any closing remarks.
Martin de los Santos: Well, thank you, everybody. As we mentioned, we are super excited with the result of the quarter that we're closing a great 2023. And we look forward to seeing you when we present results of Q1 of 2024. Thank you very much.
Operator: Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day. |
BKNG | 4 | 2,023 | 2024-02-22 21:03:03 | Operator: Welcome to Booking Holdings Fourth Quarter and Full Year 2023 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical fact are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings’ actual results to differ materially from those described in the forward-looking statements – please refer to the safe harbor statement at the end of Booking Holdings’ earnings press release as well as Booking Holdings’ most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings’ earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings’ website at www.bookingholdings.com. And now I’d like to introduce Booking Holdings speakers for this afternoon, Glenn Fogel and David Goulden. Please go ahead, gentlemen.
Glenn Fogel: Thank you, and welcome to Booking Holdings’ fourth quarter conference call. I am joined this afternoon by our CFO, David Goulden. I am pleased to report a solid finish to 2023 as fourth quarter room nights slightly exceeded our expectations and grew a bit more than 9% year-over-year or 11% when excludes Israel from both periods. When compared to 2019, our room nights grew 21% versus our expectations of 20%. We delivered record fourth quarter revenue of $4.8 billion and record adjusted EBITDA of $1.5 billion, which were ahead of our expectations. Finally, the GAAP and earnings per share in the quarter grew 29% year-over-year, helped by the reduction in our share count versus last year. At the start of 2024, we continue to see resiliency in global leisure travel demand. As we look to the year ahead, we see strong growth on the books for travel that’s scheduled to take place in 2024, which gives early indications of potentially another record summer travel season. As we’ve noted previously, a high percentage of these bookings are capable and what is on the books today for the summer period represents a small percentage of the total bookings that we expect to ultimately receive. David will provide further details on fourth quarter results and on our thoughts about the first quarter and full year 2024. Looking back at the full year of 2023, I am proud of our efforts to drive more benefits to our travelers and supply partners while also delivering record-setting industry-leading financial results. We reached a significant milestone last year with our customers’ booking an all-time high of over 1 billion room nights on our platform, which was an increase of 17% versus 2022. Gross bookings of $151 billion increased 24% versus 2022. In 2023, we reached a new revenue record of over $21 billion, which was 25% higher than 2022. We achieved this strong top line result while improving our profitability with record adjusted EBITDA of $7.1 billion, an increase of 34% versus 2022, and our adjusted EBITDA margin expanded by over 2 percentage points year-over-year. Our non-GAAP earnings per share of about $152 increased 52% year-over-year and was 48% higher than our prior full year all-time high back in 2019. Across all of our key metrics in 2023, we were a meaningfully larger and faster-growing business than we were in 2019. Our ambition going forward in a normalized growth in market for the travel industry is to continue to grow our gross bookings, revenue and earnings per share faster than we did in 2019. We are confident we will achieve these objectives because we’ve invested in building a stronger business and better product offerings for our travelers and partners that we had back then. We can see this in many areas, but I will highlight a few examples of where we have strengthened our offering relative to 2019. We now have a scaled up merchant platform at Booking.com, which processed first half of Booking.com’s gross bookings in 2023. Our merchant offering brings many benefits to our travelers and partners as well as new strategic benefits to us, including the ability to merchandise. We have continued to scale up our offering at Booking.com since in 2019, with total company air tickets booked in 2023 up more than 400% over that time frame, primarily driven by Booking.com. We see this vertical bring new customers to our platform while delivering a more complete offering to our existing customers making travel planning and booking easier for them and creating opportunities to provide more value to them. On alternative accommodations, we continue to increase the mix of our alternative accommodations room nights, which treats 33% of Booking.com’s room rights in 2023 as we improve our product offering and increase our supply choices with further opportunities ahead, particularly in the U.S. Early, we are pleased that for Booking.com, we have created foundations necessary to offer insurance, attractions and ground transportation options and expect these offerings to add value to our connected trip vision. On marketing, we’ve improved our abilities in using performance marketing channels even more effectively and are now better focused on our brand spending. On loyalty, we’ve expanded and enhanced our loyalty program, Booking.com to deliver more benefits to more of our traveler customers with more of our property and rental car partners participating. And lastly, we are continuing to strengthen the direct relationship with our travelers as our mobile app room nights and total direct room nights continue to increase in our mix. We remain confident in our long-term outlook for the travel industry, which we believe will grow faster than GDP growth across our core markets. With that foundation of industry growth and the improvements we’ve made to strengthen our offerings, we are positive about our future and believe we are well positioned to deliver attractive growth across our key metrics in the coming years. With our long-term positive outlook, solid financial performance and strong balance sheet, we returned over $10 billion to shareholders during 2023 by repurchasing our shares. Returning capital to shareholders will remain a high priority for the company going forward. And today, we are taking another important step in that journey by announcing that our Board of Directors has declared a quarterly dividend to complement our existing share repurchase program. David will provide further thoughts on our approach to capital returns in his remarks. In addition to our strong financial results in 2023, we made meaningful progress against our key strategic priorities, which include: advancing our connected trip vision, further integrating AI technology into our offerings, supporting our supply partners and growing alternative accommodations and building more direct relationships with our traveler customers. Let me address the progress we have made in each of these areas. On the connected trip, we continue to take steps towards our long-term vision to make planning, booking and experiencing travel easier, more personal and more enjoyable, while delivering better value to our travelers and supplier partners. We believe this is important because we know the current travel experience is much more complicated, fragmented and frustrating to travelers than it should be. The contribution aims to greatly improve that experience for consumers which we believe will drive further differentiation of our offerings and lead to improved loyalty, increase direct bookings, higher frequency and a greater share of total travel spend on our platform over time. This is good not only for our travelers, but also for our partner suppliers who will be able to utilize different elements of the connected trip to obtain additional business in an efficient and lower cost way. As we continue to make progress in developing the connected trip, you will see incremental improvements and enhancements to our platform that moves us closer to this long-term vision. This approach allows us to realize benefits while we are building towards that future state. In fact, some of the key improvements to our platform over the last few years that I spoke about earlier were driven by our work on the connected trip. For example, our emerging platform at Booking.com is a foundational base to the connected trip, and it helps deliver a more seamless and frictionless booking experience for our travelers. Plus, it enables us to smartly merchandise a variety of partner and self-supply offers when appropriate. Another example would be the development of flights on Booking.com, with flights being one of the most important elements of travel outside of accommodations. In 2023, air tickets booked on our platforms increased 58% year-over-year driven primarily by the growth of Booking.com site offering. We continue to see a healthy number of new customers to Booking.com through the flight vertical, and are encouraged by the right that these customers book other services on our platform. Outside of flights and accommodations, we need solid progress in expanding the breadth of our attraction supply that is available to our travelers. While we do not expect attractions to be a major financial contributor on its own, we see benefits from a strong attractions offering given the potential bundling opportunities as we will see ability to increase traveler engagement with the app while travelers are in destination. Overall, we believe we have made great progress in building toward our Connected revision and we are starting to see early signs of the benefits. We continue to see a growing percentage of transactions, which we count as connectors though these are still a small percentage of our total transactions today. Importantly, we see these types of customers returning to us more frequently, and we point to experiment with expanding Genius program to include all travel verticals in 2024, which we expect will drive more value to travelers across the different elements of the connected trip. We plan to continue to build out our Connected Trip vision, which we believe will result in increased travel and supplier engagement with our platform. In order to achieve the easier and more personalized experience of the Connected Trip, we have always envisioned AI technology playing a central role. Over the last few quarters, I have discussed the hard work our teams have been doing to integrate generative AI into our offerings in innovative ways, including Booking.com’s AI trip planner and Priceline’s generative AI travels – named Penny. After launching Booking.com’s AI trip planner in the U.S. last summer, we expanded the rollout to the UK market in the fourth quarter. At this early stage, the team remains focused. I learn more about customers who want to interact with the tool and what types of questions they will ask. We see the AI trip planner is getting better answering customers’ inquiries and we are excited to start testing other verticals out of accommodations. At Priceline, last week, they announced their weaker product release, which included several enhancements to Penny following 6 months of real-world interaction with users that resulted in valuable learnings from the Priceline team. Priceline’s AI travel assisted product can now help travelers be on just the hotel category as it now covers flights, car rentals and vacation packages. While was nicely launched at the end of the booking funnel on the checkout page, it is now available on the Priceline homepage where it can help with travel planning, booking and modifying a trip as we booked. This is a clear example of how our teams iterate and enhance our AI-powered products as we learn more through user interactions. We continue to see encouraging signs that Priceline’s Penny product helps lower customer service contact across travel verticals, and we believe, improves the customer experience. Beyond improving customer service contact rates, we believe that, over time, we can leverage generative AI technology to help make our customer service agents more efficient across our entire Outside of customer service, we continue to explore areas where we believe we can use generative AI tools to increase productivity. We have early indications that using generative AI enhances the productivity of our software developers and are encouraged by the results so far. We look forward to experimenting with these and other ways Gen AI tools might make our business more efficient in the future. Turning to our supply partners. We strive to be a trusted and valuable partner for all accommodation types on our platform. And we look to add value for our partners by delivering incremental bookings and developing products and features to help support their businesses. The majority of our partners are small independent businesses, and we are pleased to see many are reporting significantly improved business performance over the last year. We believe that helping our smaller partners thrive contributes to the long-term diversity and sustainability of our sector. One area in which we work with many small independent businesses is through our alternative combination offering comp. This is an area which we have continued to strengthen our business, increasing supply and raising product awareness on many travelers. Also combination room nights grew 19% year-over-year in the fourth quarter and 24% for the full year, which was faster our traditional hotel category. We saw meaningfully higher growth in our U.S. alternative accommodation room nights, though this is all a relatively small Globally, alternative accommodations represented about 33% of Booking.com’s total room nights in 2023, which was 3 percentage points higher than in 2022. Our strong trend of accommodation room nights growth is benefiting from having more listings available on our platform were travelers to choose from. We are seeing continued momentum in annual turn combination supply both globally and in the U.S. with global listings reaching about 7.4 million by the end of 2023, which is about 12% higher than the 6.6 million last year. We’re focused on continuing to build on this progress by further improving the product for our supply partners and travelers, particularly in the U.S. For our travelers, we remain focused on building a better experience that leads to increasing loyalty, frequency, spend and direct relationships over time. I am encouraged that in 2023 at Booking.com, we had strong growth in our base of our peak bookers, demonstrating strong retention, while we’re also pleased with the increase in the number of new users to our platform versus 2022. We’re also strengthening the direct relationship with our travelers as our mix of customers booking directly on our platforms continues to increase year-over-year in the fourth quarter and when measured for the full year. We see a very high level of direct bookings in the mobile app, which is an important platform as it allows us more opportunities to engage directly with travelers. Our mix overnight through our mobile apps increased year-over-year by about 5 percentage points for the full year to 49%. Booking.com remained the number one downloaded travel app in the world in 2023. In Asia, Booking.com and Agoda are top five travel apps. And in the U.S. Booking.com, Priceline and OpenTable are all in the top 10 travel apps. We will continue our efforts to enhance the app experience to build on the recent success we have seen here. Finally, I want to briefly address a regulatory matter that’s impacting the financial results we are reporting today. The Spanish Competition Authority has issued a draft decision alleging infringement by Booking.com of Spanish competition law and then intends to issue a fine of $530 million. We could not disagree more with this draft decision and the arbitrarily large fine that they imposed, which is completely disproportionate to the alleged conduct. If the draft decision were to become fine, we plan to appeal. The success of our business is built on a mutually beneficial and balanced partnership with our millions of hotels and other accommodation partners around the world. We provide exceptional choice, value and service for travelers and we provide a marketplace for hotels and other partners that allows them to attract travelers from around the world at lower cost than many other marketing channels. We have a clear track record of cooperating with many competition and consumer authorities to find amicable and workable solutions to their concerns, including working with the year being commission on the Digital Markets Act. As we have previously disclosed, we plan to file our notification for designation under the DMA suit. And we believe the main concerns raised by the Spanish Authority overlap with the DMA. We will continue to work closely with these regulatory bodies to maintain consistent rules. And most importantly, we will continue to ensure that we are offering the best possible platform to our partners and our customers. In conclusion, I am encouraged by the strong fourth quarter results and the continued of leisure travel demand. Our teams continue to execute well against our key strategic priorities, which helps position our business well over the long-term. We continue our work to deliver a better offering experience for our supply partners and our travelers. We are confident in the long-term growth of travel and the opportunities ahead for our company. I will now turn the call over to our CFO, David Goulden.
David Goulden: Thank you, Glenn, and good afternoon. I will review our results for the fourth quarter and provide some color on the trends we see in the first quarter and – on 2024. All growth rates are on a year-on-year basis unless otherwise indicated. We will be making some references to the comparable periods in 2019 where we think these are helpful. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. We will post our prepared remarks to the Booking Holdings Investor Relations website after the conclusion of the earnings call. One housekeeping item before discussing our results. We have reclassified digital services taxes into sales and other expenses and out of G&A expense. Due to the highly variable nature of GSTs, which are tied to the revenue earned in the countries where GST are enacted. We have provided a table with two areas of updated quarterly financials in our earnings press release that reflects this chain P&L geography, and all of my comments on this call will also reflect the change. Now on to our quarter results. Our room nights in the fourth quarter grew 9% year-over-year and 21% versus 2019, which was slightly better than our expectations of about 9% and 20%. Excluding Israel, Q4 room rights were up 11% versus 2022 and 22% versus 2019. Looking at our year-over-year room nights by region in the fourth quarter, Asia was up mid-teens Europe was up low double digits, Rest of World was up low single digits, and the U.S. was flat. All regions improved from October. The average booking window of Booking.com expanded in Q4 versus the same period in both 2022 and 2019, but was a bit less expanded than it was in the third quarter. In Q4, mobile app mix of about 53% was about 5 percentage points higher than the fourth quarter of 2022. We continue to see an increasing mix of our total room nights coming to us through the direct channel. The direct channel increased as a percentage of our room nights in the fourth quarter relative to the fourth quarter of 2022. The international mix of our room nights in Q4 was 50%, up from about 48% in the fourth quarter of 2022 and reaching about the same level as the pre-pandemic Q4 mix. Our cancellation rate in the fourth quarter was slightly higher than Q4 2022, impacted by the war in the Middle East. As we expected, the higher overall cancellation in October normalized by the end of the quarter. For our alternative accommodations at Booking.com, our Q4 room night growth was 19% year-over-year, and the global mix of alternative body room nights was about 32%, which was up versus about 29% in the fourth quarter of 2022. Q4 gross bookings increased 16% year-over-year or about 15% on a constant currency basis, which was ahead of our expectations. The 16% increase in gross bookings was 7 percentage points higher than the 9% room night growth due to about 4% higher accommodation constant currency ADRs, plus over 1 percentage point of positive impact from each of FX movements and flight bookings. Our year-over-year ADR growth was natively impacted by regional mix due to higher mix of room nights from Asia. Excluding regional mix, constant currency ADRs were up about 5 percentage points year-over-year. Despite higher ADRs in the fourth quarter, we have not seen a change in the mix of hotel star rating levels being booked or changes in the length of stay that could indicate that consumers are trading down. We continue to watch the dynamics closely. Airline tickets booked in the fourth quarter were up about 46% year-over-year, driven by the continued growth of Booking.com’s flight offering. Revenue for the fourth quarter exceeded our expectations, increasing 18% year-over-year or about 17% on a constant currency basis. Revenue as a percentage of gross bookings was 15.1%, which was about in line with our expectations. Marketing expense, which is a highly variable expense line increased 9% year-over-year. Marketing expense as a percentage of gross bookings was about 30 basis points lower than Q4 2022 due to higher ROIs in our paid channels and a higher mix of business. Performance margin ROIs increased year-over-year, helped by our ongoing efforts to improve the efficiency of our marketing spend. Marketing and merchandising combined as a percentage of gross bookings in Q4 was about 15 basis points lower than last year, which was better than our expectation due to lower merchandising expense, higher direct mix and better performance marketing ROIs. Q4 sales and other expenses as a percentage of gross bookings were up about 20 basis points compared with last year and also about 20 basis points above our expectation normalize for the DST reclassification, due in large parts to higher accounts receivable provisions related to our decision to delay some collections during the partner payment issue we discussed last quarter. We do not expect this to be an ongoing issue. More fixed expenses in aggregate were up 21% year-over-year, which was below our expectations primarily due to lower personnel and IT expense as well as due to the DST reclassification. 21% is calculated usually on non-GAAP expenses in both Q4 2023 and Q4 2022. Adjusted EBITDA of almost $1.5 billion was ahead of our expectation and was up 18% year-over-year and would have been about 22% on a constant currency basis. Separately, Q4 adjusted EBITDA was negatively impacted by a $37 million loss recorded in other income related to the devaluation of the Argentinian peso, which is not factored into our prior guidance. This reduced Q4 adjusted EBITDA margin by almost 1%. Non-GAAP net income of $1.1 billion resulted in non-GAAP earnings per share of $32 a share, which was up 29% year-over-year. Our average share count in the fourth quarter was 9% below Q4 2022. Our non-GAAP results exclude $276 million or expense in personnel related to a ruling in the Netherlands pension fund matter and $530 million of expense in G&A related to a draft decision by a Spanish Competition Authority. I’d like to provide some perspective on each of these. As Glenn mentioned, we strongly disagree with the draft decision and unprecedented fine proposed by Spanish Competition Authority, which we plan to appeal if it becomes final. The appeal process could take a few years. During any appeal process, we would expect to influence some changes to our business practices in Spain, we do not currently undertake that these will have a significant impact on our business. Turning to the Dutch pension case. In January, the court of appeal in the ruled the most Booking.com employees in the Netherlands should enroll – in a travel industry-wide pension fund. The liability we recorded in our Q4 results is for prior periods related to this pension plan. We’re working through how we align this travel industry-wide plan with the existing pension plan we offer to our employees in the Netherlands. We expect there will be some increase in our pension plan costs in the Netherlands going forward, but we do not expect these to be material. On a GAAP basis, we had net income of $222 million in the quarter. When looking at the full year, we are pleased to report that our – 2023 room nights grew 17% year-over-year, and our gross bookings grew 24% and about 25% on a constant currency basis. Our full year revenue was over $21 million, which was up 25% year-over-year and up similarly on a constant currency basis. Full year revenue as a percentage of gross bookings was 14.2% in 2023, which is up slightly versus 14.1% in 2022. For the full year, there is more than 0.5 points of positive impact from timing as well the benefit to take rates from increased revenues associated with payments, but this was mostly offset by an increase in the mix of flights, an increase in Asia mix has really recovered and by our increased investments in merchandising. Our underlying accommodation take rates continue to be in line with 2019 levels. For the full year, our marketing plus merchandising at Booking.com as a percentage of gross bookings was 5.6%, down from 5.9% in 2022, driven by marketing efficiencies and direct mix. The 5.6% in 2023 is still up from 5.5% in 2019 and are leading into a recovered travel market more than offset gains due to increased direct mix. For the full year, the direct channel as a percentage of our room nights, continue to increase in mix. When we exclude our B2B or business-to-business, our direct mix was in the low 60% range for the year. Our full year EBITDA was more than $7 million and was up 34% year-over-year and up about 37% on a constant currency basis. Adjusted EBITDA margin was 33%, which was 12 percentage points higher than our adjusted EBITDA margin in 2022 and in-line with our expectations at the start of the year. Our full year non-GAAP earnings per share was about $152 a share, which is up 52% year and up about 58% on a constant currency basis. Now on to our cash and liquidity position. Our Q4 ending cash and investment balance of $13.1 billion was down versus our Q3 ending balance of $14.3 billion due to the $2.4 billion in share repurchases we completed in the quarter partially offset by the $1.3 billion of free cash flow we generated in the fourth quarter. For the full year, we generated $7 billion in free cash flow. We repurchased over $10 billion worth of shares in 2023, taking our remaining repurchase authorization down to $14 billion and reducing our year-end share count by 9% versus 2022 and by 16% versus 2021, which is just before we restarted our share repurchase program. As we think about our capital structure and allocation framework going forward, we remain focused on appropriately investing in our business and growing returns for our shareholders while maintaining our strong investment-grade credit ratings. Given our confidence in our earnings power, strong free cash flow profile and our ability to consistently shareholders, we are announcing today that our Board of Directors declared a quarterly dividend of $8.75 per share to complement our existing share repurchase program. The dividend is payable March 28, 2024 to shareholders record on March 8, 2024. We believe the introduction of a dividend will allow us to enhance our capital return program and further expand our base of investors. In terms of composition of capital returns, we expect the share repurchases will represent the vast majority of our total capital return to shareholders going forward. We continue to expect to complete the $24 billion share repurchase authorization we announced early 2023 within 4 years where we started, which would be before the end of 2026. We reiterate our previously stated gross leverage target 2x, and our goal to move to a 1x net leverage over time. The initiation of a dividend does not change our thinking around these targets. Now on to our thoughts for the first quarter of 2024. All growth rates are on a year-on-year basis. Given that we’re now beyond the COVID period, when granular short-term information was helpful in assessing the path – we’re returning to our historical guidance approach with outcome range for the full quarter ahead and less detail on monthly trends and individual P&L line items. Based on the solid travel demands we’ve seen so far in the first quarter, we expect Q1 room night growth to be between 4% and 6%. We expect the ongoing war in the Middle East have a negative 1% impact on Q1 room night growth. We’re also comparing with a strong start to the year in 2023 when we started to see an expansion of the booking window. January room night growth was above the high end of that range. As we move through the quarter, every room bank growth will benefit from an extra day, our March room night growth will be hurt by Easter being in March. We expect these to roughly offset each other. We expect Q1 gross bookings growth to be between 5% and 7%, about 1 percentage point faster than room night growth due to slightly higher accommodation constant currency ADRs and faster growth from flights, partially offset by about 1 percentage point of FX pressure. We expect Q1 revenue growth will be between 11% and 13%, faster than Q1 bookings growth due in part to the Easter shift, which we expect to bear the Q1 revenue by about 3 percentage points. We expect a similar native impact on revenue growth in Q2. We expect Q1 adjusted EBITDA to be between $680 million and $720 million, which at the midpoint would be 19% year-on-year growth and about a 1 percentage point increase in EBITDA margin. We expect EBITDA margin to bank from market expenses growing slower than revenue and growing similar to gross bookings, which we expect will more than offset our fixed OpEx growth growing slightly faster than revenue. As we set our course to the full year ahead, I want to first address our longer-term ambition for growth in our business. As we’ve discussed previously, in a more normalized market environment, we’re aiming to achieve constant currency growth rates for gross booking revenue and earnings per share that are higher than what we achieved in 2019. This would remain growing above 8% for each of the top line metrics and about 15% for earnings per share. We believe we’ll be able to achieve these levels of growth, given the investments we made to build a stronger business and a better offering for our travelers and partners versus what we had 5 years ago. At recent FX rates, we expect changes in FX will negatively impact our reported growth rate by a little more than 1 percentage point. With that framework and with FX in mind, we expect to grow our full year 2024 slightly faster than 7% and including the assumption that the war in the Middle East will negatively impact our full year 2024 growth rate by 1%. We expect revenue for the year to grow at similar rate to our gross bookings growth. We expect a more fixed expense in 2024 to grow in the low to mid-teens. We are planning to leverage from these more fixed expenses in 2025. We expect 2024 adjusted EBITDA will grow slightly faster than revenue, largely due to expectations for an increased direct mix. We expect adjusted EBITDA margins to expand year-over-year by a bit less than a percentage point. Lastly, we expect EPS growth to be above 40%. In closing, we are pleased with our Q4 results, our Q1 outlook and our expectation in 2024 to grow faster than 2019 across gross bookings, revenue, adjusted EBITDA and EPS with exceeding EBITDA margin year-over-year. We expect 2024 to be another strong year for us. We’ll now move to Q&A. Sarah, will you please open the lines?
Operator: [Operator Instructions] Your first question comes from the line of Justin Post with Bank of America/Merrill Lynch. Your line is open.
Justin Post: Great. Thanks for taking my questions. One for David, and I guess this might be your last call, I would love to hear about your – who you are on CFO transition. But the guidance, is January growing above the 4% to 6% for room nights? I thought January might have tougher comps. So, maybe talk a little bit about the shape of the quarter. And then maybe bigger picture for Glenn. Just was wondering, you have so much data as the share leader in room nights. How do you think the AI transition could play out for booking? And do you think you have some advantages versus search engines or your peers? How you are thinking about that? Thank you.
David Goulden: Yes, Justin thanks. Let me take the first one, and handover to Glenn for the second one. So, yes, as I have said in my remarks, just to reiterate, January is – did grow faster than the high end of the 4% to 6% range that we talked about. It did benefit, we believe, slightly maybe in the range of about 1% from the shift of Chinese New Year this year, which we expect to be offset in February. And as we said, we would expect therefore, February and March to have a lower growth rate, in January, essentially consistent with our prior guidance of expecting deceleration during the quarter.
Glenn Fogel: Thanks Dave for that. And Justin, AI, obviously incredibly important subject for everybody in any business right now. And I think I talked about it at the last call and have been talking about it a lot whenever I speak about how important this is for anybody who is looking to the future to create something that could be transformational. We are very early, as I have said in the past. I like pointing out the things that we have done so far and some of the early signs we see that this is going to be just fantastic for us. Nobody knows how long it will take. One of the things I love is us being in a position because of our financial position, because of the number of people we have who have capabilities to look into this. Because of the data we have, as you pointed out, that people can then be able to use it to create models and use it in ways that are complementary to other people, are doing in terms of creating large language models and so on. I do believe we have an advantage because of our size and scale and the capabilities of our people to create something in all parts of the business, whether it would be, as I discussed, things that help the traveler, which are the sort of products there or helping us in the back part of our business, the back office and make these more efficient, going throughout. I think we do have an advantage, of course, we will see over time how well and how quickly we can actually translate that into better numbers in terms of margins, in terms of more people coming to us, people increasing loyalty, etcetera. But I am very encouraged with what I am seeing so far. And I certainly believe that we do have the full position here in the travel industry.
David Goulden: Justin, just before we hand back to the operator for the next question. I just want to reiterate two other things I said about the Q1 room night guide. This is growth after the impact of about a point of hurt from the Middle East. And of course, we are comping against a very strong start to last year when we saw room nights of the booking window moving from a contracted position to an expanded position in the first quarter that also created some strong results in Q1 last year. So, you have to factor those things into account as well.
Justin Post: Great. Thank you. And David, this is your last call. We will miss you. Thanks for all the work over the years.
David Goulden: Thanks Justin.
Operator: Your next question comes from the line of Kevin Kopelman with TD Cowen. Your line is open.
Kevin Kopelman: Thanks so much. I wanted to ask about marketing. First, merchandising was only up slightly in the mix or only up slightly as a percentage of GBV, I should say, 2023. Do you feel that that’s reached a steady state in the mix, or do you see incremental pushes this year in merchandising? And then on advertising, are you seeing any changes to the bidding environment?
David Goulden: Okay. Yes. So Kevin, so we have now, I think as you characterize, we can ask here with our merchandising activities that’s been something that we have been ramping up over time, Booking.com. And I think we now kind of deploy it in place in where we plan to deploy it. So, it has reached more of a state and new store, only a slight increase in merchandising in total from last year to this year as a percentage of GBV. So, when we kind of look at our model going forward, we do expect that across marketing merchandising with our continued increase in direct mix, that can be a source of leverage for us. And of course, as I mentioned in my commentary about the full year, that will be the biggest driver of our EBITDA margin expansion this year and will be joined by OpEx next year. And then relative to the competitive environment, it stays competitive. I mean these are very competitive markets. There are many players in there. I think people realize it’s not just the OTAs, there are meta players, there are hotel players, there are chains you name it, a lot of people are bidding in these marketplaces. So, I think it just remains competitive, but we are pleased with how we are doing in a competitive marketplace.
Glenn Fogel: And Kevin, just a reference back to Justin’s question about AI and data and merchandising, how we do it, etcetera. One of the great things I really see about our position is that using data, using all things you know to merchandise smartly. Do it where we think it’s going to give us an advantage and not do it where we are just giving away money. And I really see as all as AI technology develops further, as we begin to optimize over time, with all the different parts of the connected trip, we are going to be able to provide value to both the travelers and be able to get our suppliers to help provide merchandising opportunities and us doing an intelligent way. So, it’s win for the traveler, win for the partner and us as the people are doing all this, we will also win.
Kevin Kopelman: Great. Thanks Glenn.
Operator: Your next question comes from the line of Mark Mahaney with Evercore ISI. Your line is open.
Mark Mahaney: Okay. Thanks. Two questions, please. In terms of your guidance for the full year on the margins side, what are you embedding in there in terms of marketing or sales and marketing spend and merchandising spend as a percentage of bookings? Are you assuming a little bit of leverage in there? And I am sorry if you covered that in your published comments, but if you could answer that. And then secondly, on the buybacks in Q3, I think they were a little – in Q4, I think they were a little bit lower than in Q3, was that your intention? Was there a particular reason why you maybe – may have been a little less active than the market in Q4? Thank you very much.
David Goulden: Alright. Thank you, Mark. I will take those. So, as I have said in the prepared remarks, the biggest driver of leverage we expect this year on EBITDA margin going to be from our direct mix increase, which means that we will have a small sustain to the business, which has paid a higher percent of mix and therefore, we would expect to get some leverage on marketing and merchandise. We expect to continue to be aggressive and still lead into the markets where we are spending money on paid marketing and we don’t necessarily – we are offsetting anything about our ROI on that to tip any hand, but we would expect that it would be the direct mix increase. It will be the driver of leverage in marketing and merchandising therefore would be the driver of improvement in our EBITDA margins. On the buybacks in Q4, I think they are roughly same in size to Q3. At the start of Q4, where share price was lower, we said if the share price stays at a lower level, we will buy more in Q4 than we did in Q3. Share price moved up during the quarter, and we take share price into account when thinking about the level of buybacks and of course we have taken the long-term view. But in the short-term, we do moderate based upon how share price moves. So, that’s perhaps why it’s being a little bit less than you may have expected. A little bit less than we perhaps indicated on the last earnings call, but still a big number and still over $10 billion for the year as you see a significant reduction in our share count…
Mark Mahaney: Thank you, David. It makes a lot of sense. Thank you very much.
Operator: Your next question comes from the line of Doug Anmuth with JPMorgan. Your line is open.
Doug Anmuth: Thanks for taking the question. I just want to follow-up on the full year outlook. I mean it sounds like you are very confident in the business overall. Just does the full year outlook reflect just normalization of trends in ‘24? The tough comp and the Middle East impact that you mentioned, is there anything else to consider here? Thanks.
David Goulden: Yes. I think there is a couple of things to bear in mind in the full year outlook. Bear in mind, we talked about our framework. So, we said that we would grow faster than 8 and 8.15 on a constant currency basis. And we are saying we are going to do that with the impact of the Middle East on slowing our business down. So, I think that is a positive outlook. Of course, we have adjusted the numbers to a reported number. So, when you include the FX shift at current rates of roughly 1%, then the 8, 8.15 becomes 7, 7.4. But again, it’s essentially 8, 8.15 on a constant currency basis, and we expect to be higher than that even with roughly a point of hurt to the business on the top line and the bottom line from what’s happening in the Middle East. So, it’s consistent with our framework and I believe is confident of our position of the travel market and our continued ability to gain share in travel.
Doug Anmuth: Thank you, David.
Operator: Your next question comes from the line of Brian Nowak with Morgan Stanley. Your line is open.
Brian Nowak: Thanks for taking my questions guys. I have two sort of on the U.S. The first one, when you talk about the U.S. being flat, does that include alternative accommodations? So, is the hotel business in the U.S. actually declining then? That’s the first one. And then just sort of, Glenn, as you look into 2024, what are the investments you have to make in the U.S., both on the hotel side as well as the alternative accommodation side to sort of drive more and more durable, consistent growth from here?
David Goulden: Yes. I will start with the first one, back to Glenn, the second one. So, U.S. was flat for the quarter, but bear in mind, it was down in October. And October, it was driven very much by the kind of ripple shock effect of the – what was happening in the Middle East. So, therefore it was back into growth mode in November and December in order to put our plant for the quarter. So, I wouldn’t read too much into a whole quarter that you have got to kind of look what happened in October. Yes, that doesn’t call alternatives. As Glenn said, alternative grew very nicely in the U.S., but it’s a much lower mix of our business in the U.S. than it is in other parts of the world. So, again, I wouldn’t go too much into assuming that means that hotels are…
Glenn Fogel: Yes. And regarding – the question regarding how we are going to do even better in the U.S., we have talked about the numbers that we have shown so far. I am very pleased you look back to 2019, see what our steer was, that what numbers we then look at them now, it goes really fantastic growth and great work by the team. I think last quarter, I had out to the team then and I will do it again because they are doing fantastic work. One of the things is because the under-indexed, because we are smaller in terms of not clear [ph] of the U.S. versus other parts, this is a great opportunity for us. And I have talked about we have to continue to improve our product particularly in the alternative accommodation on account of that, and we have been doing that. And that’s why we have this large growth rate in the U.S. alternative accommodations. Very pleased to see that happening. They continue to provide to our hotel partners what they need and what they want is incremental demand. They don’t want us to be a provider to manage they think they can always get. And one of the great things about our team is working closely with our hotel partners. As you know, a lot of the U.S. is large chains, and we have developed, I think a very good relation with them to work together to help them, do what they need to do to achieve their results and us being a provider of those services and getting what we need, which is more bookings. I am pleased with the results we have done so far. And I think we have got a great opportunity to continue to do so for a long time.
Brian Nowak: Thank you both.
Operator: Your next question comes from the line of James Lee with Mizuho. Your line is open.
James Lee: Great. Thanks for taking my questions. Two here, I think Glenn, you talked about maybe increasing supply of home accommodation – alternative accommodation in the U.S. Can you elaborate, maybe talk about that plan a little bit, help us understand your strategy there. And also secondly, I think you guys talked about maybe on the loyalty program to include all verticals in 2024 would be great, you provide some details there as well. Thanks.
Glenn Fogel: Thanks James. And I didn’t quite get the second one. Let’s start with the first one, maybe in front of the second one. So, it’s interesting because in our last call, I went into a little bit about what do we need to do to increase that supply of alternative combinations. And I talked a little bit – and this is that high, it wasn’t the first time I talked about this. Where we have – while we are even into urban and rural and such, I have talked in the past, though, how we don’t have as many of the single properties that perhaps some of our competitors have less area down the road. But the whole idea is we want to do things efficiently and want do things effectively, which means it goes through the things where you can get larger groups of properties listing quicker by going to the big property managers who have a lot of them. That may be that you are going to end up with more things that are not with single home properties. But then after we have that enough, and that’s the low-hanging fruit after we got that comes, then we got to go on and start getting more of the single homes, etcetera. And I have expressed my own disappointment that when I look for a single property sometimes I have mentioned, at one point on the call about wanting to get something out in the Hampton and New York for the summer and not seeing enough properties for us. There is lots of opportunity. But I look at this as an opportunity, not as a negative, but then you look how well we are doing, even though there is all the other stuff to go out and get. That’s the way I feel about it, and I am pleased the way the team is going out. Look, 12% increase in our listings or $6.6 million, now over $7.4 million, I like the fact that we are increasing those numbers, doing it in a nice size and also particularly really like the fact that our growth rate of return on the combination was significantly higher than some other people in our space. So, I was very happy to see that. I didn’t catch the second part of James’ question.
James Lee: Yes, of course. The second part of the question is about your loyalty program Genius. I think Glenn you had mentioned you want to include all travel verticals into the program this year. And I was wondering if you can provide some details on that.
Glenn Fogel: Sure. Okay. So, what I would said is we are going to experiment. And we really see, we always want to experiment, where do things work, where do we see return for it, where do we see how this is working so well. So, we are going to continue to experiment and we do have, for example, rental cars well established into our Genius program. Obviously, our combination as well and we are going to experiment with all the different verticals. And the thing, is there a way to do in flights, is there a way to do it in track and how do we do it in terms of potentially even insurance, in all sorts of ways, our ride business when people need a ride from the airport to the hotel or hotel to the airport or from their home to the airport. Again, and this goes back to the first question, I think it was Justin asked about AI and about how you use data. And that’s kind of one of the key things is when you have these models, and you can figure out what the best way to provide a benefit, and that’s through our loyalty Genius program, that’s doing that in a way that it provides value to the traveler, that’s where they use us, that’s why they come back to us. That’s why they come to us direct. Maybe they will use the app because it’s so simple to do it. At the same time, Genus is primarily almost right now, primarily being funded by our partners because they see value in that. They see value in providing a discount or some other type of benefit that we put into the offering, so that the travelers will book, that supplier what they want to sell. And doing to get it in a scientific way in doing it in a way that is going to make sure that we are not leaving value out of the cycle in a way that’s not going to be beneficial to our supplier partners, doing it smartly, that’s the thing that I love. And that’s why we are going to continue to experiment on that. And I think it’s worked so well in hotels and I think it’s in a combination, alternative accommodations, I think this is going to work great in all of it. But we will see after we expand it.
James Lee: Great. Thank you.
Operator: Your next question comes from the line of Eric Sheridan with Goldman Sachs. Your line is open.
Eric Sheridan: Thanks so much. Maybe following up on that last question from James, you talked earlier about connected trip and feeling optimistic about attach rates there, but still work to do. When you think about what you are trying to accomplish with Connected Trip longer term and you think about rising conversion, reducing friction. What do you put it down to? Is it consumer education? Is it supply? How should we be thinking about the building blocks behind connected trip to accomplish your longer term goals? Thank you.
Glenn Fogel: So, if the question was really how do we get from here early stage showing good signs, but it’s still small to scale and really showing the bottom line and top line and a loyalty and all those things, I think that – is that the question really?
Eric Sheridan: It is Glenn. Thanks.
Glenn Fogel: Yes. So, look, one of the things that we have to – and I have said this is a long-term path. And the first thing was we had to build the verticals to begin with. One of the fun things was to mention that we started Booking.com we got off the ground in 2019 and now put all our flight numbers together, you see 400% increase there that’s included, of course, Priceline had placed before that, where you just see the growth rate of flights right now, great. So, we got that vertical up and we got excellences up and attract is still early, but up. But these things – all of these things are the car rental was up, but we still do on that and of course the rides business and others. All of these things are at different levels of development, but still relatively new. And one of that, then we have to build all the modeling, all the ways to figure out what’s the best way to offer one versus the other, and make sure that we are doing it the right way. And then it’s working with our partner suppliers to provide us and prove out to them that this is worthwhile to them. All of these things take time. But I do like to say, we are seeing those signals. We are seeing the numbers. It is early and I am not going to do – I am sure you would like me to give you some numbers, say, here is what it’s going to be tomorrow. Here is what the next milestone. I am going to do that. And I can’t say I see we are on the right path.
Eric Sheridan: Great. Thank you. And thank you for everything David, congrats on the last call and good luck for everything.
David Goulden: Thank you, Eric.
Operator: That is all the time we have for questions. I will turn the call to Glenn for closing remarks.
Glenn Fogel: Thank you. So, I want to thank our partners, our customers, our dedicated employees, our shareholders. And as mentioned by a couple of people on the call, I have to give out a very special thank you to my very good friend and colleague, David Goulden. As you know, after 24 earnings calls as Booking Holdings CFO, he is retiring from this role and will be working on other areas of the business going forward. We greatly appreciate everything that David has done for this company, and we greatly appreciate everyone else’s support as well as we continue to build on the long-term vision of our company. Thank you very much and good night.
Operator: This concludes today’s call. We thank you for joining. You may now disconnect your lines. |
INTU | 2 | 2,024 | 2024-02-22 19:40:25 | Operator: Good afternoon, my name is Angela, and I will be your conference operator. At this time I would like to welcome everyone to Intuit’s Second Quarter Fiscal Year 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. [Operator Instructions] With that, I’ll now turn the call over to Kim Watkins, Intuit’s Vice President of Investor Relations. Ms. Watkins?
Kim Watkins: Thanks, Angela. Good afternoon and welcome to Intuit’s second quarter fiscal 2024 conference call. I’m here with Intuit’s CEO, Sasan Goodarzi; and our CFO, Sandeep Aujla. Before we start, I’d like to remind everyone that our remarks will include forward-looking statements. There are a number of factors that could cause Intuit’s results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2023 and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit’s website at intuit.com. We assume no obligation to update any forward-looking statements. Some of the numbers in these remarks are presented on a non-GAAP basis. We’ve reconciled the comparable GAAP and non-GAAP numbers in today’s press release. Unless otherwise noted, all growth rates refer to the current period versus the comparable prior-year period, and the business metrics and associated growth rates refer to worldwide business metrics. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. And with that, I’ll turn the call over to Sasan.
Sasan Goodarzi: Thanks Kim, and thanks to all of you for joining us today. We had another strong quarter and have great momentum innovating on our platform. We’re executing on our strategy to be the global AI-driven expert platform powering prosperity for consumers and small businesses. Second quarter revenue grew by 11%, and we are on track to achieve our fiscal year 2024 full year guidance of 11% to 12% revenue growth while expanding operating margins. Let’s start with tax. We are confident in our innovation and game plan to win, and are reiterating our full fiscal year guidance of 7% to 8% revenue growth for the Consumer Group. Tax preparation represents a $35 billion TAM. This includes $31 billion within the assisted consumer and business tax categories, which we have barely started to penetrate. We are well-positioned to disrupt the assisted category by leveraging data, AI, and our Virtual Expert Platform, to revolutionize how taxes get done for consumers and small businesses. By leveraging the power of our platform and ecosystem, we’re also extending TurboTax to our Credit Karma members and QuickBooks Online small business customers by enabling them to complete their taxes and access expertise directly within these products. Let me share more about our – the areas of focus this season. First, we can serve consumers however they want to file, virtually or in-person, while providing confidence their taxes are being done accurately and they are getting their maximum refund. More than 80% of U.S. filers live within a 10 mile radius of a TurboTax expert. These experts use Intuit’s Virtual Expert Platform that’s powered by data and AI, to deliver best-in-class service. While it’s early in the season, TurboTax Live Full Service is resonating with customers. We’re seeing strong growth and the offering has a Product Recommendation Score of 88 season-to-date, one of the highest at Intuit. Second, small businesses can file their taxes with TurboTax and, if a small business is a QuickBooks Online customer, they can file their taxes with an expert. With these offerings, they can maximize their refund, and get advice from experts when they need it. Our campaigns and easy to use experience are driving strong early interest. Business tax returns have a much higher average revenue per return because they are more complex and we expect them to contribute to average revenue per return expansion over time. Third, we’re more deeply integrating Credit Karma and TurboTax, making it even more seamless for Credit Karma members to file with TurboTax directly in the Credit Karma app, with exclusive offers for members, whether they want to file themselves or with an expert. We’re also unlocking the benefits of the Credit Karma platform for tax filers to make smart money decisions. This includes earlier access to their refund or, for those that qualify, access to an interest-free Refund Advance loan in as little as 30 seconds after IRS acceptance, when depositing their refund into a Credit Karma Money account. This is designed to lead to higher engagement and monetization in Credit Karma over time. Fourth, Intuit Assist, our GenAI powered financial assistant, is live in TurboTax this season. With Intuit Assist, we are creating a future of "done for you," where the hard work is done "automagically" on behalf of our customers with a gateway to human expertise, fueling their financial success. For example, customers are using Intuit Assist to better understand their refund. In early results, Intuit Assist’s helpfulness rating is 1.5x greater than our legacy explanations, indicating Intuit Assist is helping deliver confidence to TurboTax customers. Our focus this tax season further showcases how our Big Bets have accelerated innovation and growth for the future. We’re leveraging the power of data and AI with Intuit Assist to revolutionize the speed to benefit for customers, disrupting the assisted consumer and business tax categories by connecting people with experts virtually, and bringing the TurboTax and Credit Karma experience together to unlock smart money decisions. We are off to a great start in tax. Let me now highlight progress across two of our Big Bets. As a reminder, our five Big Bets are: revolutionize speed to benefit, connect people to experts, unlock smart money decisions, be the center of small business growth, and disrupt the small business mid-market. Our first big bet is to "revolutionize speed to benefit." Our platform enables us to innovate for our customers with speed and at scale, which is foundational to all of our other Big Bets. Five years ago, we declared our strategy to be an AI-driven expert platform, with data and AI fueling innovation across the platform. At the core of our platform is powerful, relevant data for our 100 million customers. We have 500,000 customer and financial attributes per small business, and 60,000 financial and tax attributes per consumer which fuels what’s possible with AI. And with our GenAI Operating System, GenOS, we empower Intuit technologists to create breakthrough GenAI experiences across our platform. This includes utilizing our own powerful financial LLMs, as well as those from other leaders in GenAI, which together unlock new opportunities to serve our customers with accuracy and speed in a cost efficient way. As I mentioned earlier, with Intuit Assist, we are creating a future of "done for you," where the hard work is done "automagically" on behalf of our customers with a gateway to human expertise, fueling their success. Intuit Assist is critical to delivering unparalleled benefits for our customers over the next decade, and is in the hands of select customers now. We believe Intuit Assist will lead to higher frequency of engagement and monetization across the platform, driving customer growth, accelerated adoption of services and live offerings. I’m excited about the rapid pace at which we are innovating, testing, learning, and adapting to deliver our core benefits of more money, no work and complete confidence for customers. Let me share a few updates. First TurboTax, as I shared earlier, Intuit Assist is live in the product this season and is delivering increased confidence to our customers. Second, Mailchimp, to help small businesses grow revenue and save them time, we’re providing AI-powered automations and content generation using Intuit Assist. Third, QuickBooks, Intuit Assist is in beta and is designed to help small businesses optimize cash flow and make confident decisions to grow their business. New customers who were previously running their business manually will be able to get started quickly by sharing their email, website and bank account information. Their unstructured data will be translated into benefits for them, such as generating customized pay-enabled invoices that save time and enable customers to get paid faster, experiencing the benefits of switching to a digital platform. And for existing customers, we will translate their data and analyze their money in and money out transactions into insights and recommendations. Intuit Assist will do the work for our customers in the background with suggested automated actions that increases customer productivity by saving time and leading to better outcomes such as getting paid faster and updating capital. Furthermore, we intend to provide an option to connect and interact with an expert to help provide insights and make decisions specific to their financial situation and fuel their success at the moments that matter most, such as closing their books. Fourth, Credit Karma, Intuit Assist for Credit Karma is in beta and we’re excited about the rapid innovation and the progress we’re making to help connect members to financial products that are right for them, saving them time and money. We’re focused on using GenAI to interact with members to help answer their questions in a highly personalized way when shopping for financial products. Customers can interact, learn more, and ask questions to help make confident decisions. Intuit Assist will engage more members with a wide range of financial needs beyond Credit. We recently expanded by 6x the number of topics we can provide help on and now address items like major purchases, home buying, savings, and more. We believe this can drive increased member engagement and conversion, and drive higher revenue per monthly active user. We remain excited with our early progress with Intuit Assist across the company. It’s changing our relationship with customers as we move from being a transactional workflow platform to a trusted assistant that customers can rely on daily to power their prosperity. Our fourth big bet is to become the center of small business growth by helping our customers get new customers, get paid fast, manage capital, and pay employees with confidence in an omnichannel world. We are well on our way to becoming the source of truth for our customers to help them grow and run their business. In Mailchimp, we’re focused on better serving mid market customers across different stages of their lifecycle to drive higher engagement and retention. After we have successfully onboarded them, we’re pairing larger customers with an account manager to help them understand and adopt the breadth of Mailchimp’s capabilities. We’re seeing green shoots from account management, which gives us confidence in the future. Customers who have engaged with an account manager have higher monthly revenue retention. We believe this will also drive higher ARPC over time. Intuit Assist is live in Mailchimp’s higher end offerings and is designed to help customers develop personalized marketing campaigns and drive their revenue growth. We’re offering customers three AI-powered automations today, including new customer welcome, abandoned shopping cart and recovering lost customers. Automations are time consuming to set up, but can drive higher revenue. Intuit Assist personalized automations are 50% more likely to be activated by customers. Intuit Assist is also reducing work by generating new content and editing existing content for marketing campaigns. Recent improvements have driven GenAI text generation adoption rates by more than 70% over the past several months, reducing work for our customers. Getting paid fast remains a big challenge for small businesses. We are uniquely positioned to help customers with our end-to-end money platform and innovations such as easy discovery, auto-enabled payments, payment-enabled invoices, instant deposit and get paid up front, which are all helping our customers get paid faster and drive adoption of payments. Total online payment volume growth was 20% in the quarter. We are beginning to roll out a new payment-enabled invoicing experience that will provide more benefits to customers, including more ways to get paid. While early, we’re seeing that customers who use the new invoicing experience are engaging more driving increase in customer adoption of our payment rails to get their invoices paid. We’re also making progress digitizing B2B payments to accelerate and automate transactions between small businesses and ultimately improve their cash flow. The number of connections in our QuickBooks business network has doubled since August, and we’re pleased with the initial adoption of our bill pay offering. To better serve small businesses, during the quarter, we began rolling out faster payment timelines for qualified customers that reduce payment time by 40%, including a paid next-day ACH option and batch payments, allowing customers to hold on to their cash longer and save time. Wrapping up, with our durable AI-driven expert platform strategy and focus on innovating with GenAI across our platform, we are more excited than ever about the opportunity in front of us, and our ability to power prosperity for our customers. We’re honored to be recognized by Bloomberg as one of the top 50 Companies to Watch in 2024 and to be ranked 22 on this year’s Just 100, and the highest ranked customer or software company on the list. Now let me hand it over to Sandeep.
Sandeep Aujla: Thanks, Sasan. For the second quarter of fiscal 2024 we delivered another strong quarter, despite the IRS opening approximately one week later this year. We achieved healthy operating margins and are on track to achieve our full year guidance as we continue to deliver operating leverage across the business. Our Q2 results include revenue of $3.4 billion, up 11%, GAAP operating income of $369 million versus $270 million last year, up 37%. Non-GAAP operating income of $1 billion versus $856 million last year, up 17%. GAAP diluted earnings per share of $1.25 versus $0.60 a year ago and non-GAAP diluted earnings per share of $2.63 versus $2.20 last year, up 20%. Turning to our business segments. Small Business and Self-Employed Group revenue grew 18% during the quarter, driven by online ecosystem revenue, which grew 21%. Our results continue to demonstrate the power of our small business platform and the mission-critical nature of our offerings, which resonates with customers as they look to grow their business and improve cash flow in any economic environment. With the goal of being the source of truth for small businesses, our strategic focus within the small business and self-employed group is threefold: grow the core, connect the ecosystem and expand globally. First, we continue to focus on growing the core. QuickBooks Online Accounting revenue grew 19% in Q2, driven mainly by customer growth, higher effective prices and mix shift. We continue to prioritize disrupting the small business mid-market through continued focus on both go-to-market and product innovations. While mid-market customers are a smaller subset of the total small business TAM, they drive a higher ARPC over time given their more complex needs and higher usage of services across our platform. This coupled with our strategy to sell more of our ecosystem services to existing customers, shift the emphasis in our growth formula towards ARPC over time. Second, we continue to focus on connecting the ecosystem. Online services revenue grew 24% in Q2, driven by payroll, payments, Mailchimp, capital and time tracking. Within payroll, revenue growth in the quarter reflects an increase in customers adopting our payroll solutions, higher effective prices and a mix shift towards higher end offerings. Within payments, the revenue growth in the quarter reflects ongoing customer growth as more customers adopt our payment offerings to manage their cash flow, higher effective prices and an increase in total payment volume per customer. Mailchimp revenue growth was driven by higher effective prices and paid customer growth. Third, we continue to make progress expanding globally by executing a refreshed international strategy, which includes leading with both QuickBooks Online and Mailchimp in our established markets and leading with Mailchimp in all other markets as we continue to execute on localized product and lineup. On a constant currency basis, total international online ecosystem revenue grew 16% in Q2. Now moving to our Desktop Ecosystem. Desktop Ecosystem revenue grew 10% in the second quarter, and QuickBooks Desktop Enterprise revenue grew in the mid-teens. We are more than two years into a three-year transition for customers that remain on a license-based desktop offering to a recurring subscription model. In fiscal 2025, the tailwinds from the three-year transition will be behind us, but we expect our Desktop Enterprise offering, which accounts for over half of desktop accounting revenue to grow in the high single-digit range. We also will continue to encourage remaining desktops subscription customers who tend to be more complex and higher value to migrate seamlessly to either QuickBooks Online or our desktop enterprise offering when they are ready. Additionally, we see opportunities to continue to price the product for value. The online ecosystem remains a growth catalyst longer term. Shifting to our Consumer and ProTax Groups. Our full year outlook remains unchanged, even though Consumer Group revenue declined 5% in the quarter, reflecting an approximately one week later IRS opened this year. We are confident in our game plan to win this season and are reiterating our guidance for Consumer Group of 7% to 8% revenue growth in fiscal 2024. Turning to the ProTax Group, the revenue grew 8% to $274 million in Q2, reflecting the timing of when tax forms were delivered, which is a driver for revenue recognition. Moving to Credit Karma. Credit Karma delivered revenue of $375 million in Q2, flat to a year ago, primarily reflecting growth in Credit Karma Money, credit cards and auto loans offset by decline in home loans, personal loans and auto insurance. We saw select partners taking a conservative approach to extending credit in both personal loans and credit cards in Q2, reflecting expected macro trends. And as a reminder, Q2 is typically the seasonally weakest quarter of the year. We expect Q3 to benefit from additional Credit Karma Money revenue during tax season. In summary, I am pleased with our continued momentum this fiscal year. Now shifting to our balance sheet and capital allocation. Our financial principles guide our decisions. They remain our long-term commitment and are unchanged. We finished the quarter with $1.5 billion in cash and investments and $6 billion in debt on our balance sheet. We repurchased $536 million of stock during the second quarter. Depending on our market conditions and other factors, our aim is to be in the market each quarter. The Board approved a quarterly dividend of $0.90 per share, payable on April 18, 2024. This represents a 15% increase versus last year. Moving on to guidance. We are reaffirming our fiscal 2024 guidance. This includes total company revenue growth of 11% to 12% and GAAP operating income growth of 15% to 18%; non-GAAP operating income growth of 12% to 14%. GAAP earnings per share growth of 11% to 15% and non-GAAP earnings per share growth of 12% to 14%. Our guidance for the third quarter of fiscal 2024 includes revenue growth of 10% to 11%, GAAP earnings per share of $7.77 to $7.84, and non-GAAP earnings per share of $9.31 to $9.38. As a reminder, we are taking a prudent approach with guidance given the continued macroeconomic uncertainty. You can find our full year fiscal 2024 and Q3 guidance details in our press release and on our fact sheet. With that, I’ll turn it back over to Sasan.
Sasan Goodarzi: Great. Thank you, Sandeep. And just to quickly wrap up, we’re very confident in our AI-driven expert platform strategy, our progress with our five big bets, and creating a future of done for you with a gateway to human expertise. We believe that this will change our relationship with our customers, becoming their trusted advisors, leading to higher engagement and monetization. The combination of our assets and our strategy creates a growth flywheel for Intuit to accelerate penetrating our $300 billion in TAM. With that, let’s open it up to your questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Siti Panigrahi with Mizuho. Please go ahead.
Siti Panigrahi: Thank you. Thanks for taking my question. Sasan and Sandeep, I want to dig into the health of the small business. Just two part question, on the online accounting system, revenue seems to be in line, our expectation site to decel. Is there any one-time factor that influenced and how should you think about second half, given that’s an easy comp? And other part is on the services, while we’re pleasantly surprised, it’s accelerated. And you talked about some of this payroll payments and Mailchimp. Is there anything like you are doing differently, specifically drilling into the Mailchimp, how is that part of the business doing?
Sasan Goodarzi: Yes, Siti, thank you for your question. Maybe I’ll start us off. And Sandeep, please jump in as you wish. I mean as the headline that I would give Siti is that we’re really pleased with the momentum that we have, the growth that we’ve experienced. When you think about it in context of the current macro environment, we’re continuing to see larger, higher value customers, mid market customers want to shift to digitization. And the more we spend time with them, with our account managers, with our sales folks, with our customer success folks, they tend to have a tendency of wanting to move more of their services to us because for the most part, we are already the standard of financial management solutions that they use for their financial records. But they see it as an opportunity to get paid faster, manage their workforce to be able to use our capabilities, to be able to market to their customers. And so the net of it that I would leave you with is I like our momentum in this macro environment. We expect that to continue for the rest of the year. And there’s a lot of puts and takes in our online accounting and online services. And so I wouldn’t read anything into it. The most important element to take away is the 21% overall online growth. And our services are strong and we continue to innovate with our services. And I expect that we’ll continue to lead digitization and transformation for our small businesses. Sandeep, I don’t know if you want to add anything, but those would be the headlines for me, Siti.
Sandeep Aujla: Yes. Sasan, good coverage [ph]. Siti, what I would also remind you of is, as we’ve shared in the past, there are three imperatives that you focus on as a management team, new customer acquisition, driving adoption of our platform and being better together across our platform. And with that in new customer acquisition, our team continues to focus on mid-market customers. As you call those mid-market customers, they’re a larger, richer revenue pool. They have higher customer acquisition costs, but they also take a little longer to ramp up because most of the size of the price in those mid-market customers on services revenue, which ramps up as opposed to accounting, which you start booking as soon as they become a customer, so just a dynamic to keep in mind. That’s why in my prepared remarks, I called out that our growth formula will continue to start leaning more towards ARPC going forward. And the second component of the services is basically us executing on our focus of driving adoption of our platform.
Siti Panigrahi: Thanks. Great execution, guys.
Sasan Goodarzi: Thank you.
Operator: The next question comes from Kash Rangan with Goldman Sachs.
Kash Rangan: Hi, congratulations to Sasan and Sandeep. Really good call here. I’m wondering if you can give us an update on what’s happening in the SMB market. Looks like enterprise spending seems to be stabilizing. I know that you’re not really enterprise except for QuickBooks Advanced, but how did you characterize the outlook for small businesses given that the economy is on stable footing and we don’t have the worries that we had going into calendar 2022? Thank you so much once again.
Sasan Goodarzi: Kash, great to hear from you. Great question. I would – let me categorize the answer in two buckets. First of all, facts are friendly, and let me start with some facts. What we see across our base is that cash reserves are down 11% year-over-year. That’s really what small businesses care about. But it’s actually up 115% over pre-pandemic levels. And so the takeaway you should have in that is small businesses are being challenged in this macro environment. Consumers are spending less dollars, but they’re actually healthier at the aggregate level than they were several years ago. In fact, what I would call out is the number of hours worked is higher this year, several points compared to last year. So that just the strength of the work that they’re doing, being able to have access to talent is in a better position for small businesses compared to last year. And that, by the way, as you can imagine differs by country and by sector, sectors like real estate, IT spending is struggling if the sector small business is in, but things like professional services, auto repairs is actually quite healthy. Last thing I would end with is the higher value customers more the mid-market customers are healthier than those that are small and just starting out, which by the way, we’ve seen this in our 20 plus years, right, we’ve seen this is a normal trend whereby the larger businesses have a lot more levers to be able to pull and they’re generally healthier. Lastly, our view, and we’re not economists, but we see a lot of data. Our view is that 2024 is going to be a lot of the same for small businesses. We don’t believe that there’s going to be any kind of an economic tailwind as we think about the next – the rest of the calendar year.
Kash Rangan: Thank you so much.
Sasan Goodarzi: Yes. You’re very welcome.
Operator: The next question comes from Brad Zelnick with Deutsche Bank.
Brad Zelnick: Great. Thank you so much and nice job in Q2. Maybe a tax question, just with the slower start to the season, Sasan, and we appreciate every season is more and more backend loaded, but can you talk about what it is that you’re seeing in the funnel and anything else that supports your confidence in the full year consumer guide? Thanks.
Sasan Goodarzi: Yes. Sure, Brad. First of all, I’ll amplify what you started out with. Having been in the tax business and ran it more than ten years ago and watching our trends in the last ten years. Every season there’s a push to a later start, and it’s just a consumer behavior, and we’re seeing that this year, so that’s not anything unique. There’s two things that I would call out that are strategic to us, that are worth calling out, because we see green shoots in both with the early part of season. One is full service. Just as a refresher, there’s nearly 100 million consumers and small businesses that spend about $30 billion to have somebody else do their taxes for them. And we really leaned into our overall full service experience, we really leaned into our campaigns, both on air, digital. Very basic things, by the way, that we didn’t used to have the capabilities of that we’re now building, which is if you use an expert and you love that expert, that you can recommend that expert to a friend, that, that’s basics. But the infrastructure that we’re building to really disrupt the full service space is a necessity. And we feel very good about the green shoots that we’re seeing, both on the consumer front and on the business tax front. And I’ll remind you that this is our first year leaning all the way into business tax. So it’s beyond early, but everything that we’ve seen just indicates that this is enormous opportunity for us. So that’s on the full service front. The second I would mention is Credit Karma. This is really an area where we have nearly 45 million monthly active users. They engage more than five times a month, and the majority of those monthly active users actually use a different method and not TurboTax. And so we’ve really heavily invested in the experience, whether you want to do it yourself in the app or you want us to do it for you, which is full service and compelling offerings that we’ve been testing and scaling. And we also like the green shoots there. So those are the two things that I would call out, and it really positions us for share of spend. I’ll end with the following, which is we’ve set the goal line in taxes, our share of total IRS returns, and really what matters is the share of spend that we’re getting. And full service is essential for that, both this year and in the future.
Brad Zelnick: Thanks, Sasan. Great color, and keep up the good work. Thank you.
Sasan Goodarzi: Thank you, Brad.
Operator: The next question comes from Michael Turrin with Wells Fargo.
Michael Turrin: Hey, great. Good afternoon. Appreciate you taking the question. I was hoping we could go back to the mix of online services, and maybe you could just help us compare and contrast in more detail what you’re seeing from a growth perspective across the payroll payments and Mailchimp business? And is there a float aspect at all to the payroll portion of the business that might be helping reinforce some of the margin strength you’re seeing? Given headwinds from the slower start to tax? I think a lot of focus on just the EPS strength in the quarter. Thank you.
Sasan Goodarzi: Sure. Do you mind repeating the last part of your question?
Michael Turrin: Yes. Just wondering if there’s at all on the payroll side a flow component that might be also just softly helping margin outside of the consumer headwinds you’re seeing.
Sasan Goodarzi: Yes. Let me start with the overall services question that you asked and Sandeep will weigh in here with some of the facts that you asked around flow. I think the thing that I would just say around services goes back to my earlier comment, which is we’re just spending a lot more time with higher value customers really helping them understand what we can do to digitize their businesses, and by the way, continuing to improve our offerings. And so as we talked about earlier, our total online payments growth this quarter was 20% in a fairly tough macro environment. That’s because we continue to invest in making the experience easier, providing multiple methods to get paid instant deposit, getting paid upfront. So those really help with, in essence, payments adoption. Our payroll adoption has been strong, particularly larger customers and with full service, and we’re continuing to really invest in some of the most important foundational elements with Mailchimp that higher value customers are adopting, and particularly some of the things that I called out with intuitive. So it’s really – it’s not one thing, it’s a combination of all of our services and the focus on higher value customers that is really helping us with some of the services adoption. Maybe. Sandeep, I’ll turn it over to you on the float and anything else you want to add.
Sandeep Aujla: Sure. So thanks, Sasan. Michael, the float component is a very small part of our payroll business, as one thing that we really aim to do for our small businesses is to hold their cash as little as possible. So float is not a big component for us. And I think the overarching theme of your question was the ability for Intuit to preserve the earnings power of the company despite the one week delay in the IRS opening. I think Sasan touched on that. And it’s also some of the great work that the team has been doing around acquiring larger customers around the lineup, work we did to make the higher end SKUs in payroll more attractive to those customers. The work the team is doing around mid market account management and Mailchimp. So it’s a plethora of activities that continues to give us confidence across portfolio of assets that we have here at Intuit.
Michael Turrin: Appreciate the details there. Thank you.
Sasan Goodarzi: Thank you, Michael.
Operator: The next question comes from Taylor McGinnis with UBS.
Taylor McGinnis: Yes, hi. Thanks so much for taking my question. Maybe another one on online services. So if I heard you correctly earlier, it sounds like you guys are expecting a more stable macro environment as we move throughout the year. So can you just talk about what that means for the durability of the acceleration in online services that we just saw to 24% year-over-year? Could you actually see online services hang in here at these levels? Was there anything one-time in nature? And just curious, as the macro remains more challenging, how the pricing lever could be used there to help you guys during this time? Thanks so much.
Sasan Goodarzi: Yes, sure. Taylor, let me add a few things if I could. First of all, I’ll start with we don’t view the macro environment as entirely remaining stable. We think it’s going to continue to be uncertain. So we’re not sort of banking on any of our growth coming from any type of a tailwind from the macro environment. We think 2024 will be somewhat choppy, like 2023 was from a macro environment perspective. And we see it in the consumer – credit scores of consumers. As you know, we see over 100 million members across Credit Karma. And their credit scores in the last couple of years are down almost 20 points. Gen Z credit card balances are up over 60% and those are just a couple of illustrative examples that consumers are strained. So the first uber-point would be that we think the environment is stable to uncertain and we’re not trying to outguess the economy, but really focus on our customers and our innovation, which gets to the second point, and that is we have confidence in the guidance that we provided of the 16% to 17% for the year, even in context of the macro environment, just because we continue to really emphasize and focus with our high value mid-market customers digitization. And that’s really what’s leading to our overall 21% online growth that we talked about. And that’s what gives us confidence in our guidance. And really, as we look into the future, our entire focus is really all about our innovation and our go-to-market to win, despite the tough economic environment.
Sandeep Aujla: Taylor, the one thing I would add, and just to build on Sasan’s point, you asked a question around pricing, pricing power. Our tenant around pricing is around the power of our offerings and the innovation we’re building into the offerings. And the perceived actual value that we’re delivering to our customers is not related to the macro environment. So that’s another point I just wanted to emphasize in terms of how we think about our pricing.
Taylor McGinnis: Thanks. Really appreciate the thoughts.
Sasan Goodarzi: You’re very welcome.
Operator: The next question comes from Alex Zukin with Wolfe Research.
Alex Zukin: Hey guys, thanks for taking the question and congrats on the quarter. Sasan, maybe a GenAI question for you. Clearly it’s something that continues to really evolve and become a core part and parcel of the company, both on the SMB side and the consumer side. I wanted to ask, if you look at the coming tax season on the consumer side, how do you expect to see the benefit of some of the assist functionality? Is it more converting kind of free to pay? Is it pay to pay more? And then similarly on both Credit Karma and on the SMB side, if you think about the progression of the year, kind of where are you seeing the biggest opportunities as you start to see the interactions build on the platform?
Sasan Goodarzi: Yes, Alex, thank you. Great question. Let me start with one headline, particularly as we’ve been in beta or with certain capabilities at scale and GA. I’ll start with a headline which is we believe that over time, and I want to emphasize the overtime piece, that this is going to create an entirely new category of experiences and growth that is not even possible today because of truly creating a set of experiences where the work is done for customers. And there’s always a gateway to human expert that’s all AI powered. And the more we’re in market, the more we’re learning, adjusting, adapting, the more we are convinced that we’re going to be able to create a new category of services and what’s possible to penetrate our $300 billion in TAM. Now with that said, let me get real specific and sort of real tactical. The second headline news that I would give is none of the work that we’re doing with Intuit Assist, which is really about what we’re doing across the platform. It’s not a feature. None of it is in our results today, and we’re not counting on it to be in our results in the near future. But with that said, to answer your question in tax, to start with, there’s a couple of areas where it will have profound impact. One is full service. And the profound impact, by the way, is from the investments that we’ve made in the last five years. I mean, to do what we’re doing in full service at scale and think about it, it’s really based on data, AI, ecosystem of apps, because now we can do your taxes through Credit Karma, through the cookbooks platform and one of the largest networks of experts that we have. And all of that sits on machine learning, knowledge engineering and now GenAI capabilities. So the biggest in our view, based on what we’re seeing in market, right, the biggest opportunity is about the ease and the speed of getting people’s taxes done. So imagine a world where you’re a full service customer that we can get your taxes done in less than an hour, maximum refund and extend your dollars because of what we can do with you on the Credit Karma platform and excellent service, the best service you can imagine in the world, which by the way is supported by our product recommendation score of 88. So really it’s full service that will have the biggest impact. Now the whole underlying platform is what full service uses. And so the other is over time. Yes, it will help with conversion. And really it’s about confidence. And we’re seeing that right now where Intuit assist when it’s engaged to understand my tax outcome and refund outcome, the helpful rating is one and a half times better than we’ve ever seen and by the way, we are very early, we haven’t perfected it by any means. So that’s on the tax front. Just very quickly, let me touch on Credit Karma. As you know, one of the powers of Credit Karma on behalf of our customers is we know everything about the customer. We know have all the data and leverage AI to deliver personalized credit cards that are right for them, or personal loans, whatever it may be. One thing that’s profound with GenAI that we’re learning and seeing in market today is now customers can interact with Credit Karma, whereas before they couldn’t. The from to is, the from is, I would show you the three credit cards that are right for you based on everything that I know about you. But now you can interact with Credit Karma and ask, hey, I’m looking for travel rewards, which of these three credit cards are the best for me? And then we interact with you and help you understand, which one is the best for you based on an additional set of questions that you’ve asked, where we now know more about you. That’s profound, because that will, over time, drive higher engagement, monetization, et cetera. And on the small business front, our entire focus is revenue and profitability increase. Everything that we are testing in market, learning in market is so that we can help you with campaigns that increases your revenue or manage your cash flow that better helps you with profitability. And one of the things we’re testing with is to have experts that actually provide insights to you and those insights could be, hey, it’s time to take out capital because your sales are strong, or hey, I just finished doing your books for you. Would you like to have a conversation so you can understand your cash flow and how your books close for the month? And that’s a monetizable event for us. So probably a longer answer that you were looking for, but those are the things that are in market where we’re learning and adjusting and we think over time. We haven’t perfected any of this yet, because it’s actually hard, but we believe it’ll create an entirely new category of services and growth.
Alex Zukin: Super insightful. Thank you, guys.
Sasan Goodarzi: Yes. Thank you, Alex.
Operator: The next question comes from Kirk Materne with Evercore ISI.
Kirk Materne: Yes, thanks very much. And I’ll echo the congrats on the quarter. Yes, Sasan, can you just remind us where we are in terms of some of the cross-sell of QuickBooks into the Mailchimp base and vice versa? And when Intuit Assist goes GA for QuickBooks, will that be the point at which Intuit – can answer questions across sort of the front office and back office for customers? Can you just talk about that a little bit? Thanks so much.
Sasan Goodarzi: Yes, great question, Kirk. Let me start with the Intuit Assist question first. And I’ll share with you how we’re sequencing it. Right now our entire focus and remember, everything that we are doing here is based on data and AI. A lot of our investments are what you don’t see, which is ensuring that the data is usable, that it’s clean, that it’s structured the right way, and that our machine learning, knowledge engineering and GenAI capabilities can digest all of the data. Inclusive of data by the way, that’s contributed by the customer, like access to their Gmail account, access to their Excel spreadsheet, because a lot of customers data are in those two places, or they’re in shoeboxes and being able to take pictures. And for us to be able to digest that data and actually deliver insights. So our first priority of order is to ensure that if you’re using our small business platform and if you are looking to put together marketing campaigns, that Intuit Assist is doing that for you. The second element of what we are focused on is then being able to transfer and use Intuitive Assist across QuickBooks and Mailchimp, because all the data points are connected. That is absolutely where we are headed and it’s sequenced in second place compared to what I just articulated, because we have to nail via the basics. But that’s actually where the power of our platform will show up for our customers, where whether you’re in Credit Karma or TurboTax, you can ask whatever question you want that is relevant in your life and we can answer it because all of our data points are connected and our AI capabilities are, in essence, working across the product. So that is sequence, but we’re working on that as we speak. The second is cross-sell. First of all, I’ll start with we’re not thinking about it in terms of cross-sell. We’re thinking about it in terms of product integration. So what we are really focused on, and this is, by the way, this applies to TurboTax and Credit Karma. This applies to Mailchimp and QuickBooks. What we’re really focused on is integrating the product at moments of truth that matters most based on how the customer does the work. Like, for instance, if you are in QuickBooks on your left lap [ph]. This is just an illustrative example because we’re actually testing a lot of this, is that you can actually see how you can manage your customers and put together marketing campaigns. And when you engage and click on that, you have the Mailchimp engine that is working behind the scenes. And after maybe a couple of free trials, then we share with you how much it is to pay for these capabilities. So that’s what I mean by product integration. We want to nail the benefits at the moment of truth that matters versus just try to sell you Mailchimp within the platform. We’ve found over time that that’s not as effective. What’s most effective is the product integration. So that’s the approach that we’re taking across all of our platforms.
Kirk Materne: That’s it. Thanks so much.
Sasan Goodarzi: Thank you. You’re very welcome.
Operator: The next question comes from Brent Thill with Jefferies.
Brent Thill: Just on for [ph] Credit Karma to get back to growth, what are the key ingredients that you need to see for that to get back to growth versus the declines we’ve seen the last year?
Sasan Goodarzi: Yes, a good question. A couple of things. One, which we are starting to see, which is just stability of partners and the environment. For the most part, other than some select partners, we’ve actually seen stability with our partners. And we’ve actually seen verticals like insurance come back, which saw a big decline last year. So one is just stability, and then the second is just the areas of innovation that we are focused on. One is we’ve redesigned the entire app. Now it’s rolled out to all members, which is a massive, massive feat. And based on the redesign of the app, there are many ways in which we can engage customers more so than we could before. And that will actually drive monetization. So that’s one lever beyond the macro that I mentioned. The second is Intuit Assist. It’s the example I provided earlier where now customers can actually interact with us and ask questions and let us know what’s important to them and we can personalize things in a way that we could never before. And based on very early testing, we see the engagement is higher when customers are interacting with Intuit Assist, which over time will lead to monetization. That’s the second area. Third is just a number of initiatives that we have around prime. As we’ve mentioned before, prime is actually quite a large part of our monthly active users, but we’ve never really focused on it and now that’s an area of focus. And then last but not least is TurboTax. And TurboTax, the way we’re thinking about it is actually about product integration because the more we can engage members year round around, if they took out a mortgage or having them take a snapshot of their W-2 and letting them know what their refund could be, the more we can actually penetrate more of the members to use TurboTax as a method to get their access to the refund, all those things creating one platform is what we believe and are confident actually that will get us to accelerated growth and it’s really in that order. So let me pause there hopefully, is that helps Brent?
Brent Thill: Yes, it was great. Thank you.
Sasan Goodarzi: You’re very welcome.
Operator: The next question comes from James Friedman with Susquehanna.
James Friedman: Hi. Thank you. I was hoping to get your thoughts on the opportunity for additional bill pay options. I believe Sasan, you mentioned in your prepared remarks rolling out same day ACH. But any high level thoughts on other bill pay options, including virtual credit cards? Thank you.
Sasan Goodarzi: Yes, thank you for the question. First of all, the key to success for us, given where we are on the rollout is one network connections. And as you heard in our remarks, albeit very early, the number of business network connections has doubled since August. And that’s important because it helps, it’s a huge step forward to then digitize how we in essence help customers get paid and pay bills. The second is just executing on our roadmap. The big thing that we’re starting to roll out that we talked about earlier is just faster payments and that’s through both paid ACH next day that we’re rolling out and also batch payments. And so we’re going to continue to look at what’s most important for our customers and that’s what’s informing our roadmap. But we have to do it in conjunction with continuing to increase network connections. And we’re really excited about in the long term what’s possible, digitizing all of B2B, because it’s very – it’s incredibly beneficial to our customers because they get paid faster, and two, it’s really a sticky product.
James Friedman: Thank you so much.
Sasan Goodarzi: You’re very welcome.
Operator: The next question comes from Raimo Lenschow with Barclays.
Raimo Lenschow: Thank you. Congrats for me as well. Question for Sandeep. As we think about this year, you kind of said you didn’t expect a lot of kind of recovery to help. It’s just like how you manage the business. But if you think about cost, so far you’ve been doing really well on margins. But there’s also obviously an element of getting ready for things are getting better. How do you see the progression of investments this year? Thank you.
Sandeep Aujla: Hey Raimo. Thanks for that question. Super important one, and let me share some of my thoughts. First and foremost, I’ll start with the fact that we’re deliberately building this business to scale growth while increasing our profitability. In fact, those are principle ones and two of our financial principles that we use to manage this company. So that’s a very deliberate approach that we are taking. And we have a track record of expanding margin over the years while bringing innovation to markets such as Intuit Assist, such as building innovation to address the opportunity we have in the mid-market such as innovation to localize products in Mailchimp for the international market. So we are not leaving growth opportunities on the table with our focus to scale growth and drive innovation. Now, the second component of your question, in terms of the profitability profile so far this year, we look at our margins and aim to deliver our margin commitments for the full year. And I feel quite confident in our path to do so. And the performance we had in the first couple of quarters, in fact, bolster the confidence that I have in our full year guidance.
Raimo Lenschow: Perfect. Thank you.
Operator: The next question comes from Mark Murphy with JPMorgan.
Mark Murphy: Thank you very much. So, Sasan, within the QuickBooks business you have this growth vector in the up market [ph], and I’m curious if you’re able to comment on the growth and traction that you’re seeing in that 10 to 100 employee segment versus the one to nine or zero to nine employee segment. For instance is one of those growing mid-20s and the other is high teens just interested in how much of a spread you see there and maybe where you see it trending this year?
Sasan Goodarzi: Yes. Sure. I’ll add a perspective and would invite Sandeep to chime-in as well. I think the short answer is we are seeing more traction in our higher value customers and our mid-market customers, which I think to your frame is 10, 15 employees and up or more higher revenue customers. We are seeing more traction there, more momentum there. And by the way a big part of it is that’s where we’re really focusing our innovation, our go-to-market. At the same time to be clear we – we always remain paranoid and always believe in the notion of disrupting from the low end, which is by the way why we just launched a Solopreneur offering, which is to be able to serve those small businesses that in essence they’re on their own. Because we believe that it’s helping entrepreneurs when they’re a team of one, because one-day some will become a team of thousands. So we’re not taking our eye off the ball on the low-end at all, but we’re doubling down on our focus on the higher value customers. And yes, we do see more resiliency, more momentum with these larger customers.
Sandeep Aujla: And to covered the topic, the only thing I would add is that the unit economics on the upmarket is also something that we find quite attractive. These customers, they tend to scale to much higher ARPC especially as we get them to adopt our platform. They by definition have more employees. They by definition of processing more payments, so that’s also something that we find attractive and is very much an area that we are having our go-to-market teams and our product teams deliberately lean in this year.
Mark Murphy: Thank you very much.
Sandeep Aujla: Very welcome.
Operator: The next question comes from Steve Enders with Citi.
Steve Enders: Okay. Great. Thanks for taking the questions here. I guess maybe just on the SMB side again; I think you made a comment in the prepared remarks about shifting towards ARPC over time as a growth lever. I guess one want to clarify that comment and then secondarily, does that change how you think about the levers of growth moving forward for the SMB segment, more towards ARPC, away from the customer side?
Sasan Goodarzi: Thanks for the question, Steve. The way we think about it, and as we were just addressing in the prior question, we see tremendous opportunity in the mid-market for those that we currently define as having ten to 100 employees. And what really excites us about this opportunity is that these customers come with a much higher lifetime value, much higher ARPC, and have better retention. And so that just helps out our economics, but these customers also tend to have higher customer acquisition costs and there are relatively fewer of those than the smaller customers by definition, when you look at the overall addressable market. So as we focus on these larger customers, that means we will get higher ARPC per customer, even though there are fewer of those. So that is where the growth formula, we continue to abide by the growth formula that we have publicly discussed about 10% to 20% customer growth, 10% to 20% ARPC growth. But as we continue to focus on the mid market, you should expect us to lean in more towards the ARPC growth because of this dynamic with the mid-market, and that we think that’s actually a good thing for the business going forward.
Steve Enders: Okay. Perfect. Thanks.
Operator: The next question comes from Scott Schneeberger with Oppenheimer.
Scott Schneeberger: Thanks very much. Good afternoon. Sasan, a couple of task questions. One, we’re three weeks in. We’re pretty well through the early season. You had anticipated earlier, before the tax season that we would see a probably flattish year for the industry. And that felt kind of conservative. Now that we’re in a bit and we’ve also seen a return to DIY category shift, I’m curious if you have any update on what you’re seeing for the industry overall thus far. And then the second part is on full service. You sound very happy with it, the 88 number recommendation score. Could you speak to some of the growing pain points you had last year and the fixes you’re seeing this year as you’re working your way through the early season? Thanks.
Sasan Goodarzi: Yes. Sure. Thank you for the question. Our view, having been through however many tax seasons we’ve been through as a company, is it’s early in the season to estimate how many folks will ultimately file when it’s all said and done. With that said, our belief is still the same. It will probably be total of number of filers will probably flattish, maybe up a little bit. Our perspective really hasn’t changed because our focus is how do we win as many filers within the category that are going to file. So the first answer is our view hasn’t really changed. The second, on full service and some of the growing pains, I would call out a few from last year compared to what we’re doing this year. One is, we actually made it difficult for customers to get into full service last year. And by the way, it was more trying to ensure the customers were really, really getting into the right service. But we had so much friction that we had created up front. And if you think about somebody that just walks into somebody’s home or office and sort of hands everything over and says, here, get my taxes done. And then they interact until three or four weeks later until their taxes are done, the notion of engaging and putting a lot of friction up and asking a lot of questions up front is not a behavior they’re used to. So that was a big learning and growing pain, a lot of which we have removed all the friction and engage – get a customer to engage an expert, depending on what we know about them, very, very early. So that’s one. I think the second one, we learned a lot about what did and did not work in our campaigns last year. And there’s a lot we are doing differently to really help customers, both on air, digitally, but also the infrastructure that we are working on, which, by the way, is not going to be done this season. Right. We’re going to be investing in it for several years. Were basic things which, by the way, are very powerful, where if I did your taxes and you love the work that I did for you, and by the way, our product recommendation score of 88 would suggest that our experts are delivering excellent service. You’d want to recommend me to your friend? Well, last year you could not do that. And this year we’re building the capabilities that you could actually recommend me to a friend. And that virality is a very big thing, especially when you have an 88 product recommendation score. And then lastly is 43% of those that use an assisted method, that choose to switch to somebody else. 43% will actually go on Google and Google is there a tax pro near me? And again, that’s another example of where we didn’t have the infrastructure to show up and we’re building that infrastructure. So I can tell you for a fact, in San Jose, California, right or in Los Gatos, I should say if you put in tax pro near me, we will show up top of the list. We being TurboTax. If you do it in Atlanta, which is where I was a few weeks ago, we don’t show up because we’re working on. So that’s an example of the things that we learned last year that we’re implementing this year, but not just for this tax season, but really to nail it with excellence as we think about the future.
Scott Schneeberger: Great. Thanks.
Sasan Goodarzi: Very welcome.
Operator: The next question comes from Keith Weiss with Morgan Stanley.
Keith Weiss: Excellent. Thank you guys for taking the question. This one’s for Sandeep as well. Another margin question, but a little bit of a different angle. When it comes to generative AI, we’re really been talking a lot about the potential top line impacts. Are there operating margin benefits that you guys can see through? Just better usage of the GenAI technology internally, whether it’s stuff like code assist or whatnot. And then on the flip side of the equation, given that a lot of this stuff is still ramping up. Is there anything we should be looking out for on the gross margin line in terms of just like these capabilities being that much more compute intensive and that much more impactful on COGS versus what you’re seeing in consent assessment today? Thank you.
Sasan Goodarzi: Keith. So let me start by just reminding us all that the GenAI cost for the current fiscal year have been incorporated into our guidance. So that’s first and foremost. But now let me address the themes of your question as I think about the cost structure, and I’ll focus on the cost structure, since that’s where your question was. We actually feel that we are quite advantageous versus the market in the sense that the data that we have, that we have touched on, that’s residing behind our firewalls, that we are training our large language models on, that are delivering more contextually relevant answers at a faster speed versus other generally available large language models, and that they are doing that at a fraction of the cost. So just from a unit economics point of view, for the GenAI, it’s actually advantageous the way we are running it. Two, we don’t have our own data center, and we rely on AWS and other third party data centers to run our model. So that, again, is a cost advantage because we don’t have that build out cost as some others might have. Furthermore, as I look across our business, I do see opportunities for us to, over time, improve our economics using GenAI and AI. Now, we’ve already given examples on things such as in customer success, where agents no longer have to take notes or spend minutes summarizing the call that they just had. AI does that, and that’s just one small example. But expect that to continue to lead to more efficiencies in a customer success calls lead to more better unit economics in a full service than live offerings, as you kind of carry that forward. Also, how we are staffing up builders in terms of project managers to designers to engineers ratios. So I see many opportunities for us to continue to benefit from GenAI, and I feel good about the early start that we have leaning into some of those capabilities.
Keith Weiss: Got it. So, Net-net, it seems like a positive dynamic versus something that could drag on margins overall.
Sasan Goodarzi: That would be the right takeaway, I guess.
Keith Weiss: Excellent. Thank you, guys.
Operator: Ladies and gentlemen, this does conclude today’s question-and-answer period. I will now turn the program back over to our presenters for any additional or closing remarks.
Sasan Goodarzi: All right, awesome, everybody. Thank you for listening in. Thank you for your wonderful questions. Be safe. We’ll talk to you next quarter. Thank you, everybody.
Operator: Ladies and gentlemen, thank you for participating. This concludes today’s conference call. |
MRNA | 4 | 2,023 | 2024-02-22 11:30:03 | Operator: Good day, and thank you for standing by. Welcome to the Moderna Fourth Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised, today's conference is being recorded. I would now like to hand the conference over to your speaker today, Lavina Talukdar. Please go ahead.
Lavina Talukdar : Thank you, Kevin. Good morning, everyone, and thank you for joining us on today's call to discuss Moderna's fourth quarter and full year 2023 financial results and business updates. You can access the press release issued this morning as well as the slides that we'll be reviewing by going to the investor section of our website. On today's call are Stéphane Bancel, our Chief Executive Officer; Stephen Hoge, our President; and Jamey Mock, our Chief Financial Officer. Before we begin, please note that this conference call will include forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please see slide two of the accompanying presentation and our SEC filings for important risk factors that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements. With that, I'll turn it over to Stéphane.
Stéphane Bancel: Thank you, Lavina. Good morning or good afternoon, everyone. Thank you for joining us today. I will start with a review of 2023. Jamey will then present our financial results. Stephen will then review our late-stage clinical programs, and I will close by sharing our 2024 priorities. Let me start with our mission, Moderna's commitment to deliver the greatest possible impact to people through mRNA medicine. In 2023, every member of the Moderna team helped to advance our mission, which is a driving force that motivates our team every single day. We impacted more than 100 million people around the world and we advanced our development pipeline across all of our franchises, including infectious disease, oncology, and rare disease. 2023 was a difficult year as we transitioned from a pandemic to a seasonal endemic market. We reported sales of $6.1 billion for 2023, which was at the low end of our financial framework range. These sales exclude the recognition of $600 million of deferred revenue from Gavi. In the U.S., the vaccination rate was down year-over-year. We were pleased that our U.S. commercial team drove an increase in our retail market share from 37% to 48%. Outside of the U.S., we were not able to compete in the EU market in the second half of 2023 due to a competitor contract, and our performance led to a low market share in Japan. We did have a strong performance in Israel, Switzerland and Taiwan. We took several important actions in 2023 that we set our commercial COVID business up for success. We resized our manufacturing footprint, which has been established to support capacity at pandemic levels. We exited contract manufacturing relationships and reduced inventory levels. These initiatives will improve cash flow from our COVID business moving forward. We also flattened the commercial structure. All regions report directly to me now for more targeted sales execution and also a better integration with global teams. We focused on R&D spending and our SG&A expenditures towards near-term growth and higher return on investment projects. While sales were challenging in 2023, our development team had a great year with excellent progress across many of our late-stage pipeline programs. In 2023, we advanced our pipeline and now have nine late-stage programs. Let's start with Respiratory vaccine. For RSV, we filed for approvals around the world. We reported positive data from a flu P303 study, and we are fully enrolled in the Phase 3 studies for our next-gen COVID, mRNA-1283, and flu plus COVID combination vaccine, mRNA-1083. In our latent franchise, we are very excited that our Phase 3 CMV trial is now fully enrolled. In our Individualized Neoantigen Therapy Program or INT, where we partner with Merck, Phase 3 studies in adjuvant melanoma and non-small cell lung cancer are enrolling. We purchased and are currently building out a manufacturing site in Marlborough, Massachusetts to enable commercialization of our INT program. Our rare disease therapeutic programs continue to progress well. We are in dose selection of the restrictional study of our Propionic Acidemia Program. In MMA, we are pleased to see improvement in biomarkers and clinical outcomes. In research, we made six estimated [ph] investments, including one acquisition, which we expect will increase the strategic reach and also the breadth of our mRNA platform. Now turning to our 2023 financial summary, we reported GAAP revenue of $6.8 billion, a net loss of $4.7 billion, primarily driven by mostly non-cash charges of $3.7 billion related to resizing of manufacturing and the tax valuation allowance. We are pleased to end the year with cash and cash investment of $13.3 billion. Let me turn to Jamey for more color on our financials.
Jamey Mock: Thank you, Stéphane, and hello everyone. Today, I will review our financial performance for both the fourth quarter and the full year of 2023. I'll also provide our financial framework for 2024. Let me start with a review of our commercial performance this year. In the first half of 2023, we reported product sales of $2.1 billion, with the majority of sales from advanced purchase agreements signed for delivery in 2022 that were deferred into 2023. We do not expect these sales to repeat in 2024. In the second half of 2023, we recorded $4 billion in sales from seasonal endemic demand and an additional $600 million from deferred revenue related to Gavi. Sales in the fourth quarter were $2.8 billion, with $0.8 billion in sales in the U.S. and $0.6 billion in Europe and $1.4 billion in the rest of the world, including the deferred revenue from Gavi. For the full year, 2023, product sales were $6.7 billion, comprised of $1.7 billion in sales in the U.S., $1.4 billion in Europe, and $3.6 billion in the rest of the world, again, including deferred revenue from Gavi. Moving to side 10. As mentioned, net product sales were $2.8 billion this quarter, a 43% decrease from last year. This was largely attributable to the anticipated reduction in sales volume, which was partially offset by a higher average selling price. This decrease is indicative of the evolving market dynamics as we navigate the transition of the COVID-19 vaccine market towards a more predictable seasonal pattern like traditional flu vaccines. Cost of sales was $929 million, down from 39% of net product sales in the previous year to 33% this year. This is a demonstration of our strategic efforts in Q3 to resize our manufacturing footprint, which as expected, led to additional charges in Q4 of $169 million, primarily related to the wind down of certain contract manufacturing operations. Additionally, faster sales also includes an inventory write-down of $322 million, reflecting revised demand forecasts. R&D expenses increased by 16% to $1.4 billion. This uptick reflects our commitment to advancing our late-stage clinical development programs, particularly with our RSV vaccine, CMV vaccine, combination vaccine against flu and COVID-19, as well as our INT program. The increase also included an upfront payment of $120 million associated with the strategic research and development collaboration with Immatics. SG&A expenses were $470 million, up 25% year-over-year. The increase in spending was primarily due to the expansion of our commercial operations, particularly in the U.S. market. Income tax was a benefit of $147 million for the fourth quarter of 2023, largely attributable to the tax benefits as part of finalizing our 2022 U.S. tax return. Net income for the quarter was $217 million, compared to $1.5 billion in the fourth quarter last year. Diluted earnings per share was $0.55 compared to $3.61 in 2022. We closed the quarter with a strong cash position of $13.3 billion, which is slightly higher than the $12.8 billion we had at the end of the prior quarter. Now, let's turn to our annual performance on Page 11. Net product sales for the full year of 2023 were $6.7 billion, a decrease of 64% from the previous year, mainly due to lower sales volume of our COVID-19 vaccine. As mentioned earlier, this includes the recognition of $0.6 billion from the deferred revenue related to Gavi. Excluding this item, our sales of $6.1 billion were still in line with the framework we provided for the full year. Cost of sales for the full year represented 70% of net product sales, a substantial increase from 29% of product sales in 2022. This shift is largely attributable to our strategic efforts to optimize our manufacturing operations, resulting in charges of $1.6 billion, and other manufacturing and distribution costs over reduced sales volume. Overall, cost of sales came in at $4.7 billion, slightly below the $5 billion we provided in our latest framework. Research and development spend was $4.8 billion, and SG&A was $1.5 billion, both in line with our expectations. Our income tax provision was $772 million for the full year 2023. During our Q3 earnings call, we discussed the requirement under GAAP to establish a valuation allowance against deferred tax assets, when the current year and cumulative income projection for the next three years is in a loss position. It's important to note that future income from products not yet approved by regulators are excluded from these income projections, which restricts us to just our COVID vaccine, and it does not include expected future launches. This valuation allowance does not impact cash flows, future tax returns or the company's ability to utilize deferred tax assets in future periods. Net loss for the year was $4.7 billion, compared to net income of $8.4 billion last year. The decrease in profit was primarily due to lower product sales and higher R&D expenses in 2023. Diluted loss per share was $12.33, compared to diluted earnings per share of $20.12 in 2022. So now let's move to slide 12. We wanted to provide you additional perspective on our full-year financial results by presenting them alongside a summarized version that excludes the impact of the Gavi deferred revenue recognition, our resizing charges, and the tax valuation allowance. Our total GAAP net loss for the full year was $4.7 billion. However, when excluding these primarily non-cash items, the net loss is reduced to $1.6 billion. Now let's turn to our 2024 financial framework on slide 13, which is mostly in line with what I shared on our Q3 call. We expect net sales for 2024 of approximately $4 billion, which we think will be a low point, as we expect to return to growth in 2025. Sales in the first half of the year are expected to be approximately $100 million, reflecting the strong seasonality of respiratory vaccines. We expect cost of sales of approximately 35% of product sales, in line with our cost of sales framework which we introduced in our Q3 earnings call last year. For R&D we expect full year expenses to be approximately $4.5 billion, down from $4.8 billion in 2023, and for SG&A, we expect full year expenses to be approximately $1.3 billion, down from $1.5 billion in 2023. We also expect taxes to be negligible in 2024. In our Q3 earnings call, I provided our Moderna operating principles, which largely centered around a very disciplined approach to capital allocation. Our number one priority has been, and will continue to be, reinvesting in the business. In addition to the investment into our pipeline, we expect capital expenditures in 2024 to be approximately $0.9 billion, as we mostly complete the construction of our facilities across the globe. Our teams are laser-focused on operational improvements for both expense management and working capital. As a result, we expect to end 2024 with approximately $9 billion in cash. I will now turn the call over to Stephen.
Stephen Hoge : Thank you, Jamey. Good morning or good afternoon, everyone. Today I'll do a quick review of our clinical highlights from our late-stage programs in 2023, and then look ahead to anticipated milestones in 2024. While we have over 40 programs in development, they'll focus on our late-stage pipeline, which consists of nine programs across four franchises, all made significant progress in 2023. Four of these programs are in our respiratory vaccine franchise. We hope to launch all of these potential products by the end of 2025. I'll discuss these further in a moment. The other five late-stage programs are spread across latent vaccines, oncology therapeutics, and rare disease therapeutics. We hope to begin launching these beginning in 2026, and I'll discuss our progress in these areas as well. In infectious disease vaccines, we've achieved many important clinical milestones in 2023. Within our respiratory vaccine franchise, we filed for RSV vaccine approvals in many countries around the world. We recently presented follow-up data from our Phase 3 study at the RSVVW meeting that I'll recap in a moment. In our mRNA-1010 flu program, our Phase 3 P303 study met its primary safety endpoints and hit all eight co-primary immunogenicity endpoints against all strains of influenza. We're also excited that we fully enrolled the Phase 3 immunogenicity and safety study of our Next-Gen COVID vaccine and the Phase 3 immunogenicity safety and safety study of our flu and COVID combination vaccine. In our latent and other vaccines franchise, we're proud of the great progress our team made to complete enrollment in the Phase 3 study of our CMV vaccine in 2023. That study is now accruing cases towards its first interim analysis of efficacy. On slide 17, I want to briefly review the primary analysis for our RSV vaccine, which was first shared in January of 2023. The study met its primary and key secondary endpoints, leading the DSMB to recommend unblinding. Vaccine efficacy was 83.7% against RSV with two or more symptoms of lower respiratory tract disease at a median follow-up of 3.7 months with a wide range of two weeks to 12 months of total follow-up. The primary analysis also showed 82.4% and 68.4% vaccine efficacy against three or more symptoms and acute respiratory distress respectively. These data were recently published in the New England Journal of Medicine in December of last year. We've continued to follow the participants in the trial and announced follow-up data at the RSVVW conference earlier this month. An additional analysis showed sustained vaccine efficacy against RSV with VE of 63.3% against RSV, lower respiratory tract disease with two or more symptoms through a medium follow-up of 8.6 months and a maximum follow-up of 17.7 months. The vaccine efficacy was 74.6% against RSV, lower respiratory tract disease associated with shortness of breath, which has been shown to be a key driver of seeking a higher level of medical care and the associated burdens and costs. Now, slide 19 summarizes the overall timing of enrollment, primary efficacy analysis, and subsequent analysis overlaid against the epidemiology of RSV over the two seasons that have now contributed to the efficacy in the trial. Our trial enrolled steadily over 13 months between November 2021 and December 2022. As a result, the primary efficacy analysis included cases from both the smaller RSV season of 2021 and 2022 and the much more significant RSV season of 2022 and 2023. Due to enrollment throughout the year, the median follow-up of the primary analysis was 3.7 months, but as I noted, the maximum follow-up was 12 months. The primary analysis met its success criteria leading to a study on blinding. We continued a pre-plan additional analysis on April 30, 2023. At that analysis, the medium follow-up was 8.6 months, with a maximum follow-up of 17.7 months. Or put another way, approximately 17,000 participants were between nine and 18 months of study follow-up at the time of the analysis, with many completing their second RSV season on the study. Per protocol, we are continuing to follow cases through one year, but as is evident from the epidemiology, very few cases would be expected in the six months after the April 30th cutoff date from the last analysis. In summary, we are pleased that the data shows sustained efficacy through two seasons, including the large RSV season of 2022, 2023, and we look forward to providing further updates from this ongoing study. We also achieved clinical milestones across our therapeutics franchises in 2023. In oncology, our Individualized Neoantigen Therapy developed in partnership with Merck, began Phase 3 clinical studies in both adjuvant melanoma and non-small cell lung cancer. Both phase three trials are now actively enrolling. Our primary analysis from the Phase 2 study was recently published in The Lancet, giving greater detail on the two-year follow-up data that we had released in 2022. Now in December of 2023, we shared top-line follow-up data from that same Phase 2 study in adjuvant melanoma patients, confirming the durability of the initially reported responses. At a medium follow-up of now three years, the recurrence-free survival and distant metastasis-free survival remained extremely favorable, with a reduction of the risk of recurrence or death by 49% and a reduction of the risk of distant metastasis or death of 62%. Both results were highly statistically significant at three years. And in PA and MMA, our most advanced rare-disease therapeutic programs, we continued to see positive clinical data in our Phase 1/2 studies, including improvements in biomarkers and clinical outcomes, such as metabolic decompensations. Now, turning to slide 21. While we're proud of the progress in 2023, we have much more ahead in 2024. Let me take you through some of the late-stage milestones we anticipate for this year. I'll start with our respiratory franchise, where we are targeting the first approval for our RSV vaccine, beginning in the first half of 2024, with commercial launches shortly thereafter. With our flu vaccine, we're in discussions with regulators about potential submissions for approvals, and we expect to begin filing this year. Phase 3 data from our Next-Gen COVID vaccine is expected in the first half of 2024, which will inform the next steps. And we expect Phase 3 data for our flu and COVID combination vaccine this year. In latent vaccines, we are looking forward to potential efficacy data from our CMV Phase 3 study. In oncology, we expect continued progress enrolling our two Phase 3 studies in INT for adjuvant melanoma and non-small cell lung cancer. We also expect to expand into additional tumor types this year. And finally in rare diseases, we expect to move into registrational studies for both PA and MMA in 2024. It'll be a very busy year, and we look forward to sharing progress with you as the year progresses. With that, I'll turn the call over to Stéphane.
Stéphane Bancel : Thank you, Stephen and Jamie. For Moderna and the patients we serve, 2024 is all about execution. Execution in commercial, execution of our late-stage pipeline, and execution with financial discipline. Starting with commercial, first our COVID vaccine. We continue to work with health authorities to increase vaccination rates and improve public health by reducing the substantial burden of disease from COVID in this upcoming 2024-2025 season. While I am pleased with the U.S. market share outcome of the current season, I believe we can and must do better on vaccination rates. Our teams are actively working on it already. A few weeks ago, the EU published a new mRNA COVID vaccine tender, up to 36 million doses per year for up to four years. Our team is actively working to respond to this standard. We are prioritizing our commercial focus on specific markets around the world to deliver where it matters the most. Moving to our RSV vaccine candidates, we are very excited about launching the RSV vaccine this year. That will be the launch of our second product. Our mRNA platform is delivering. The FDA PDUFA date is May 12. If the outcome is positive, we anticipate that ACIP will include mRNA-1345 on the agenda in late June. In Europe, we expect Germany to launch in 2024. We also expect Australia to launch this year, while other markets will likely launch in 2025. In many markets around the world, we need to secure regulatory approval before we can participate in tenders. As communicated last year, given expected approval outside the U.S., Germany and Australia will anticipate launching RSV in this market in 2025. The RSV market is estimated to be a $10 billion opportunity, consisting roughly of $6 billion to $8 billion in older adults and $2 billion to $4 billion in the pediatric and maternal setting. In 2023, the first-year RSV vaccine launches, consumer awareness of RSV, and demand for RSV vaccine was strong. The 2023 adult RSV vaccine market was around $2.5 billion. This is quite impressive, given the first year RSV vaccines were available, they were not even available for a full year, and the products were not approved in many countries. With 2023 RSV vaccination rate as a small percentage of a total addressable market, we are quite excited to launch our product into this large and growing market. Let me now turn to our RSV vaccine profile. We believe we have the best profile to serve patients and completing the RSV market, efficacy, safety, and ease of use. Our clinical data shows strong vaccine efficacy. We have a well-established safety and tolerability profile that leverages the same mRNA technology that has been delivered in over 1 billion COVID vaccines. Additionally, we have not seen any case of Guillain-Barre Syndrome or GBS in our Phase 3 trials. We expect to be the only company to offer an RSV vaccine in ready-to-use prefilled syringe or PFS. Our one-step administration compares well relative to competitive products and requires multiple preparation steps by pharmacists and clinicians. As you know, one of our competitors’ products requires nine steps of preparation for each consumer needing an RSV vaccine, and the other competitors’ product requires four steps of preparation. With over 90% of U.S. RSV vaccines given to-date in the pharmacy setting, PFS presentations offer ease of use, time saving and the potential to reduce medical errors. Given the labor shortage in retail pharmacy channels, we anticipate our PFS presentation will be welcomed by pharmacists in a very busy respiratory vaccine season, where pharmacists need, in addition to their regular tasks, to administer flu vaccine, COVID vaccine and RSV vaccine. Today we talked about how much progress we made in the late-stage pipeline in 2023. This year, we look forward to continue the execution and reporting milestones in each of these programs. If you look at this slide, it is going to be a very busy and very exciting year with multiple Phase 3 readouts like the COVID Next-Gen, also Flu plus COVID Phase 3 data, and potentially CMV Phase 3 data. But also we're going to be filing products like flu, which will be our product file, and of course approvals in many countries around the world for RSV. Finally, we are all committed to exercise financial discipline across the business. While we have resized our manufacturing footprint in 2023, we will continue to find ongoing cost improvements in manufacturing. We will reduce operating expenses in R&D and SG&A and prioritize programming R&D with near-term commercial potential in areas of unmet medical needs. Overall, our CapEx will be up modestly in 2024 compared to 2023, and will mostly complete construction of several important plans in Marlborough, Massachusetts for INT, and Canada, UK and Australia. In 2025, we expect CapEx to be down significantly. We're also targeting working capital improvements. And importantly as you know, we are adopting AI across the business, which we expect to save time, increase productivity, and drive scalability in addition to cost saving. Our use of AI is increasing by the week, and new use cases are exciting to see how our teams are embracing this new tool across the business. In summary, 2024 is an important year of execution across our company, one that will set the stage for the next several years. I am very excited by how our company is positioned. I believe 2024 will be a year where many observers of Moderna go from thinking of us as a COVID vaccine company, to seeing Moderna as an mRNA platform company, with several products approved and more approvals on the way for 2025 and beyond. Over the next few years, our ability to deliver on our mission will increase significantly and be very meaningful for our teams. With that, Operator, we'll be now happy to take questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Michael Yee with Jeffries. Your line is open.
Michael Yee: Hey guys. Good morning and thanks for the question. Focusing on RSV, I know you made a number of nice comments about comparing the data. Maybe you could talk to two or three points. One is perhaps how it will work in the commercial market in the U.S. with contracting. Is that contracting season or do you have to have contracts and how does that work between the two different other competitors? And secondly, how would that work at the pharmacy level when either patients or doctors are making the selection, given the fact that Pfizer and GSK both had similar sales but different profiles? Maybe talk to those two different things and how you expect that to play out for this year. Thank you.
Stéphane Bancel: Great. Thank you, Michael. It’s Stéphane. So in terms of contracting, obviously we cannot start contracting now, because the product is not approved. But our medical team has been quite engaged across the board at medical conferences, talking to healthcare professionals and sharing the great data that was published in December, as you know, for a Phase 3 in the New England Journal of Medicine. So we have active discussions. There is quite high excitement about the possibility, again, if a product was to be approved to get a pre-filled syringe product. As we discussed in my remarks, as you know, labor shortages are a big issue in pharmacy. For any of us that has gone to a pharmacy in the fall, you could see it was very busy, sometimes a bit too hectic, and so the leadership of the big retail pharmacies is very engaged to think about COVID versus RSV and how to simplify the workflow, how to reduce medical errors, which is why those medical discussions that we're having so far give me significant hope that our products will be meaningful tools for our customers.
Operator: Thank you. Our next question comes from Gena Wang with Barclays. Your line is open.
Gena Wang: Thank you. I have two very quick questions. First one is regarding the RSV vaccine. What portion of 35,000 to 36,000 participants that completed two seasons and regarding February 29 ACIP meeting, what additional data you will be presenting? And very quickly on 2024 guidance, now we have a better understanding of both COVID and RSV market size for 2023 and 2024 season. What could be the upside or downside for your 2024 revenue guidance of $4 billion?
Stephen Hoge: Great. Thanks Gena. I'll take the first part of that. So I actually can't – I don't know off the top of my head the proportion, because there are both Southern and Northern Hemisphere participants that were enrolled in the study. And so counting the two RSV seasons will depend upon that. It is a sizable proportion, because as I said, the maximum follow-up at the additional analysis is about 18 months, medium was nine months. And so by definition, about half, as you just said, about 17,000 participants are between it. And we did enroll pretty continuously over 13 months, not exactly evenly, but pretty close to it. So I don't want to give you an inaccurate number, but I would suspect it is a pretty sizable proportion because of that steady, pretty consistent enrollment over the course of 13 months. It's not exactly equal, but it trended in that direction. As far as the digital data for the ACIP meeting, we will obviously continue to provide updates from any additional analysis we're doing on durability. We obviously have immunogenicity data, as well as data across different subpopulations. And if we're fortunate enough to have the opportunity to present at the ACIP, we will of course listen to the committee on anything they would like to see as well on the performance of mRNA 1345 as a vaccine, and the performance of the vaccines in general in terms of durability, as it guides decision-making around repeat dosing or boosting on some schedule and the public health.
Stéphane Bancel: Thanks Stephen. And Gena, its Stéphane, on the upside and downside on the sales for this year. I think on the upside obviously, the COVID in Europe, as I just mentioned, we couldn't participate in the market last fall. The new tender is an opportunity for us to participate. Quite a number of doctors, hospitals, public health leaders have actually complained that the Moderna vaccine, given the higher efficacy reported for reduction of hospitalization was not available, especially for the elderly, for immunocompromised people, so that's an interesting upside. Of course, the vaccination rate in the U.S. as we reported, the vaccination rate in the current ending season was lower than last year. As I said in my remarks, we need to do better to protect more people. And our team is actively already working in a cross-functional matter to address the VCR and increase the vaccination rate. And the other upside could be the RSV, both for market growth, as well as our share. How quickly can we get share from the current two solutions available. On the downside, of course, the vaccination rate could be a downside. And the other one is of course timing of RSV launch, given we rely on regulators for the approval of products, and then the public health recommendations like CDC over different NITAGs in the different countries, that could of course delay launches and of course impacting sales. Thank you.
Operator: Thank you. Our next question comes from Eli Merle with UBS. Your line is open.
Eli Merle : Hey guys, thanks so much for taking the question. Just turning to the CMV Phase 3, can you talk a little bit about what you would view as clinically meaningful or commercially relevant on vaccine efficacy? And if successful, also, how are you thinking about use in seronegative versus seropositive patients? Thanks.
Stephen Hoge : For sure. So thank you for the question. So in CMV, obviously there's currently no vaccine that can prevent infection against CMV. And as it is a source of devastating birth defects, anything that provides a statistically significant reduction in the rate of infection and therefore vertical transmission would be, we think terrific. Now, the minimum bar that we are powering in our study would support is a vaccine efficacy of approximately 50% as we've shared previously. Anything above that would obviously beat our expectations and be incredibly exciting for the field. We are in the Phase 3 study, enrolling both seropositive and seronegative participants. And part of the reason for that is that there's currently no broadly used diagnostic. And so we want to demonstrate benefit or safety in both populations, because we do believe that the most likely use of the vaccine could be that it's given regardless of serostatus to both seronegatives and seropositives. And there are potential benefits for seropositives that could include control of shedding or viremia or other long-term sequelae of CMV, but we would have to prove those. And again, those are not something we're exploring explicitly in the current Phase 3 study. So as a practical matter, from a labelling perspective and a launch perspective, our goal is to try and launch the product for both seropositives and seronegatives, so that no diagnostic would be needed and it can be broadly used across populations to try and prevent the devastating effects of CMV on vertical transmission to newborn babies.
Operator: Thank you. Our next question comes from Hartaj Singh with Oppenheimer. Your line is open.
Hartaj Singh : Great. Thank you. You had indicated that you are going to complete the enrollment for CMV this year and maybe have a readout. Can you just walk us through the steps or how that would look like, and maybe just give us some ideas on powering statistical assumptions? Thank you.
Stephen Hoge : Yeah, of course. Thanks Hartaj. So we're currently fully enrolled and we're accruing cases in that study. I think as we've shared before, we've actually made substantial progress in a number of cases. It is a case-driven endpoint and we'll need to see approximately 80 cases before we'll do the first interim analysis for efficacy. That, its 81 cases to be specific. That interim analysis actually will look a lot like our other vaccine efficacy studies. DSMB will evaluate that data and if we meet the statistical threshold, which is for early efficacy, meaning we're doing better than our minimum of 49.5% vaccine efficacy, then they will at that moment tell us to unblind and share the results, and of course, we will share them broadly with the world. If for whatever reason we don't quite have the statistical power in that first interim analysis efficacy, the study is powered to continue on and continue to accrue cases towards a final analysis of efficacy. Now, given the rate of the final analysis at 112 cases, now given the rate of a case accrual that we're currently seeing in the study, we do expect that we will have more than enough cases this year. We are therefore pretty confident that we're going to be seeing a readout from the interim analysis, possibly even a final analysis for efficacy in 2024. But again, since its case and event driven, we just have to bide our time. And ultimately, we will depend upon the DSMB to tell us whether or not we've met that statistical threshold.
Operator: Thank you. Our next question comes from Luca Issi with RBC Capital. Your line is open.
Luca Issi : Oh, great. Thanks so much for taking my question. Maybe Stephen, at INT, maybe can you remind us what's your latest thinking in terms of potential for accelerated approval there for melanoma? And then maybe on the additional tumor types that you guys and Merck are thinking about it, can you just maybe talk about what are the tumor types that you are contemplating and whether those tumor types are going to be in the adjuvant settings or in the metastatic settings? And then maybe on RSV quickly, can you just maybe expand on durability in the context of your competitor? Is there a scenario where ACIP recommends the GSK vaccine for every other year versus your vaccine for every year? Any color there is much appreciated. Thanks so much.
Stephen Hoge : Quite a few questions there. I'll try and get them all. I apologize if I forget any one. So first on the question of INT and accelerated approval in the adjuvant melanoma setting. So as we've said before, we continue to be really excited about the data and are excited to start looking to talk to regulators about it. There have been three things that we've tried to say that had to be true for us to believe it was appropriate to even ask about accelerated approval. The first was we had to see durability. And clearly the data that we just saw from December, just two months ago, shows that durability and really a clear statistically significant result where the comparator arm, the control arm looks really just like the labeled data, and so we're incredibly encouraged by that durability, that was criteria one. But the second and third are still there and really important. The second is that we have to substantially enroll the confirmatory Phase 3 study. For an accelerated approval in this space, we do believe we have to show we've really already done the diligence to allow that confirmatory data to come in, so that three or four years from now, that further readout would confirm anything that would happen in accelerated approval context. And then the third and perhaps now increasingly important criteria, was that we had to establish the commercial manufacturing facility. And so as we've announced, we've been building a facility in Marlborough, Massachusetts. It'll be a purpose-built, personalized, individualized neoantigen therapy facility that is ultimately what will be licensed to create this product for the world, whether it's in an accelerated context or in the future with full approval. That facility is coming online. We look forward to hosting many of you and others in tours as we bring it online. But without that facility, there isn't really a product here to talk about. And so all three of them are essential. We're making progress on all three. And I think the most exciting thing is what you were just alluding to, which is the durability of the benefit we've been seeing really causes us to now lean into completing, working hard to complete the enrollment of that confirmatory study criteria too, and finish the build out of that Marlborough facility, which is the third criteria. Now, on the point of other indications that we're going after, I will defer to our partners, Merck, on the specifics. We will do it together at the right time, opening up additional Phase 3 and confirmatory studies. We do expect to open multiple this year. Those include some additional adjuvant indications. They also include some potential metastatic indications, and we are looking at monotherapy indications. And that can be either in places where PD-1s, KEYTRUDA, may not be indicated or even earlier lines of therapy. And so all of those are under consideration, and as soon as we start those studies up and begin enrolling, of course, we'll make announcements about them with our partner, Merck. Now lastly, on the question of RSV, we continue to be really enthusiastic about the data that our product has, and I think the durability now shown through this second large season is quite encouraging. We'll be sharing that data with the ACIP. Well, first we have to get to the regulatory process and approval in this country. And Stéphane mentioned our PDUFA date in May. And if we have the opportunity, we'll be sharing the data with the ACIP, which includes, in our case, booster data on immunogenicity from ongoing work that has actually already previously been presented publicly at meetings. And so just like our competitors, we have shared data of what a second dose looks like in terms of boosting neutralizing antibody titers back up, both at one year, and we're also going to be looking at two years. And all of the data, ourselves, as well as that similar booster data from the competitor products, will likely be brought together to inform the ACIP's recommendation of how they think RSV vaccines should be readministered when a booster might be necessary. It really falls to the committee to make that determination, not us. Your question was about whether we expect there to be any difference or distinction in terms of how they treat the vaccine. You know at this point, given the immunogenicity data and booster data that has been shared across all three products, which is remarkably consistent, as well as the consistent picture in terms of efficacy, including some waning efficacy for all products in the second year, we would suspect that they will continue to view the products as more similar than not and therefore continue with consistent recommendations. But it's really up to the committee to make that determination. At least from my perspective, I certainly think the science would support that.
Operator: Thank you. Our next question comes from Salveen Richter with Goldman Sachs. Your line is open.
Elizabeth Webster : Hey, good morning, and thank you for taking our questions. This is Elizabeth on for Salveen. Two questions from us. First, can you just remind us of where you stand with evaluating the RSV vaccine in the paediatric population? And then for the Phase 3 CMV vaccine, can you walk us through what you've seen on durability to-date and how you are thinking about the durability of that vaccine, particularly as it relates to the potential commercial opportunity in a younger adult women/adolescent population? Thank you.
Stéphane Bancel : Hey. So I'll take the question. So on RSV vaccines [ph], we have not started the study yet. We are of course considering taking this into a Phase 3. It is in the clinic with Phase 1/2. We are waiting for the data to be able to move at the right time into the paediatric setting. In terms of CMV, we don't have data yet on durability. Again, like we've done for other programs, when we share the data, we share the data, including durability, because it's very important. As you know, the benefit of young women is they have a very strong immune system. As we've shown in our INT programs, our T-cells work very well in terms of the vaccination technology of Moderna. So we really expect to have good durability over time. But again, we have to wait for the data to make such a determination. Thank you.
Operator: Thank you. Our next question comes from Geoff Meacham with Bank of America. Your line is open.
Alex Hammond: Hi, this is Alex Hammond on for Geoff Meacham. Thank you for taking our question. So a great way to equalize vaccine efficacy results is to use a correlative of protection. So for RSV, when do you think we could have a line of sight into those type of metric? And how important could this be for competitive dynamics? Thank you.
Stéphane Bancel : Good morning. This is Stéphane.
Stephen Hoge : Hi. Sorry about that -- small technical snafu. So I'm back. I believe I caught the end of the question, which is when do we think we'll have a correlative of protection that can inform dynamics, both between products and boosting, if that's correct. We and all the other manufacturers have been sharing publicly our work on a correlative protection. We do believe that we've identified a strong candidate in neutralizing antibodies, not surprisingly, from our clinical study. We've been sharing that data with regulators, and we've been sharing the preliminary analysis with public health officials, including advisory groups and ITAGs like the ACIP. We will be publishing that data and ultimately submitting that to our regulatory submissions as a correlate through the balance of this year. And if we and I think the other competitors are successful in establishing neutralizing antibodies against RSV as a correlative protection in RSV, then it really will probably be the primary way that public health officials make determinations about revaccination and boosting, and ultimately how we maintain durable protection against RSV for high-risk populations like older adults. From a competitive dynamics perspective, once each product has established their correlate, their correlate will relate to them. But we do think there's probably going to be more commonality than not in the correlates of protection, which makes sense, because at the end of the day we're still talking about the same virus and vaccination against it for all three products.
Operator: Thank you. Our next question comes from Terence Flynn with Morgan Stanley. Your line is open.
Terence Flynn : Great. Thanks for taking the question. I was just wondering if you could provide an update on your discussions with the FDA for 1010, your seasonal flu vaccine, and what's gating to filing here. Thank you.
Stephen Hoge : Thanks. So we are speaking to the FDA and regulators around the world about what would be – what they would like to see from a submission perspective for – in first-generation or influenza program, our mRNA 1010 program, as you referenced. I don't have any specific updates right now. We're in those conversations as we speak. I really don't want to get ahead of them. The kinds of things we're talking about are what's the total submission data package, what's the duration of follow-up in some of these studies, and what additional studies or data might be supportive to the application. Those conversations are ongoing. We will provide updates as and when we have them, but I have nothing further to add right now.
Operator: Thank you. Our next question comes from Jessica Fye with J.P. Morgan. Your line is open.
Jessica Fye : Hey guys. Good morning. Thanks for taking my question. For INT, can you talk about what's driving your confidence to go into metastatic settings? How is enrollment going in the Phase 3 melanoma trial? And I know you touched on manufacturing being important here. What's the status of that manufacturing scale of work, and when is that facility going to be ready to go live?
Stephen Hoge : Great questions all. So, I'll take the first part of that. So first of all, metastatic. So we have not formally decided or announced that we're going into a metastatic indication. We do have data from our Phase I study, our initial Phase 1 study in metastatic patients, including non-small-cell lung cancer, but we have not yet made a determination that we're going into the metastatic indication. And I think behind your question is a view that I would agree with, which is to the extent that INT is going to provide a really substantial benefit, we think it is probably in earlier lines of therapy. So not just adjuvant, but perhaps even Stage I disease or a Stage II disease, depending on the indication, because the safety and tolerability profile is we think incredibly favorable, and the benefits we're seeing are pretty remarkable from an immune perspective. That said, there is still a really high unmet need in the metastatic space, and even immunotherapies like the PD-1s, like KEYTRUDA, provide a substantial benefit there. And so at the right time, we may well choose to study the metastatic indication, but as I said or metastatic indications and settings, but as I said, we have not yet formally decided to do that today, and we are really focused on adjuvant and earlier and monotherapy principally. On the manufacturing process and enrollment, we have substantially scaled up our ability to enroll patients in those Phase 3 studies. I can assure you that with our partner, Merck, we wouldn't have opened a second Phase 3 study and be talking about the third if we didn't have confidence in our ability to rapidly meet the demand for the substantial demand from those clinical research sites for INT manufacturing. We haven't specifically put out numbers, but suffice it to say, we are rapidly enrolling in those studies, and we would expect to make substantial progress this year and even perhaps getting close to completing enrollment in at least one of those studies if it continues trajectory. So we're excited about the progress we've made in scaling up the manufacturing for clinical supply. We're excited about the progress we're making right now in enrolling patients and the demand that we're seeing from clinical sites. And we do believe that we've solved a lot of the, for clinical research, for clinical development, the manufacturing requirements. The question then becomes commercial, and as we alluded to a few minutes ago, the Marlboro site would really become the purpose-built commercial site, which needs to not only be able to deliver high-quality products at high volumes, but also do it at a valuable price and cost point and all of that work is ongoing. We've made great progress in building that site. Our goal is to establish that site for at least clinical supply this year, but we haven't provided further guidance on when we will have that fully operational for potential commercial use. And ultimately, it depends upon discussions with regulators as well.
Lavina Talukdar: Kevin, we'll take our last question.
Operator: Okay. Our last question comes from Evan Wang with Guggenheim Securities. Your line is open.
Evan Wang: Great. Thanks guys. Two from me. First, on RSV, I know there are some additional studies to expand the initial population. Can you comment on when we may see data from the Phase 3 and 50-plus in the higher-risk younger adults, and when you could potentially supplement the filing if everything's positive? And then, I know you commented on Australia. So just, as you were thinking about or as you've talked about Australia as a proxy for COVID sales in 2023. Now can you comment on how interpretable Australia would be? Will it be through your RSV launch, and as we look for trends in COVID vaccination rates? Thanks.
Stephen Hoge : Great. I'll quickly take the first part of that and then hand it over to Stéphane for the second. So the additional data on 50-plus, we have obviously immune bridging data and co-administration data. We'll be sharing that at the appropriate time with public health officials and others. It could be as soon as the ACIP. It just depends on when the data comes in, as well as the 18-plus high-risk populations. In your question about getting those in the label, it's important to note that public health officials can recommend use even beyond the label and may choose to do that, but our responsibility would be to get it in the label, and we will need to complete the initial BLA before then we could submit the SBLA to get that data in the label. And so obviously it would follow shortly after our hopefully successful PDUFA outcome in May.
Stéphane Bancel : Thanks, Stephan. And on Australia, so a few things. First, I mean, our team has delivered a strong performance on COVID in Australia. We've been helping the government since the beginning of the pandemic. As you recall, we have announced a long-term 10-year partnership with the Australian government, and we are currently building a plant in Melbourne that is advancing quite successfully, and we are in active discussions with regulators around Australia for RSV approval. The point I will make is that Australia, as you know is a quite different market commercially to the U.S. It's really mostly driven by the government, so I will compare Australia more to a European market than to the U.S. market. I don't think we can draw any positive or negative correlation in terms of what happened in Australia, COVID or RSV, to what will happen in the U.S. in the fall ‘24, winter ‘25.
Stéphane Bancel: Thank you so much for the questions today. Thank you for taking the time to be with us. We look forward to talking and seeing many of you in the coming days and weeks. I hope that you will have on March 27, Annual Vaccine Day in your calendar. We'll start the presentation at 9 a.m. Eastern Time. So have a great day and thank you for joining.
Operator: Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day. |
NVDA | 4 | 2,024 | 2024-02-21 20:59:03 | Operator: Good afternoon. My name is Rob and I'll be your conference operator today. At this time, I would like to welcome everyone to the NVIDIA's Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Simona Jankowski, you may begin your conference.
Simona Jankowski: Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the fourth quarter and fiscal 2024. With me today from NVIDIA are Jen-Hsun Huang, President and Chief Executive Officer, and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the first quarter of fiscal 2025. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent Forms 10-K and 10-Q and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All our statements are made as of today, February 21, 2024, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. With that let me turn the call over to Colette.
Colette Kress: Thanks, Simona. Q4 was another record quarter. Revenue of $22.1 billion was up 22% sequentially and up to 265% year-on-year and well above our outlook of $20 billion. For fiscal 2024, revenue was $60.9 billion and up 126% from the prior year. Starting with data center. Data center revenue for the fiscal 2024 year was $47.5 billion, more than tripling from the prior year. The world has reached the tipping point of new computing era. The $1 trillion installed base of data center infrastructure is rapidly transitioning from general purpose to accelerated computing. As Moore's Law slows while computing demand continues to skyrocket, companies may accelerate every workload possible to drive future improvement in performance, TCO and energy efficiency. At the same time, companies have started to build the next generation of modern data centers, what we refer to as AI factories, purpose built to refine raw data and produce valuable intelligence in the era of generative AI. In the fourth quarter, data center revenue of $18.4 billion was a record, up 27% sequentially and up 409% year-over-year, driven by the NVIDIA Hopper GPU computing platform along with InfiniBand end-to-end networking. Compute revenue grew more than 5x and networking revenue tripled from last year. We are delighted that supply of Hopper architecture products is improving. Demand for Hopper remains very strong. We expect our next-generation products to be supply constrained as demand far exceeds supply. Fourth quarter data center growth was driven by both training and inference of generative AI and large language models across a broad set of industries, use cases and regions. The versatility and leading performance of our data center platform enables a high return on investment for many use cases, including AI training and inference, data processing and a broad range of CUDA accelerated workloads. We estimate in the past year approximately 40% of data center revenue was for AI inference. Building and deploying AI solutions has reached virtually every industry. Many companies across industries are training and operating their AI models and services at scale, enterprises across NVIDIA AI infrastructure through cloud providers, including hyperscales, GPU specialized and private clouds or on-premise. NVIDIA's computing stack extends seamlessly across cloud and on-premise environments, allowing customers to deploy with a multi-cloud or hybrid-cloud strategy. In the fourth quarter, large cloud providers represented more than half of our data center revenue, supporting both internal workloads and external public cloud customers. Microsoft recently noted that more than 50,000 organizations use GitHub Copilot business to supercharge the productivity of their developers, contributing to GitHub revenue growth accelerating to 40% year-over-year. And Copilot for Microsoft 365 adoption grew faster in its first two months than the two previous major Microsoft 365 enterprise suite releases did. Consumer internet companies have been early adopters of AI and represent one of our largest customer categories. Companies from search to e-commerce, social media, news and video services and entertainment are using AI for deep learning-based recommendation systems. These AI investments are generating a strong return by improving customer engagement, ad conversation and click-throughs rates. Meta in its latest quarter cited more accurate predictions and improved advertiser performance as contributing to the significant acceleration in its revenue. In addition, consumer internet companies are investing in generative AI to support content creators, advertisers and customers through automation tools for content and ad creation, online product descriptions and AI shopping assistance. Enterprise software companies are applying generative AI to help customers realize productivity gains. Early customers we've partnered with for both training and inference of generative AI are already seeing notable commercial success. ServiceNow's generative AI products in their latest quarter drove their largest ever net new annual contract value contribution of any new product family release. We are working with many other leading AI and enterprise software platforms as well, including Adobe, Databricks, Getty Images, SAP and Snowflake. The field of foundation of large-language models is thriving. Anthropic, Google, Inflection, Microsoft, OpenAI and xAI are leading with continued amazing breakthrough in generative AI. Exciting companies like Adept, AI21, Character.ai, Cohere, Mistral, Perplexity and Runway are building platforms to serve enterprises and creators. New startups are creating LLMs to serve the specific languages, cultures and customs of the world many regions. And others are creating foundation models to address entirely different industries like Recursion Pharmaceuticals and Generate:Biomedicines for biology. These companies are driving demand for NVIDIA AI infrastructure through hyperscale or GPU specialized cloud providers. Just this morning, we announced that we've collaborated with Google to optimize its state-of-the art new Gemma language models to accelerate their inference performance on NVIDIA GPUs in the cloud data center and PC. One of the most notable trends over the past year is the significant adoption of AI by enterprises across the industry verticals such as automotive, healthcare and financial services. NVIDIA offers multiple application frameworks to help companies adopt AI in vertical domains such as autonomous driving, drug discovery, low latency machine learning for fraud detection or robotics, leveraging our full stack accelerated computing platform. We estimate the data center revenue contribution of the automotive vertical through the cloud or on-prem exceeded $1 billion last year. NVIDIA DRIVE infrastructure solutions includes systems and software for the development of autonomous driving, including data ingestion, creation, labeling and AI training, plus validation through simulation. Almost 80 vehicle manufacturers across global OEMs, new energy vehicles, trucking, robotaxi and Tier 1 suppliers are using NVIDIA's AI infrastructure to train LLMs and other AI models for automated driving and AI cockpit applications. And in fact, nearly every automotive company working on AI is working with NVIDIA. As AV algorithms move to video transformers and more cars are equipped with cameras, we expect NVIDIA's automotive data center processing demand to grow significantly. In healthcare, digital biology and generative AI are helping to reinvent drug discovery, surgery, medical imaging and wearable devices. We have built deep domain expertise in healthcare over the past decade, creating the NVIDIA Clara healthcare platform and NVIDIA BioNeMo, a generative AI service to develop, customize and deploy AI foundation models for computer-aided drug discovery. BioNeMo features a growing collection of pre-trained Biomolecular AI models that can be applied to the end-to-end drug discovery processes. We announced Recursion is making available for their proprietary AI model through BioNeMo for the drug discovery ecosystem. In financial services, customers are using AI for a growing set of use cases from trading and risk management to customer service and fraud detection. For example, American Express improved fraud detection accuracy by 6% using NVIDIA AI. Shifting to our data center revenue by geography. Growth was strong across all regions, except for China where our data center revenue declined significantly following the U.S. government export control regulations imposed in October. Although we have not received licenses from the U.S. government to ship restricted products to China, we have started shipping alternatives that don't require a license for the China market. China represented a mid-single digit percentage of our data center revenue in Q4. And we expect it to stay in a similar range in the first-quarter. In regions outside of the U.S. and China, sovereign AI has become an additional demand driver. Countries around the world are investing in AI infrastructure to support the building of large-language models in their own language, on domestic data and in support of their local research and enterprise ecosystems. From a product perspective, the vast majority of revenue was driven by our Hopper architecture along with InfiniBand networking. Together, they have emerged as the de-facto standard for accelerated computing and AI infrastructure. We are on track to ramp H200 with initial shipments in the second quarter. Demand is strong as H200 nearly doubles the inference performance of H100. Networking exceeded a $13 billion annualized revenue run rate. Our end-to-end networking solutions define modern AI data centers. Our Quantum InfiniBand solutions grew more than 5x year on year. NVIDIA Quantum InfiniBand is the standard for the highest performance AI-dedicated infrastructures. We are now entering the ethernet networking space with the launch of our new Spectrum-X end-to-end offering designed for an AI-optimized networking for the data center. Spectrum-X introduces new technologies over ethernet, that are purpose built for AI. Technologies incorporated in our Spectrum switch, BlueField DPU and software stack deliver 1.6x higher networking performance for AI processing compared with traditional ethernet. Leading OEMs, including Dell, HPE, Lenovo and Super Micro, with their global sales channels, are partnering with us to expand our AI solution to enterprises worldwide. We are on track to ship Spectrum-X this quarter. We also made great progress with our software and services offerings, which reached an annualized revenue run rate of $1 billion in Q4. We announced that NVIDIA DGX Cloud will expand its list of partners to include Amazon's AWS, joining Microsoft Azure, Google Cloud and Oracle Cloud. DGX Cloud is used for NVIDIA's own AI R&D and custom model development as well as NVIDIA developers. It brings the CUDA ecosystem to NVIDIA CSP partners. Okay, moving to gaming. Gaming revenue was $2.87 billion, was flat sequentially and up 56% year on year, better than our outlook on solid consumer demand for NVIDIA GeForce RTX GPUs during the holidays. Fiscal year revenue of $10.45 billion was up 15%. At CES, we announced our GeForce RTX 40 Super Series family of GPUs. Starting at $599, they deliver incredible gaming performance and generative AI capabilities. Sales are off to a great start. NVIDIA AI Tensor cores and the GPUs deliver up to 836 AI tops, perfect for powering AI for gaming, creating an everyday productivity. The rich software stack we offer with our RTX GPUs further accelerates AI. With our DLSS technologies, seven out of eight pixels can be AI generated, resulting up to 4x faster ray tracing and better image quality. And with the Tensor RT LLM for Windows, our open-source library that accelerates inference performance for the latest large-language models generative AI can run up to 5X faster on RTX AI PCs. At CES, we also announced a wave of new RTX 40 Series AI laptops from every major OEMs. These bring high-performance gaming and AI capabilities to a wide range of form factors, including 14 inch and thin and light laptops. With up to 686 tops of AI performance, these next-generation AI PCs increase generative AI performance by up to 60x, making them the best-performing AI PC platforms. At CES, we announced NVIDIA Avatar Cloud Engine microservices, which allowed developers to integrate state-of-the-art generative AI models into digital avatars. ACE won several Best of CES 2024 awards. NVIDIA has an end-to-end platform for building and deploying generative AI applications for RTX PCs and workstations. This includes libraries, SDKs, tools and services developers can incorporate into their generative AI workloads. NVIDIA is fueling the next wave of generative AI applications coming to the PC. With over 100 million RTX PCs in the installed-base and over 500 AI-enabled PC applications and games, we are on our way. Moving to Pro Visualization. Revenue of $463 million was up 11% sequentially and up 105% year on year. Fiscal year revenue of $1.55 billion was up 1%. Sequential growth in the quarter was driven by a rich mix of RTX Ada architecture GPUs continuing to ramp. Enterprises are refreshing their workstations to support generative AI-related workloads, such as data preparation, LLM fine-tuning and retrieval augmented generation. These key industrial verticals driving demand include manufacturing, automotive and robotics. The automotive industry has also been an early adopter of NVIDIA Omniverse as it seeks to digitize work flows from design to build, simulate, operate and experience their factories and cars. At CES, we announced that creative partners and developers including Brickland, WPP and ZeroLight are building Omniverse-powered car configurators. Leading automakers like LOTUS are adopting the technology to bring new levels of personalization, realism and interactivity to the car buying experience. Moving to Automotive. Revenue was $281 million, up 8% sequentially and down 4% year on year. Fiscal year revenue of $1.09 billion was up 21%, crossing the $1 billion mark for the first time on continued adoption of the NVIDIA DRIVE platform by automakers. NVIDIA DRIVE Orin is the AI car computer of choice for software-defined AV fleets. Its successor, NVIDIA DRIVE Thor, designed for vision transformers often -- offers more AI performance and integrates a wide range of intelligent capabilities into a single AI compute platform, including autonomous driving and parking, driver and passenger monitoring and AI cockpit functionality and will be available next year. There were several automotive customer announcements this quarter, Li Auto, Great Wall Motor, ZEEKR, the premium EV subsidiary of Geely and Jeremy Xiaomi EV all announced new vehicles built on NVIDIA. Moving to the rest of the P&L. GAAP gross margins expanded sequentially to 76% and non-GAAP gross margins to 76.7% on strong data center growth and mix. Our gross margins in Q4 benefited from favorable component costs. Sequentially, GAAP operating expenses were up 6% and non-GAAP operating expenses were up 9%, primarily reflecting higher compute and infrastructure investments and employee growth. In Q4, we returned $2.8 billion to shareholders in the form of share repurchases and cash dividends. During fiscal year '24, we utilized cash of $9.9 billion towards shareholder returns, including $9.5 billion in share repurchases. Let me turn to the outlook for the first quarter. Total revenue is expected to be $24 billion, plus or minus 2%. We expect sequential growth in data center and proviz, partially offset by seasonal decline in gaming. GAAP and non-GAAP gross margins are expected to be 76.3% and 77% respectively, plus or minus 50 basis-points. Similar to Q4, Q1 gross margins are benefiting from favorable component costs. Beyond Q1, for the remainder of the year, we expect gross margins to return to the mid-70s percent range. GAAP and non-GAAP operating expenses are expected to be approximately $3.5 billion and $2.5 billion respectively. Fiscal year 2025 GAAP and non-GAAP operating expenses are expected to grow in the mid-30% range as we continue to invest in the large opportunities ahead of us. GAAP and non-GAAP other income and expenses are expected to be an income of approximately $250 million, excluding gains and losses from non-affiliated investments. GAAP and non-GAAP tax rates are expected to be 17%, plus or minus 1% excluding any discrete items. Further financial details are included in the CFO commentary and other information available on our IR website. In closing, let me highlight some upcoming events for the financial community. We will attend the Morgan Stanley Technology and Media and Telecom Conference in San Francisco on March 4 and the TD Cowen's 44th Annual Healthcare Conference in Boston on March 5. And of course, please join us for our Annual DTC conference starting Monday March 18 in San Jose, California, to be held in-person for the first time in five years. DTC will kick off with Jen-Hsun's keynote and we will host a Q&A session for financial analysts the next day, March 19. At this time, we will now open the call for questions. Operator, would you please poll for questions?
Operator: [Operator Instructions] Your first question comes from the line of Toshiya Hari from Goldman Sachs. Your line is open.
Toshiya Hari: Hi. Thank you so much for taking the question and congratulations on the really strong results. My question is for Jen-Hsun on the data center business. Clearly, you're doing extremely well in the business. I'm curious how your expectations for calendar '24 and '25 have evolved over the past 90 days. And as you answer the question, I was hoping you can touch on some of the newer buckets within data center, things like software. Sovereign AI, I think you've been pretty vocal about how to think about that medium-to-long term. And recently, there was an article about NVIDIA potentially participating in the ASIC market. Is there any credence to that, and if so, how should we think about you guys playing in that market over the next several years? Thank you.
Jensen Huang: Thanks, Toshiya. Let's see. There were three questions, one more time. First question was -- can you -- well?
Toshiya Hari: I guess your expectations for data center, how they've evolved. Thank you.
Jensen Huang: Okay. Yeah. Well, we guide one quarter at a time. But fundamentally, the conditions are excellent for continued growth calendar '24, to calendar '25 and beyond. And let me tell you why? We're at the beginning of two industry-wide transitions and both of them are industry wide. The first one is a transition from general to accelerated computing. General-purpose computing, as you know, is starting to run out of steam. And you can tell by the CSPs extending and many data centers, including our own for general-purpose computing, extending the depreciation from four to six years. There's just no reason to update with more CPUs when you can't fundamentally and dramatically enhance its throughput like you used to. And so you have to accelerate everything. This is what NVIDIA has been pioneering for some time. And with accelerated computing, you can dramatically improve your energy efficiency. You can dramatically improve your cost in data processing by 20 to 1. Huge numbers. And of course, the speed. That speed is so incredible that we enabled a second industry-wide transition called generative AI. Generative AI, I'm sure we're going to talk plenty -- plenty about it during the call. But remember, generative AI is a new application. It is enabling a new way of doing software, new types of software are being created. It is a new way of computing. You can't do generative AI on traditional general-purpose computing. You have to accelerate it. And the third is it is enabling a whole new industry, and this is something worthwhile to take a step back and look at and it connects to your last question about sovereign AI. A whole new industry in the sense that for the very first time a data center is not just about computing data and storing data and serving the employees of a company. We now have a new type of data center that is about AI generation, an AI generation factory. And you've heard me describe it as AI factories. But basically, it takes raw material, which is data, it transforms it with these AI supercomputers that NVIDIA builds, and it turns them into incredibly valuable tokens. These tokens are what people experience on the amazing ChatGPT or Midjourney or, search these days are augmented by that. All of your recommender systems are now augmented by that, the hyper-personalization that goes along with it. All of these incredible startups in digital biology, generating proteins and generating chemicals and the list goes on. And so all of these tokens are generated in a very specialized type of data center. And this data center we call AI supercomputers and AI generation factories. But we're seeing diversity -- one of the other reasons -- so at the foundation is that. The way it manifests into new markets is in all of the diversity that you're seeing us in. One, the amount of inference that we do is just off the charts now. Almost every single time you interact with ChatGPT, that we're inferencing. Every time you use Midjourney, we're inferencing. Every time you see amazing -- these Sora videos that are being generated or Runway, the videos that they're editing, Firefly, NVIDIA is doing inferencing. The inference part of our business has grown tremendously. We estimate about 40%. The amount of training is continuing, because these models are getting larger and larger, the amount of inference is increasing. But we're also diversifying into new industries. The large CSPs are still continuing to build out. You can see from their CapEx and their discussions, but there's a whole new category called GPU specialized CSPs. They specialize in NVIDIA AI infrastructure, GPU specialized CSPs. You're seeing enterprise software platforms deploying AI. ServiceNow is just a really, really great example. You see Adobe. There's the others, SAP and others. You see consumer Internet services that are now augmenting all of their services of the past with generative AI. So they can have even more hyper-personalized content to be created. You see us talking about industrial generative AI. Now our industries represent multi-billion dollar businesses, auto, health, financial services. In total, our vertical industries are multi-billion dollar businesses now. And of course sovereign AI. The reason for sovereign AI has to do with the fact that the language, the knowledge, the history, the culture of each region are different and they own their own data. They would like to use their data, train it with to create their own digital intelligence and provision it to harness that raw material themselves. It belongs to them, each one of the regions around the world. The data belongs to them. The data is most useful to their society. And so they want to protect the data. They want to transform it themselves, value-added transformation, into AI and provision those services themselves. So we're seeing sovereign AI infrastructure is being built in Japan, in Canada, in France, so many other regions. And so my expectation is that what is being experienced here in the United States, in the West, will surely be replicated around the world, and these AI generation factories are going to be in every industry, every company, every region. And so I think the last -- this last year, we've seen a generative AI really becoming a whole new application space, a whole new way of doing computing, a whole new industry is being formed and that's driving our growth.
Operator: Your next question comes from the line of Joe Moore from Morgan Stanley. Your line is open.
Joe Moore: Great. Thank you. I wanted to follow up on the 40% of revenues coming from inference. That's a bigger number than I expected. Can you give us some sense of where that number was maybe a year before, how much you're seeing growth around LLMs from inference? And how are you measuring that? Is that -- I assume it's in some cases the same GPUs you use for training and inference. How solid is that measurement? Thank you.
Jensen Huang: I'll go backwards. The estimate is probably understated. And -- but we estimated it. And let me tell you why. Whenever -- a year ago, the recommender systems that people are -- when you run the internet, the news, the videos, the music, the products that are being recommended to you because as you know, the internet has trillions -- I don't know how many trillions, but trillions of things out there and your phone is 3-inches square. And so the ability for them to fit all of that information down to something, such a small real estate, is through a system, an amazing system called recommender systems. These recommender systems used to be all based on CPU approaches. But the recent migration to deep learning and now generative AI has really put these recommender systems now directly into the path of GPU acceleration. It needs GPU acceleration for the embeddings. It needs GPU acceleration for the nearest neighbor search. It needs GPU acceleration for the re-ranking and it needs GPU acceleration to generate the augmented information for you. So GPUs are in every single step of a recommender system now. And as you know, recommender system is the single largest software engine on the planet. Almost every major company in the world has to run these large recommender systems. Whenever you use ChatGPT, it's being inferenced. Whenever you hear about Midjourney and just the number of things that they're generating for consumers, when you when you see Getty, the work that we do with Getty and Firefly from Adobe. These are all generative models. The list goes on. And none of these, as I mentioned, existed a year ago, 100% new.
Operator: Your next question comes from the line of Stacy Rasgon from Bernstein Research. Your line is open.
Stacy Rasgon: Hi, guys. Thanks for taking my question. I wanted Colette -- I wanted to touch on your comment that you expected the next generation of products -- I assume that meant Blackwell, to be supply constrained. Could you dig into that a little bit, what is the driver of that? Why does that get constrained as Hopper is easing up? And how long do you expect that to be constrained, like do you expect the next generation to be constrained like all the way through calendar '25, like when do those start to ease?
Jensen Huang: Yeah. The first thing is overall, our supply is improving, overall. Our supply chain is just doing an incredible job for us, everything from of course the wafers, the packaging, the memories, all of the power regulators, to transceivers and networking and cables and you name it. The list of components that we ship -- as you know, people think that NVIDIA GPUs is like a chip. But the NVIDIA Hopper GPU has 35,000 parts. It weighs 70 pounds. These things are really complicated things we've built. People call it an AI supercomputer for good reason. If you ever look in the back of the data center, the systems, the cabling system is mind boggling. It is the most dense complex cabling system for networking the world's ever seen. Our InfiniBand business grew 5x year over year. The supply chain is really doing fantastic supporting us. And so overall, the supply is improving. We expect the demand will continue to be stronger than our supply provides and -- through the year and we'll do our best. The cycle times are improving and we're going to continue to do our best. However, whenever we have new products, as you know, it ramps from zero to a very large number. And you can't do that overnight. Everything is ramped up. It doesn't step up. And so whenever we have a new generation of products -- and right now, we are ramping H200's. There is no way we can reasonably keep up on demand in the short term as we ramp. We're ramping Spectrum-X. We're doing incredibly well with Spectrum-X. It's our brand-new product into the world of ethernet. InfiniBand is the standard for AI-dedicated systems. Ethernet with Spectrum-X --ethernet is just not a very good scale-out system. But with Spectrum-X, we've augmented, layered on top of ethernet, fundamental new capabilities like adaptive routing, congestion control, noise isolation or traffic isolation, so that we could optimize ethernet for AI. And so InfiniBand will be our AI-dedicated infrastructure. Spectrum-X will be our AI-optimized networking and that is ramping, and so we'll -- with all of the new products, demand is greater than supply. And that's just kind of the nature of new products and so we work as fast as we can to capture the demand. But overall, overall net-net, overall, our supply is increasing very nicely.
Operator: Your next question comes from the line of Matt Ramsay from TD Cowen. Your line is open.
Matt Ramsay: Good afternoon, Jensen, Colette. Congrats on the results. I wanted to ask I guess a two-part question, and it comes at what Stacy was just getting out on your demand being significantly more than your supply, even though supply is improving. And I guess the two sides of the question are, I guess, first for Colette, like how are you guys thinking about allocation of product in terms of customer readiness to deploy and sort of monitoring if there's any kind of build-up of product that might not yet be turned on? And then I guess Jen-Hsun, for you, I'd be really interested to hear you speak a bit about the thought that you and your company are putting into the allocation of your product across customers, many of which compete with each other, across industries to smaller startup companies, to things in the healthcare arena to government. It's a very, very unique technology that you're enabling and I'd be really interested to hear you speak a bit about how you think about quote/unquote fairly allocating sort of for the good of your company, but also for the good of the industry. Thanks.
Colette Kress: Let me first start with your question, thanks, about how we are working with our customers as they look into how they are building out their GPU instances and our allocation process. The folks that we work with, our customers that we work with, have been partners with us for many years as we have been assisting them both in what they set up in the cloud, as well as what they are setting up internally. Many of these providers have multiple products going at one time to serve so many different needs across their end customers but also what they need internally. So they are working in advance, of course, thinking about those new clusters that they will need. And our discussions with them continue not only on our Hopper architecture, but helping them understand the next wave and getting their interest and getting their outlook for the demand that they want. So it's always a moving process in terms of what they will purchase, what is still being built and what is in use for our end customers. But the relationships that we've built and their understanding of the sophistication of the build has really helped us with that allocation and both helped us with our communications with them.
Jensen Huang: First, our CSPs have a very clear view of our product road map and transitions. And that transparency with our CSPs gives them the confidence of which products to place and where and when. And so they know their -- they know the timing to the best of our ability. And they know quantities and of course allocation. We allocate fairly. We allocate fairly. We do the best of our -- do the best we can to allocate fairly and to avoid allocating unnecessarily. As you mentioned earlier, why allocate something when the data center's not ready. Nothing is more difficult then to have anything sit around. And so, allocate fairly, and to avoid allocating unnecessarily. And where we do -- the question that you asked about the end markets, that we have an excellent ecosystem with OEMs, ODMs, CSPs and, very importantly, end markets. What NVIDIA is really unique about is that we bring our customers, we bring our partners, CSPs and OEMs, we bring them customers. The biology companies, the healthcare companies, financial services companies, AI developers, large-language model developers, autonomous vehicle companies, robotics companies. There's just a giant suite of robotics companies that are emerging. There are warehouse robotics to surgical robotics to humanoid robotics, all kinds of really interesting robotics companies, agriculture robotics companies. All of these startups, large companies, healthcare, financial services and auto and such are working on NVIDIA's platform. We support them directly. And oftentimes, we can have a twofer by allocating to a CSP and bringing the customer to the CSP at the same time. And so this ecosystem, you're absolutely right that it's vibrant. But at the core of it, we want to allocate fairly with avoiding waste and looking for opportunities to connect partners and end users. We're looking for those opportunities all the time.
Operator: Your next question comes from the line of Timothy Arcuri from UBS. Your line is open.
Timothy Arcuri: Thanks a lot. I wanted to ask about how you're converting backlog into revenue. Obviously, lead times for your products have come down quite a bit. Colette, you didn't talk about the inventory purchase commitments. But if I sort of add up your inventory plus the purchase commits and your prepaid supply, sort of the aggregate of your supply, it was actually down a touch. How should we read that? Is that just you saying that you don't need to make as much of a financial commitment to your suppliers because the lead times are lower or is that maybe you're reaching some sort of steady state where you're closer to filling your order book and your backlog? Thanks.
Colette Kress: Yeah. So let me, highlight on those three different areas of how we look at our suppliers. You're correct. Our inventory on hand given our allocation that we're on, we're trying to, as things come into inventory, immediately work to ship them to our customers. I think our customer appreciates our ability to meet the schedules that we've looked for. The second piece of it is our purchase commitments. Our purchase commitments have many different components into it, components that we need for manufacturing. But also, often we are procuring capacity that we may need. The length of that need for capacity or the length for the components are all different. Some of them may be for the next two quarters, but some of them may be for multiple years. I can say the same regarding our prepaids. Our prepaids are pre-designed to make sure that we have the reserve capacity that we need at several of our manufacturing suppliers as we look forward. So wouldn't read into anything regarding approximately about the same numbers as we are increasing our supply. All of them just have different lengths as we have sometimes had to buy things in long-lead times or things that needed capacity to be built for us.
Operator: Your next question comes from the line of Ben Reitzes from Melius Research. Your line is open.
Ben Reitzes: Yeah. Thanks. Congratulations on the results. Colette, I wanted to talk about your comment regarding gross margins and that they should go back to the mid-70s. If you don't mind unpacking that. And also, is that due to the HBM content in the new products and what do you think are the drivers of that comment? Thanks so much.
Colette Kress: Yeah. Thanks for the question. We highlighted in our opening remarks really about our Q4 results and our outlook for Q1. Both of those quarters are unique. Those two quarters are unique in their gross margin as they include some benefit from favorable component cost in the supply chain kind of across both our compute and networking and also in several different stages of our manufacturing process. So looking forward, we have visibility into a mid-70s gross margin for the rest of the fiscal year, taking us back to where we were before this Q4 and Q1 peak that we've had here. So we're really looking at just a balance of our mix. Mix is always going to be our largest driver of what we will be shipping for the rest of the year. And those are really just the drivers.
Operator: Your next question comes from the line of C.J. Muse from Cantor Fitzgerald. Your line is open.
C.J. Muse: Yeah. Good afternoon, and thank you for taking the question. Bigger picture question for you, Jen-Hsun. When you think about the million-x improvement in GPU compute over the last decade and expectations for similar improvements in the next, how do your customers think about the long-term usability of their NVIDIA investments that they're making today? Do today's training clusters become tomorrow's inference clusters? How do you see this playing out? Thank you.
Jensen Huang: Hey, CJ. Thanks for the question. Yeah, that's the really cool part. If you look at the reason why we're able to improve performance so much, it's because we have two characteristics about our platform. One, is that it's accelerated. And two, it's programmable. It's not brittle. NVIDIA is the only architecture that has gone from the very, very beginning, literally the very beginning when CNN's and Alex Krizhevsky and Ilya Sutskever and Geoff Hinton first revealed AlexNet, all the way through to RNNs to LSTMs to every -- RLs to deep learning RLs to transformers to every single version. Every single version and every species that have come along, vision transformers, multi-modality transformers, every single -- and now time sequence stuff, and every single variation, every single species of AI that has come along, we've been able to support it, optimize our stack for it and deploy it into our installed base. This is really the great amazing part. On the one hand, we can invent new architectures and new technologies like our Tensor cores, like our transformer engine for Tensor cores, improved new numerical formats and structures of processing like we've done with the different generations of Tensor cores, meanwhile, supporting the installed base at the same time. And so, as a result, we take all of our new software algorithm invest -- inventions, all of the inventions, new inventions of models of the industry, and it runs on our installed base on the one hand. On the other hand, whenever we see something revolutionary we can -- like transformers, we can create something brand new like the Hopper transformer engine and implement it into future. And so we simultaneously have this ability to bring software to the installed base and keep making it better and better and better, so our customers installed base is enriched over time with our new software. On the other hand, for new technologies, create revolutionary capabilities. Don't be surprised if in our future generation, all of a sudden amazing breakthroughs in large-language models were made possible And those breakthroughs, some of which will be in software because they run CUDA, will be made available to the installed base. And so we carry everybody with us on the one hand. We make giant breakthroughs on the other hand.
Operator: Your next question comes from the line of Aaron Rakers from Wells Fargo. Your line is open.
Aaron Rakers: Yeah. Thanks for taking the question. I wanted to ask about the China business. I know that in your prepared comments you said that you started shipping some alternative solutions into China. You also put it out that you expect that contribution to continue to be about a mid-single digit percent of your total data center business. So I guess the question is what is the extent of products that you're shipping today into the China market and why should we not expect that maybe other alternative solutions come to the market and expand your breadth to participate in that in that opportunity again? Thank you.
Jensen Huang: Think of, at the core, remember the US government wants to limit the latest capabilities of NVIDIA's accelerated computing and AI to the Chinese market. And the U.S. government would like to see us be as successful in China as possible. Within those two constraints, within those two pillars if you will, are the restrictions, and so we had to pause when the new restrictions came out. We immediately paused. So that we understood what the restrictions are, reconfigured our products in a way that is not software hackable in any way. And that took some time. And so we reset -- we reset our product offering to China and now we're sampling to customers in China. And we're going to do our best to compete in that marketplace and succeed in that marketplace within the -- within the specifications of the restriction. And so that's it. We -- this last quarter, we -- our business significantly declined as we -- as we paused in the marketplace. We stopped shipping in the marketplace. We expect this quarter to be about the same. But after, that hopefully we can go compete for our business and do our best, and we'll see how it turns out.
Operator: Your next question comes from the line of Harsh Kumar from Piper Sandler. Your line is open.
Harsh Kumar: Yeah. Hey, Jen-Hsun, Colette and NVIDIA team. First of all, congratulations on a stunning quarter and guide. I wanted to talk about, a little bit about your software business and it's pleasing to hear that it's over a $1 billion but I was hoping Jen-Hsun or Colette if you could just help us understand what the different parts and pieces are for the software business? In other words, just help us unpack it a little bit, so we can get a better understanding of where that growth is coming from.
Jensen Huang: Let me take a step back and explain the fundamental reason why NVIDIA will be very successful in software. So first, as you know, accelerated computing really grew in the cloud. In the cloud, the cloud service providers have really large engineering teams and we work with them in a way that allows them to operate and manage their own business. And whenever there are any issues, we have large teams assigned to them. And their engineering teams are working directly with our engineering teams and we enhance, we fix, we maintain, we patch the complicated stack of software that's involved in accelerated computing. As you know, accelerated computing is very different than general-purpose computing. You're not starting from a program like C++. You compile it and things run on all your CPUs. The stacks of software necessary for every domain from data processing SQL versus -- SQL structure data versus all the images and text and PDF, which is unstructured, to classical machine-learning to computer vision to speech to large-language models, all --recommender systems. All of these things require different software stacks. That's the reason why NVIDIA has hundreds of libraries. If you don't have software, you can't open new markets. If you don't have software, you can't open and enable new applications. Software is fundamentally necessary for accelerated computing. This is the fundamental difference between accelerated computing and general-purpose computing that most people took a long time to understand. And now, people understand that the software is really key. And the way that we work with CSPs, that's really easy. We have large teams that are working with their large teams. However, now that generative AI is enabling every enterprise and every enterprise software company to embrace accelerated computing -- and when -- it is now essential to embrace accelerated computing because it is no longer possible, no longer likely anyhow to sustain improved throughput through just general-purpose computing. All of these enterprise software companies and enterprise companies don't have large engineering teams to be able to maintain and optimize their software stack to run across all of the world's clouds and private clouds and on-prem. So we are going to do the management, the optimization, the patching, the tuning, the installed-base optimization for all of their software stacks. And we containerize them into our stack. We call it NVIDIA AI Enterprise. And the way we go to market with it is that think of that NVIDIA AI Enterprise now as a run time like an operating system, it's an operating system for artificial intelligence. And we charge $4,500 per GPU per year. And my guess is that every enterprise in the world, every software enterprise company that are deploying software in all the clouds and private clouds and on-prem, will run on NVIDIA AI Enterprise, especially obviously for our GPUs. And so this is going to likely be a very significant business over time. We're off to a great start. And Colette mentioned that it's already at $1 billion run rate and we're really just getting started.
Operator: Thank you. I will now turn the call back over to Jen-Hsun Huang, CEO, for closing remarks.
Jensen Huang: The computer industry is making two simultaneous platform shifts at the same time. The trillion-dollar installed base of data centers is transitioning from general purpose to accelerated computing. Every data center will be accelerated so the world can keep up with the computing demand, with increasing throughput, while managing costs and energy. The incredible speed up of NVIDIA enabled -- that NVIDIA enabled, a whole new computing paradigm, generative AI, where software can learn, understand and generate any information from human language to the structure of biology and the 3D world. We are now at the beginning of a new industry where AI-dedicated data centers process massive raw data to refine it into digital intelligence. Like AC power generation plants of the last industrial revolution, NVIDIA AI supercomputers are essentially AI generation factories of this Industrial Revolution. Every company in every industry is fundamentally built on their proprietary business intelligence, and in the future, their proprietary generative AI. Generative AI has kicked off a whole new investment cycle to build the next trillion dollars of infrastructure of AI generation factories. We believe these two trends will drive a doubling of the world's data center infrastructure installed base in the next five years and will represent an annual market opportunity in the hundreds of billions. This new AI infrastructure will open up a whole new world of applications not possible today. We started the AI journey with the hyperscale cloud providers and consumer internet companies. And now, every industry is on board, from automotive to healthcare to financial services, to industrial to telecom, media and entertainment. NVIDIA's full stack computing platform with industry-specific applications frameworks and a huge developer and partner ecosystem, gives us the speed, scale and reach to help every company -- to help companies in every industry become an AI company. We have so much to share with you at next month's GTC in San Jose. So be sure to join us. We look forward to updating you on our progress next quarter.
Operator: This concludes today's conference call. You may now disconnect. |
ES | 4 | 2,023 | 2024-02-14 16:50:02 | Operator: Hello and welcome to the Eversource Energy Q4 and Full Year 2023 Earnings Call. My name is Elliot and I'll be coordinating your call today. [Operator Instructions] I'd now like to hand over to Bob Becker, Director for Investor Relations. The floor is yours. Please go ahead.
Robert Becker: Good morning and thank you for joining us. I am Bob Becker, Eversource Energy's Director for Investor Relations. During this call, we'll be referencing slides we posted yesterday on our website. And as you can see on Slide 1, some of the statements made during this investor call may be forward looking. These statements are based on management's current expectations and are subject to risk and uncertainty which may cause the actual results to differ materially from forecasts and projections. We undertake no obligation to update or revise any of these statements. Additional information about the various factors that may cause actual results to differ and our explanation of non-GAAP measures and how they reconcile to GAAP results is contained within our news release, the slides we posted last night and in our most recent 10-K and 10-Q. Speaking today will be Joe Nolan, our Chairman, President and Chief Executive Officer; and John Moreira, our Executive Vice President and CFO. Also joining us today is Jay Buth, our Vice President and Controller. Now, I will turn the call over to Joe.
Joseph Nolan: Thank you, Bob and thank you all for joining us on the call this morning and for your interest in Eversource. Let me begin with the pathway for a full exit of our offshore wind business on Slide 4. When we started down this path in 2016, we were very excited for the opportunity to bring much needed renewable energy to our region. The high supply prices in the Northeast are not good for anyone, particularly our customers. Until we can reduce the region's reliance on gas, by electric generation price volatility will continue to cause difficulties for our customers. State mandates for our offshore wind procurement provided a strong impetus for our engagement, along with the recognition that offshore wind is one of the few renewable resources that can be produced in quantity to reduce reliance on natural gas and dampen the volatility of our region's electric prices. Unfortunately, our offshore wind investment experienced difficulties as early-stage projects. These difficulties were largely a result of the pandemic, supply chain disruptions, rising interest rates and uncertainty around available resources for installation vessels and fabrication of turbine foundations. We are not alone, as several other offshore wind developers have also experienced similar challenges. These challenges, coupled with the lack of pricing flexibility, inherent in contracts approved by state regulators, result in a projected investment returns substantially below our required thresholds. At the same time, our core business is well positioned to deliver solid operational and financial results, as we move forward in supporting the region's transition to a cleaner energy environment. This led us to seek out a path to refocus our investment portfolio on our utility business, with its strong opportunities for growth. For this reason, I am pleased about our announcement that we have reached an agreement to sell our existing 50% interest in the South Fork and Revolution Wind projects, to Global Infrastructure Partners, our leading infrastructure investor that will generate approximately $1.1 billion of cash proceeds. With the pending sale to GIP, our announcement last month, regarding the conditional sale of Sunrise Wind to Orsted and the sale of the offshore wind lease area that closed last year, I'm pleased to say that we have the pathway in place to finalize a full exit from the offshore wind business. For the year, we have taken a noncash cumulative impairment charge of approximately $1.95 billion, after tax. John will discuss the impairment in more detail. However, I will say that the impairment reflects assumptions that our Board views as appropriate, given the uncertainty around the ultimate outcome of the Sunrise Wind rebid process. As John will discuss, the terms of the agreement with GIP are assumed and reflected in the impairment charge in our long-term financing plan. By taking this impairment charge, we are accounting for our full exit from Offshore Wind. We are pleased to be in the final stage of this long journey and we feel confident that we are turning over the range of the wind business to capable and committed parties. We will remain involved in managing onshore construction for all 3 projects and through our tax equity investment in the South Fork. I'll close my comments on offshore wind, with a brief update on the status of the project construction activity. As the first utility scale, offshore wind farm in commercial operation in the U.S., South Fork Wind has been supplying power to Long Island since late November 2023, when the first turbine was installed. We are now in the process of installing the 12th and final turbine. We expect all turbines to be producing power by March. We continue to advance on both onshore and offshore construction of Revolution Wind, after reaching a positive final investment decision in October of last year. Work on the site of the new onshore substation in Rhode Island, has been underway since late last year. Seabed preparation for the installation of wind turbine foundations is currently in process. Lastly on Sunrise Wind, we continue to get closer to the BOEM record of decision, while we await the results of the latest submission into New York's RFP floor. We made this submission jointly with Orsted, on January 25. Next, let me discuss the water distribution announcement, we made last evening, shown on Slide 5. Our water business is a valuable, well-performing and well-managed company. Although the Water business is earnings accretive to Eversource, we see the potential seal of our water business, as an opportunity to reduce equity needs and improve our regulatory diversity. With its current $1.3 billion rate base and a national reputation for operational excellence, the water business has a strong potential to be of substantial value to another owner, as part of a larger Water business, our strategic infrastructure platform. As a result, we plan to launch a process for evaluating market interest in a transaction for the water business, with the objective of delivering value to both customers and investors. If successful, the proceeds from the sale will provide a source of cash without going to the equity market, thereby enhancing our balance sheet. Moving forward, Eversource will focus on the delivery of clean, safe, reliable energy to our customers and preparing for the clean energy future that our states, our customers and our investors expect. Now I'll turn to our excellent financial and operating performance results on Slide 6. Starting with the financials; we delivered another strong year with reoccurring earnings of $4.34 per share in 2023, representing growth of nearly 6% over 2022. Our Board has approved a dividend increase for the first quarter 2024 of $0.715 per share which amounts to $2.86 per share on an annualized basis; this reflects an increase of 6% over 2023's dividend level. Moving to operations; I am extremely proud of our team once again for delivering reliable electric, natural gas and water service to our 4.4 million customers. As you can see, our electric reliability ranks in the top decile among our peers. We're focused on providing reliable electric service to our customers, who on average have gone nearly 2 years without an outage. In 2023, Eversource again outperformed its target injury rate. Our teams are keeping a strong focus on safe work practices not just during major storm events, when conditions are tough but every day on every job. On natural gas safety, once again, the team delivered another strong year, replacing 145 miles of natural gas pipeline and delivering on-time emergency response times of 98% within 45 minutes. A performance that well exceeds our regulatory requirements. I want to congratulate the Eversource team on these accomplishments. I am very proud of the skill and commitment of the entire team in the way that our employees are aligned in our shared vision of providing the highest level of safety, innovation, service quality and financial discipline for the benefit of our customers. Turning to Slide 7. At Eversource, we know our customers expect us to not only deliver energy today but also to be prepared for the future. To that end, we are actively engaging with our states to enable the Clean Energy future that our customers and our communities envision. At the end of January, we submitted our Electric Sector Modernization Plan, or ESMP to the Massachusetts Department of Public Utilities. After extensive input from the Grid Modernization Advisory Council and stakeholders across the commonwealth. The ESMP is the road map for building out the electric infrastructure and technology platforms to enable a reliable transition to a Clean Energy future in alignment with the state's Clean Energy plan. The filing specifically addresses the coming 5 and 10 years with a vision toward an 85% reduction in greenhouse gas emissions by 2050. Eversource has taken a leadership role in this endeavor and is viewed as a trusted partner at the table in planning the Clean Energy future for Massachusetts. We expect that the Department of Public Utilities to issue a final decision on our plan in August of 2024, addressing approximately $600 million of proposed incremental investment, among other components. In Connecticut, we are continuing to work on our comprehensive outreach plan with participation from across the company. We are leveraging our internal talent to educate Connecticut's stakeholders on the importance of infrastructure investment to our customers in the broader Connecticut economy, as well as the affordability programs that we offer to customers. This approach has proven to be productive, in terms of raising awareness on the value of utility investment. And on the point that Eversource is [indiscernible] that is ready, willing and able to help Connecticut meet its Clean Energy goals. Lastly, in New Hampshire. We are gearing up for a number of regulatory initiatives, including a potential PBR proposal, in evaluating ways to help the state advance Clean Energy projects, such as large-scale solar development. We're excited about the role Eversource will continue to play, to enable a Clean Energy future that's affordable and equitable for all customers. We'll continue to engage with all stakeholders to move this massive complex effort forward. Turning to Slide 8. As you may know, Eversource is an industry and market leader in environmental, social and governance. We continue that focus in 2023. We expanded the charter of the Board's governance, environmental and social responsibility committee, to extend this oversight to include climate-related matters. The full Board receives regular reports on our climate-related goals, key industry updates and policy activity through the Eversource climate scorecard. We continue to make progress on reaching our carbon neutrality goal by 2030 and we submitted our application for a new science-based target in December. I'm pleased to report that due to our continued leadership on ESG, last week, Eversource was named one of America's Most JUST Companies, as announced by JUST Capital and CNBC, for the fifth consecutive year. We have a very exciting future here at Eversource, focused on what we do best. I will now turn the call over to John Moreira.
John Moreira: Thank you, Joe. And good morning, everyone. This morning, I will cover our 2023 financial results, the offshore wind impairment, the 2023 regulatory update, an update of our 5-year investment forecast for our regulated businesses. And I'll wrap up with our 2024 recurring earnings guidance, long-term financing plan and 5-year earnings and dividend growth guidance. I'll start with 2023 results on Slide 10. Our GAAP results for the year were a loss of $1.26 per share, compared with GAAP earnings of $4.05 per share in 2022. In the fourth quarter, results were a loss of $3.68 per share, compared with GAAP earnings of $0.92 per share in the fourth quarter of 2022. Results for the full year 2023 include an after-tax impairment charge of $5.58 per share, related to our offshore wind investment and $0.02 per share after-tax charge related to our nonrecurring costs. Results for 2022 include a $0.04 per share charge, primarily related to transition costs associated with a completed integration of EGMA. Excluding these charges and the offshore wind impairment, our non-GAAP recurring earnings were $4.34 per share in 2023 as compared to $4.09 per share in 2022. Breaking down our 2023 full year non-GAAP recurring earnings of $4.34 into segments. electric transmission earned $1.84 per share for 2023, as compared with earnings of $1.72 per share in 2022. Improved results were driven by continued investments in our transmission system and lower income tax expense. Our electric distribution earnings were $1.74 per share in 2023, as compared with earnings of $1.71 per share in 2022. A base distribution increase at NSTAR Electric was partially offset by higher interest expense, property taxes and depreciation. Our natural gas distribution segment earned $0.64 per share in 2023, as compared to $0.67 per share in 2022. Increases in depreciation and interest expense, higher effective tax rate and the impact of certain reconciliation charges exceeded the revenues we received from capital trackers and base rate increases at NSTAR Gas and EGMA that became effective November 1, 2022. Our water distribution segment earned $0.09 per share in 2023, compared with $0.11 per share in 2022. Lower results were driven by higher depreciation, O&M expense and interest expense. The results reflect the impact of a very disappointing decision in Connecticut, from PURA for the Aquarion water rate case which is under appeal. Eversource parent and other companies' earnings were $0.03 per share in 2023, as compared with a loss of $0.12 per share in 2022. The improved results reflect a lower effective tax rate and the gain on our planned liquidation of a renewable energy fund, partially offset by higher interest expense and a contribution to the Eversource Charitable Foundation. Let me now turn to offshore wind, starting with the highlights of our sale of South Fork and Revolution Wind to GIP. With South Fork Wind expected to be in service before the transaction closes, our construction contingency is primarily related to Revolution. The terms of the transaction include a capital cost sharing agreement. Under this agreement, capital expenditure overruns incurred for the 50% interest in the project, up to approximately $240 million will be shared equally between Eversource and GIP. Above this threshold, 50% of any project cost overruns would be borne by Eversource. If the final project costs come in under the current construction forecast, Eversource will receive a payment for this difference. The terms and pricing of this agreement with GIP are assumed in the impairment charge and in our long-term financing plan. Let me review the offshore wind impairment, as shown on Slide 11. In 2023, we recorded impairment charges on our offshore wind investment of approximately $2.17 billion pretax or $1.95 billion after tax. As you can see on this slide, the impairment charge was driven by a lower-than-expected sales value of approximately $400 million for the 3 projects, after completing our strategic review in the second quarter of last year. As a result of adverse developments in the fourth quarter, including the further reduction in the expected sales prices driven by higher project costs and the October 2023 denial of the OREC pricing petition for Sunrise Wind, we realized an additional impairment charge in the fourth quarter of approximately $1.77 billion. The Sunrise Wind project drove about $1.22 billion of the impairment charge. In large part due to the OREC repricing denial which led to a lower assumed revenues and ultimately, an evaluation of the potential abandonment cost of Sunrise, if it is unsuccessful in the New York RFP for solicitation. As a reminder, to participate in the process to submit a rebid in the solicitation NYSERDA required any existing projects to terminate their current OREC agreements. This potential loss of both a contract revenue stream and ultimate project viability and any related termination costs was factored into our impairment analysis. Therefore, we assume that if Sunrise is not successful, in the rebid. This would result in no sales proceeds and no value attributable to the ITC adder. These items, coupled with estimated cancellation costs for the project, net of any salvage value, drove the additional impairment charge. Although we have factored this downside set of assumptions and probabilities into our impairment analysis, if Sunrise is ultimately successful in the RFP, Eversource would then sell its ownership interest in the project to Orsted, under the terms of our recently announced agreement. With the completion of that sale, our interest in Sunrise would be terminated. We would not be subject to any further construction contingencies or project cancellation costs. If we are successful selling Sunrise to Orsted, it would provide a full exit for the Offshore Wind business. Turning to Slide 12. I'll walk you through the carrying value of our offshore wind investment, as of December 31, 2023. The carrying value that I will discuss reflects the impact of our fourth quarter impairment charge by project. As you can see, the value of both Sunrise and Revolution were impacted by the fourth quarter impairment. The value of South Fork was not impacted. The fourth quarter impairment charge assumes a set of scenarios regarding potential construction contingencies for Revolution Wind. The charge also assumes that Sunrise Wind would be abandoned. We are very disappointed by the financial impact recognized on these early-stage Offshore Wind projects. However, we are comfortable with the impairment charge assumptions. We have reflected these assumptions in our long-term financial plan which I'll cover in a minute. As we move forward and finalize the sale of these projects, including the result of the recent New York RFP 4, the ultimate carrying value of our offshore wind investment, could change accordingly. On the regulatory front, we had another busy year. Our key 2023 regulatory items are highlighted on Slide 13. Starting with Massachusetts, we completed proceedings on our 2018 to 2021 storm cost recovery request, of approximately $136 million. I'm pleased to report that the Massachusetts DPU conducted a very thorough review and we received approval to recover 100% of our request. This approval highlights the importance of our storm response and acknowledges the tremendous effort from my Eversource colleagues and our contractors to restore customers as quickly and as safely as possible. Also in Massachusetts, we received approval of our first annual revenue adjustment under NSTAR Electric's PBR plan. This adjustment included an increase of a capital adjustment factor or CAPA [ph] as we call it. Turning to New Hampshire. We received the final order of proven $47 million of storm cost recovery, for weather events occurring in 2020 and in 2021. Again, we were granted nearly 100% of our request. We expect to file a general rate review in New Hampshire later this year, to recover the cost of investments that we have made over the last 4 years to significantly improve reliability for customers in New Hampshire. In total, we are now recovering approximately $400 million in rates, over the next 5 years for storm costs in Massachusetts and New Hampshire. In Connecticut, at the end of December, we filed our request for a prudency review of approximately $635 million of storm costs, relating to weather events that occurred from 2018 through 2021. The Connecticut filing contains more than 10,000 pages of support for costs incurred for these significant weather events. We look forward to working through the prudency review with PURA in 2024. Lastly, in our Aquarion's appeal of its March 2023 rate decision, oral arguments were held on January 11 and we expect the court decision over the coming months. Turning to our regulated utility capital plan. Slide 14 reflects our 5-year utility infrastructure investments, by segment updated through 2028. As a reminder, this plan reflects projects that we have a good line of sight on from a regulatory approval perspective. Over this 5-year period, we expect to invest approximately $23.1 billion in our regulated electric, natural gas and water businesses, to continue providing customers with safe and reliable service to meet ongoing load growth and to achieve progress on Clean Energy objectives. Starting with transmission. Our plan includes nearly $6 billion of transmission infrastructure investments, over the next 5 years. These investments include replacement of aging infrastructure to harden the system and increase resiliency during extreme weather events. Innovative substation projects undertaken for reliability and electrification purposes and interconnection projects, adding Clean Energy resources to the grid. Our Transmission capital plan includes a launch, scale, innovative project to build a substation in Cambridge, Massachusetts, completely underground. We are working closely with the city on this project which includes nearly $1 billion of investments to interconnect 4 existing transmission lines. This project will increase capacity to enable electrification and improve the reliability of electric service for customers. Turning to Electric Distribution. Our updated capital forecast now reflects nearly $10 billion of planned utility infrastructure investments, with a continued focus on system resiliency and our top-tier reliability for Electric Service. Our planned electric distribution investments include over $0.5 billion of our AMI program, in Massachusetts. The AMI program will allow customers to save money through heightened control over their own energy consumption and to experience higher service levels through faster outage restoration and other service functions. On the natural gas side, our 5-year plan reflects nearly $5.5 billion of investments and is centered around reliability and safety. The plan is highlighted by our bare steel and cast iron pipe replacement programs in Massachusetts and Connecticut. Across our natural gas system, we'll continue to thoughtfully engage with our states to ensure our investments enable equitable transition to a Clean Energy future. Turning to the water segment. Our 5-year investments are forecasted to be over $1 billion, supporting investments in water treatment facilities and water main replacements to improve water quality. Rounding out our Eversource capital plan, our investments in technology and facilities that's forecasted at $1.1 billion. Moving to Slide 15. Our updated capital plan reflects a $1.6 billion increase in utility infrastructure investments from 2024, through 2027 versus the prior plan. This increase reflects greater visibility on the work needed to serve our customers over the next 4 years. An important consideration in relation to our 5-year capital plan is what has not been included. On the right-hand side of the slide, we show some potential infrastructure investments not currently included in our forecast which would be additive to the plan. These opportunities total up to $2 billion in the forecast period with Connecticut AMI at the top of the list at nearly $700 million. The resulting impact from our updated capital plan, is shown on Slide 16. The customer-focused core business investments included in our capital plan would result in 7.7% growth in rate base from 2022 through 2028. Next, I will turn to our 2024 earnings guidance on Slide 17. We are projecting a non-GAAP recurring earnings per share range of $4.50 to $4.67 per share for 2024. Positive drivers this year include transmission investments for system resiliency and increased electric demand, distribution base rate increases in Massachusetts and New Hampshire, continued focus on controlling O&M expense and a lower effective tax rate. In 2024, our planned distribution rate increases include the first rate base roll-in for EGMA which will adjust rates to recover 6 years of capital investments. This rate adjustment will take effect in November of this year. These positive drivers are expected to be partially offset by higher expenses related to increased capital investments and share dilution. Turning to our long-term financing plan. I'll start with our cash flow assumptions regarding offshore wind, as shown on Slide 18. As I said earlier, our wind impairment reflects a set of assumptions that we have also embedded in our long-term financing plan. Let me walk you through what is assumed in our financing plan. First, we assume cash inflows from the announced sale of South Fork and Rev Wind of $1.1 billion. These proceeds include the value of the 10% ITC adder for Revolution Wind of approximately $170 million. Also assumed in our financing plan, is the realization of our tax equity investment in South Fork Wind which we expect will bring in around $500 million of cash over the next 24 months. The last item is related to our sale of Sunrise Wind to Orsted which is not assumed in our long-term financing plan. If Sunrise is successful in the New York RFP 4 that would be a positive to our plan. I'll now cover a number of drivers that are expected to enhance our FFO to debt ratio from 2023 to 2025, as you can see on Slide 19. These drivers include the Offshore Wind proceeds that I just discussed, planned rate increases at our utilities, recovery of storm cost deferrals, scheduled equity issuances and proceeds from a potential sale of our water business. In terms of the equity assumed in our plan over the next several years, we expect to issue up to $1.3 billion of equity through our existing ATM program. We will also continue to be opportunistic with our alternatives. As Joe mentioned, we are undertaking a review of our water distribution business. Proceeds from a successful sale are assumed in our long-term financing plan, reducing the level of equity that would otherwise be needed. As you can appreciate, we cannot provide any additional details beyond what we've disclosed. We will keep you updated on any decisions from this evaluation and any changes in our financial guidance. Closing now on Slide 20, our robust 5-year capital plan and long-term financing plan drive our 5% to 7% EPS growth rate, through 2028. To be clear, the 5% to 7% is based off of our 2023 recurring EPS of $4.34. Before we get to your questions, I'll turn the call over to Joe for his closing remarks.
Joseph Nolan: Thank you, John. As I previously said, I'm very excited as I look ahead to the future of Eversource. This amazing team that delivers every day is on the brink of a critical energy transformation, that will benefit our customers, our communities and our environment. The need for utility infrastructure investment has never been greater. In fact, in a draft study released last year, ISO New England projected a need, for up to $15 billion of transmission investment, to meet the region's 2050 Clean Energy objectives. As we look ahead, we see a tremendous need for a collaborative approach to leverage our utility infrastructure development and superior operating skills in Massachusetts, New Hampshire and Connecticut. On that note, I want to thank you for your interest in Eversource and I look forward to seeing you soon. I'll now turn the call back over to Bob and we look forward to answering your questions.
Robert Becker: Thanks, Joe. I'll turn the call back to the operator to begin Q&A.
Operator: [Operator Instructions] First question comes from Shar Pourreza with Guggenheim Partners.
Shahriar Pourreza: Joe, let me ask you a question on the up to $1.3 billion equity, I guess without seeing sort of market interest with the inquiring sale and details around Sunrise, where you could get more proceeds than you embed and planned, depending on how things shake out, right which you just alluded to in your prepared, what's kind of giving you confidence around the $1.3 billion, can you beat it? And how are you thinking about the timing and the means of raising that equity?
Joseph Nolan: Sure. Good question, Shar. Thank you. I would start off by saying that Aquarion, we view Aquarion as a very valuable and attractive asset portfolio, company is well managed, well recognized as a water distribution company and its leadership. So we're -- based on that fact pattern, we've sized and we've estimated what we feel we could harvest from a potential sale. And just to be clear, the $1.3 billion is up to $1.3 billion of equity over the next several years. So we have some flexibility, so we can flex that depending on the ultimate proceeds that we receive.
Shahriar Pourreza: Sorry but the timing and the means of that equity, any sense there?
John Moreira: Yes. Well, I mean, we've been guiding the street right along for the past several years, had a $1 billion need, right? And now we're going up to $1.3 billion. So I think it will happen over the next several years. We do plan to be in a position to issue, to go to the equity markets over the coming months. And we are going to -- Shar, just wanted to know, that's why we specifically indicated that we will be executing our equity needs through our ATM program to give us the flexibility that we need.
Shahriar Pourreza: Great. And then just lastly on this one is just on revolution cost sharing. John, can you just maybe walk us through the pathways for overages on the project? I mean what can go wrong? Any way to sensitize some of the puts and takes either on the construction side, i.e., how expensive does it get putting the crew on standby on the O&M availability side?
Joseph Nolan: Yes. Sure, Shar. It's Joe. I'll take that. I'll tell you, I'm really, really proud of the work that's taken place on South Fork. It's been an opportunity for us to really dry run, get a sense as to what's involved in this installation. This is a 12 turbine installation. We have 11 out in the lease area now. the 12th one is loaded on the barge in New London. It will go there this weekend. We have been delivering power since November, to folks in Long Island which we're very, very proud of. So given that we are the first upscale offshore wind farm in the United States, that brought a great opportunity for us to be able to understand what's involved in that. So in the fall, we were able to take a real good look at the cost, all the charges associated with constructing South Fork, as we begin to kind of refresh the Revolution costs. And I will tell you that we have accounted for the vessel strategy that we have to utilize now, we're utilizing a feeder barge [indiscernible] European vessel. It's been going very, very well. Those are some of the big charges. Those are the things that have caused increases in offshore wind costs for everybody, not just us. The lack of American vessels is certainly going to be a challenge for anyone in this business. But I will tell you that we have successfully executed. We will have -- the project will be done in March in South Fork. All of the kind of lessons learned, all of the challenges, everything that we've experienced in this offshore wind market, associated with South Fork has been brought to the table on Revolution. So that we know exactly what this is going to cost. We feel very comfortable with this number, this exposure at $240 million given what we have already factored in. So I have a great deal of confidence that we will be able to bring this in and not have to worry about these -- in the overruns.
Operator: We now turn to Steve Fleishman with Wolfe Research.
Steve Fleishman: So just to close, maybe the loop on the equity issuance. I think John, I heard you say after using the ATM, also opportunistic with our alternatives. Could you just clarify what you mean by that?
John Moreira: Yes. I mean that was -- we like the ATM program for the reasons I've just stated, it gives us tremendous opportunity and we can take advantage of the market. But if we encounter a very favorable, attractive value, then we can do something -- we'll look to do something else. Whether it's a block or some other deals. So right now, we -- I want to have the most -- the greatest sense of flexibility to execute and maximize the value that we harvest.
Steve Fleishman: Okay. All right. That's very clear. On the second question, just on the FFO to debt slide. Do you have a starting point for 2023 actual first?
John Moreira: Yes. I mean we -- 2023, we have been challenged by our operating cash flow, is primarily driven by the turnaround and the methodology that we have been required to use as part of guidance from PURA. So for example, our -- we've been significantly under recovered at the COMP franchise in 2023, by a sizable amount close to $1 billion. So that's going to turn around and that's going to turn around in 2024 and 2025. We will get that cash in. So right now, we expect to be in the low single digits for 2023. We're still kind of working those numbers through. But moving forward, I feel confident that we'll be in a 14% to 15% FFO to debt, as I indicated in Slide 19. I'm sorry, I said low single digits. I'm sorry. I meant low double digits.
Steve Fleishman: Yes. And then just a few of the pieces that you highlight here on the improvement. So just maybe the South Fork part, the tax equity investment, how much like FFO to debt percentage points is that? And is that just all hit '24, '25 and then it goes away. And then I guess you fill it in with more of operating cash?
John Moreira: Exactly. So the utilization of that, Steve, will happen based on our taxable income. So a lot can happen, storm costs being one of them that we take the deduction as we incur those storm costs and that can lower the utilization of that ITC. So right now, we've modeled it over the next 24 months but if we have further deductions from an operating standpoint, that would slip into '26.
Steve Fleishman: Okay. But for now, just take that $500 million and spread it over the 2 years, if we want to calculate that?
John Moreira: Correct; that's a reasonable approach.
Steve Fleishman: Okay. And then just one other question on that slide. The storm cost recovery, is that just related to Massachusetts and New Hampshire? Or are you assuming you're able to get storm cost recovery in Connecticut somehow or is that after this period?
John Moreira: Yes. We don't have -- Connecticut is not factored in. As you -- we just said in the formal remarks, we filed for the prudency review. That's going to take some time. So none of that, it's all really predicated on Massachusetts and New Hampshire. However, once the Connecticut storm cost recovery kicks in, that will give us more inflow of cash for the out years beyond 2025.
Operator: Our next question comes from Nicholas Campanella with Barclays.
Nicholas Campanella: So good to see you reaffirming the 5% to 7%, I guess, just you previously used to say high end of that range. I just wanted to kind of clarify if you have any message on where you kind of stand in the 5% to 7% at this point? And then how do we kind of think about Aquarion sales kind of impact to that 5% to 7%? Is it baked in? Does it put you somewhere else in the range depending on those outcomes there?
John Moreira: Sure, Nick. So let me start with the latter question. The Aquarion potential sale is baked into that guidance, as I mentioned. So we are assuming that. And then the 5% to 7%, as I want to reiterate, it's a growth aspiration of 5% to 7%. We're not giving any indication where on that spectrum we will ultimately land. Right now, we're comfortable with that, a lot can happen that can move us up. But until we have that more transparency and more clarity, we're sticking with 5% to 7% growth rate. We'll continue to update you all as things progress on our long-term guidance growth.
Nicholas Campanella: Okay. I appreciate that. And then I guess just sticking with Aquarion, obviously, you're trying to find ways to mitigate equity issuance in the 5-year plan. Just what's inspiring your confidence to kind of come back to do another sales process at this point? Do you feel confident it's not going to be as drawn out as the last one? And then just how do we kind of think about like the time line and then also the agency's willingness to kind of see through another asset sale, just given you're still on negative outlook?
Joseph Nolan: Yes. Well, let me add a couple of things. I'm not going to give you a time line on the asset yield but I will tell you that it's a very different animal, Aquarion. I mean we're talking about wind partnership with another party. We only own 50%. We talked about the fact that it's very challenging and you don't own the entire asset. We own all of Aquarion. It makes things a lot less complex. This asset is very, very attractive. We've been in this business now for several years. It's a great business. It's the seventh largest water company in the country. But the fact of the matter is there are 50,000 water companies in the country. So to try to do -- to assemble water companies. It takes time, it takes effort but something of this magnitude certainly is attractive to many, many folks. So I won't give you a time line but I will tell you that it's not nearly as complex. It's not even in the same category of the wind assets. So I feel very, very good about it.
John Moreira: And I would just add, Joe, is spot on from an execution, this is a totally different animal. And then from your latter question on how the agencies, as long as we have a pathway, this kind of mitigates any further equity needs that we may have. So it's still cash coming in the door which is very appealing and supportive of our credit metrics.
Operator: Our next question comes from David Arcaro with Morgan Stanley.
David Arcaro: Could you just touch on cost savings initiatives. I think you mentioned that you're expecting lower O&M in 2024. I guess how much lower? What are the levers you're pulling there? And what are you thinking kind of going forward off of a 2024 base there, too?
John Moreira: Yes. I would say that in 2023, we did experience some higher O&M levels that we don't think will reoccur in 2024. So that's one of the drivers, David. And then we are still in the technology deployment. Right now, we are going through a new CIS system, as part of the Massachusetts AMI deployment. And we think that there are savings, there are efficiencies that we can harvest as well. We already have one of our operator in Western Massachusetts went live a couple of weeks ago. So we think that there's savings there as well that we can harvest. So those are the major drivers. And as well as other efficiencies throughout the organization.
David Arcaro: Okay, great. Then, I just wanted to clarify maybe on the New York 4 outcome with the auction. How could that change the outlook? Is -- are you saying the proceeds for Orsted are not currently contemplated in the equity need guidance? And could that come down from where it is now based on being successful in that auction?
John Moreira: That is absolutely correct. It's not -- any proceeds from an ultimate sale to Orsted has not been factored into our financing plan. So it would adjust our equity needs. And then for that reason, among other things, that's why we went out with an up to valuation. So you're thinking about it correctly.
David Arcaro: Yes, makes sense. Then just wanted to quickly clarify. Just the $1.3 billion, does that include the DRIP? Or do you -- what do you expect that to be on an annual cadence going forward?
John Moreira: The 1 point -- the up to $1.3 billion does not include the DRIP. So that level is pretty consistent about $100 million to $120 million per year and that will continue.
Operator: We now turn to Durgesh Chopra with Evercore ISI.
Durgesh Chopra: Can I go back to Aquarion? And in relation to you kind of alluding the 5% to 7% incorporates in Aquarion sale, you have the CapEx baked into your 5-year plan, the Aquarion CapEx currently. I'm just -- I guess what I'm trying to ask is, how do you fill the earnings hole for Aquarion, I understand it's small. Is it basically debt reduction from the proceeds or CapEx could go elsewhere to substitute Aquarion earnings?
John Moreira: I would say it's a combination of both. Yes, we did leave the CapEx, their CapEx in our forecast but it's clear, it's delineated. You can see how much that relates to. And the fact that in my formal remarks, I highlighted and we have it in the slide on the deck that if you look at the forecast period, forecast over forecast, we're up $1.6 billion. And in my formal remarks, I also indicated that we should be mindful of what has not been included in our 5-year forecast. And that amount could be up to $1 billion to -- up to $2 billion, once again within this forecast period. So we feel very, very optimistic, we are able not only to replace the earnings but also mitigate any of the dilution.
Durgesh Chopra: Understood. That's very clear. And then just what -- can you just remind us your earned ROEs in Connecticut, as of 2023? And what are you modeling as you think about the 5% to 7% EPS growth target going forward?
John Moreira: Yes. I mean, obviously, they have dipped a little. We've been out of Connecticut for quite some time. We've had the settlement agreement. I would say that they're probably in the CL&P [ph] is around hovering around 8% and Yankee in the 7% range.
Durgesh Chopra: Got you. And then just what are you modeling? Like are you modeling ROE improvement, ROE staying the same, perhaps going lower as you think about the 5% to 7% growth rate?
John Moreira: Well, I mean, we were -- we've determined that we're going to stay out for at least another year or longer. So we model in the appropriate assumptions as we normally do with any rate proceeding in our 5-year forecast.
Operator: We now turn to Angie Storozynski with Seaport.
Agnieszka Storozynski: So just maybe first on assumptions behind the equity needs. So again, if I just look at the $1.3 billion and what I would expect Aquarion could bring. That's a little bit -- it seems like we're getting close to $3 billion in equity, again, my estimates, that seems large versus our prior expectations. And I'm just wondering what kind of credit assumptions you have embedded in it? So do you expect that, that amount, whatever the number is, eventually allows you to keep current ratings -- credit ratings, especially with the S&P?
John Moreira: Yes. So Angie, we're very mindful of what the downgrade thresholds are. And our financing plan, we feel confident that it will meet that -- those thresholds, particularly at S&P which has moved us up to a 14% threshold, as you know.
Agnieszka Storozynski: Yes. And then secondly, you have this port challenge for Aquarion's rate case. And I'm just wondering if, one, there's an outcome we need for that sale process to be successful; and two, if you approach the regulator in Connecticut about this potential sale?
Joseph Nolan: Yes. So Angie, this is Joe. The court case was heard. We felt that the -- it went very well. We do expect a decision in the next few months. And our expectation is that it would go back to PURA. It will have no impact on our ability to transact. So we're still -- we're very, very confident in that case in the outcome.
John Moreira: Angie, I would just add that, quite honestly, as Joe mentioned, we should see that court decision in the next couple of weeks. That's our expectation. And that would actually be behind us before we execute on the transaction.
Agnieszka Storozynski: Okay. And no discussions with PURA around that potential sale or putting the asset on the block?
Joseph Nolan: Yes. No, we've had communication with the governor. I did talk to the governor and I let him know of this transaction. As you know, it's quasi-judicial Board, the PURA and there's certain things they can and can't talk about. So we're trying to be very mindful of that.
Agnieszka Storozynski: And then lastly, the dividend growth profile, is it basically mimicking the earnings growth or EPS growth?
John Moreira: Angie, you're spot on. As you heard from me, our growth rate 2023, compared to '22, hovered around a 6% growth rate. We just -- as Joe mentioned, the Board just approved on an annualized basis, another 6% dividend increase. So we have a long-standing record of continuing to grow our dividend in line with our earnings.
Operator: Our next question comes from Anthony Crowdell with Mizuho.
Anthony Crowdell: Just I guess two quick ones. One to follow up from Steve's question. I think you were talking about maybe some ITCs in your FFO to debt metrics. Any chance you could tell us what amount of ITCs you booked in '23 earnings and what your forecast is in '24 earnings?
John Moreira: Yes, Anthony, this is John. So the ITC that Steve was alluding to, relates to the South Fork equity investment, that we just completed last year. And the size of that bread box is about $500 million. We have not recognized any of those ITCs. And I would view those ITCs as being cash driven and not earnings driven.
Anthony Crowdell: Great. And then just lastly, on the 8-K you filed this morning, gave some more details on the transaction. I believe in it, you guys have guaranteed an IRR to the buyer of roughly 13%. If you use your best estimate today of what you think the project would cost and your best estimate forecasting everything, where do you think the IRR stands today?
John Moreira: Yes. With the cost pressures that we've had, I want to make sure I understand your question.
Anthony Crowdell: Well, I guess I'm wondering, it's at 13%, we were maybe forecasting a lower IRR of the project based on our assumptions. And so we're thinking that -- or is there from day 1 that you assume that there's a payment going out to the buyer to get to the 13% IRR?
Joseph Nolan: It's been -- it's already been baked in the transaction. That's what -- that's a portion of the impairment which would allow them to be able to get the return that they expect. So that's already been factored in that -- that was accounted for.
John Moreira: Yes, that's right.
Operator: We now turn to Paul Zimbardo with Bank of America.
Paul Zimbardo: To clarify, what's the forecast for capital investment into offshore wind into 2024 and specifically kind of before the close of the transaction?
John Moreira: Yes, Paul, we really haven't said that. There's time sensitivities as to when funding obligations transfer, not only to both GIP but also to Orsted as well. But I can tell you that it's not a significant level. And all of those assumptions have been baked into our financing plan.
Joseph Nolan: And whatever we put in comes back to us. It's not as if we're going to be out of any money.
Paul Zimbardo: Okay. And then on the lower effective tax rate in 2024, could you quantify what that benefit is, kind of what you had in 2023 from lower effective tax rate? And how much of the improvement is in 2024?
John Moreira: Yes. I mean, where we landed in 2023, I would say, high teens and where we project to be in 2024 is also in the high teens, I would say, 18% to 20%, is the effective tax rate. So some of the benefits that we were able to recognize, we see those recurring in 2024.
Operator: Our next question comes from Ryan Levine with Citi.
Ryan Levine: On the cost sharing or earnout clawback like structure, what's the time line where you would receive cash payments, if costs were lower than targets? And conversely, if there's any cash flows -- cash outflows? And any sense on timing when you expect those payments to be made?
Joseph Nolan: Sure. I mean would be all resolved at COD. At COD, our contingent liability is resolved. We plan to have the Revolution project in service in the fall of 2025. So that should be the timing you should be thinking.
Ryan Levine: Okay. And then given the uncertainty of the contingent payments, would you look to wait to time your equity issuance once you have resolution on COD?
Joseph Nolan: Well, the equity issuance is a multiyear program. So it wouldn't be anything, it would be right, it's still the same window of time that we're talking about. John?
John Moreira: Yes. And that's been factored into our financing plan, the timing of when that would reach COD and so we're -- we feel good. Joe, in his formal remarks and some of the Q&A that he's responded to, we feel good where we are with the most current forecast -- construction forecast for Revolution and that has become the baseline for the sharing.
Ryan Levine: Okay. And then on the water sale, to the extent you can respond, did the process already start? Or is it being initiated with the announcement last night?
Joseph Nolan: No, it's -- the process has not started. It's going to -- last night, we kicked it off and it will be -- we'll get to work on it as soon as this call is over.
Ryan Levine: Great. And then last question for me. We've seen other utilities slow the dividend growth to be less than EPS growth. Is the management or Board considering a change in dividend policy on a go-forward basis, as the capital needs and equity needs evolve?
John Moreira: No, we don't. I just reiterated what our expectations are for both long-term earnings, EPS growth of 5% to 7% and we have -- we expect to grow our dividend in line with the earnings growth.
Operator: Our next question comes from Travis Miller with Morningstar.
Travis Miller: On the Revolution, what kind of involvement are you going to continue to have on the operational construction side? And I'm thinking in part to make sure that the costs stay in line with your estimate. Will you be involved in the project or more third party?
Joseph Nolan: Yes. No, no, great question. So we're actively involved in the land-based portion of that construction. I've been down in Rhode Island. I've been with Governor McKee, we broke ground on the substation, the conduit work that runs from the point of entry from the ocean to the substation. We will play a very, very active role. And I think that having a seat at the table is important for all the reasons that you stated. So we will continue to play that role until such time as that project is in commercial operation.
Travis Miller: Okay, perfect. And then going back kind of strategic over the years. I think one of the initial thoughts that you had behind all these nonutility investments was to reduce some of the exposure to Connecticut. Now it seems like you've come back and now have more of that exposure post this. What's kind of changed over the years to -- in Connecticut to suggest that you think perhaps a better operating environment -- investment environment there?
John Moreira: Well, I would say the Aquarion transaction was more -- it's predicated on the fact that our equity needs that we need to raise equity and this is an accretive -- potential accretive transaction that we are looking to execute. So that's really kind of the impetus of us pursuing a transaction for Aquarion.
Operator: [Operator Instructions] We now turn to Paul Patterson with Glenrock Associates.
Paul Patterson: Just really quickly to make sure I understood the answer to Anthony Crowdell question. There is no earnings impact associated with 2023 and 2024 with offshore wind on a non-GAAP basis and adjusted basis. Is that correct?
John Moreira: I believe Anthony's question was more on the ITC.
Paul Patterson: Okay. Yes. Okay. Well, I'm just wondering, just generically speaking, is there any EPS impact on an adjusted non-GAAP basis for offshore wind in 2023 and 2024?
John Moreira: No.
Paul Patterson: Okay, great. And then, moving to the PBR case. I noticed that in December, you guys and also United Illuminating, as for the case to be withdrawn and then reinitiated as a new type of case. And without getting into the details because they're very complicated. But how do you see that case proceeding, I guess, at this point? I know that the commission earlier this month said no to that proposal. But obviously, there's some concerns that you guys have about it that you voiced in your filings. Any thought process we should have about what the outlook is there?
John Moreira: Yes. Paul, a couple of things there. Number one, quite honestly, we were a bit disappointed that docket or those dockets, there is actually 3 of them got delayed or pushed out a bit. So I think it's still far too early for us to speculate because I think there are proceedings that we wanted to take place. And now some of those will likely happen. So we can't speculate, as to what the outcome would be at this point. I think there's a lot more work and a lot more discussion with PURA that will have to take place.
Operator: We now turn to Jeremy Tonet with JPMorgan.
Aidan Kelly: This is actually Aidan Kelly on for Jeremy. Just one quick question on our end. What was the parent interest expense drag in '23 versus '22? And could you just talk about like the offsets behind that?
John Moreira: Well, I would say the interest obviously is higher and we said that has an impact. But I would focus your attention more on to the financing plan, that we just disseminated and the EPS growth rate and for '24 and the longer-term growth rate.
Operator: This concludes our Q&A. I'll now hand back to Bob Becker for final remarks.
Robert Becker: Thanks, Elliot and thank you, everybody, for joining us today. If you have any follow-up questions, please reach out to Investor Relations.
John Moreira: Thank you, everyone.
Joseph Nolan: Thank you, everybody.
Operator: Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines. |
PEP | 4 | 2,023 | 2024-02-09 10:15:06 | Operator: Good morning and welcome to PepsiCo's 2023 Fourth Quarter Earnings question-and-answer session. Your lines have been placed on listen-only until it's your turn to ask a question. Today's call is being recorded and will be archived at www.pepsico.com. It is now my pleasure to introduce Mr. Ravi Pamnani, Senior Vice President of Investor Relations. Mr. Pamnani, you may begin.
Ravi Pamnani: Thank you, operator. Good morning, everyone. I hope everyone has had a chance this morning to review our press release and prepared remarks, both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans, guidance, and outlook. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today, February 9, 2024, and we are under no obligation to update. When discussing our results, we refer to non-GAAP measures which exclude certain items from reported results. Please refer to our fourth quarter 2023 earnings release and 2023 Form 10-K available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. As a reminder, our reported fourth quarter and fiscal year 2022 financial results included one extra reporting week for our North America businesses. Our reported fourth quarter and fiscal year 2023 financial results in North America reflect the impacts associated with one less reporting week versus when compared to the prior year. Joining me today are PepsiCo's Chairman and CEO, Ramon Laguarta; and PepsiCo's Executive Vice President and CFO, Jamie Caulfield. We ask that you please limit yourself to one question. With that, operator, I'll turn it over for the first question.
Operator: Thank you. [Operator Instructions] Our first question comes from Bryan Spillane with Bank of America. Your line is open.
Bryan Spillane: Thanks, operator. Good morning, everybody. Jamie, I'm not sure who's more surprised we're seeing each other again, me or you, but welcome back.
Jamie Caulfield: It's great to talk to you again, Brian.
Bryan Spillane: So I have a question, I guess, just in, we fielded a few questions today about the organic sales growth guidance for the year, and maybe if you can help dimensionalize, you know, not just the reduction, but how much is recall things that are sort of external, how much are things that are under your control? And maybe you can think about, as we think the balance of that, just how much of improvement are you expecting maybe in North America versus international? Just trying to understand the moving parts of how we get the organic sales guide from here?
Ramon Laguarta: Great. Good morning, Bryan. This is Ramon. Listen, let me step back for a minute and talk about the last few years and then how next year fits into that. So the last few years we've seen a double-digit growth, top line in the business consistently. So I think it's at 11 CAGR and a 14% or double-digit EPS growth consistently as well. So three very good years. Now we see a -- in ‘24 we see a normalization of the categories, a normalization of the cost, normalization of inflation. So we see everything trending back to our long-term algorithm. Now, we guide it to upper end of the -- both top line and bottom line at the previous earnings call. We maintain the top line at the upper end for the EPS and we move back to at least four for the top line and there's a few factors that I think are material. One, is the Quaker recall. We had a food safety incident in our Quaker supply chain in the U.S., which has impacted us in November, December, and it will continue to impact us, I think for the -- at least for the first-half of the year until we recover our supply chain to normality. We're also seeing some geopolitical events around the world that are impacting some of our markets, which might potentially continue in the first-half of next year. And then the third element is we're seeing a bit of a slowdown in the U.S. both the food category and the beverage category in the Q4. Part of that is slowdown due to pricing and disposable income situation. Part of that is also pivoting between in-home consumption and away-from-home consumption that we're seeing in our business in the U.S. We think that, that might continue in next year, so that's why we're lowering our guidance. We feel good about the consumer in ‘24 in the U.S. We feel good in the sense of very low unemployment, we feel good about the fact that we think wages will go higher than inflation next year. And we hope that by the summer interest rates will go down and that will create another source of oxygen for this possible incoming household. So we feel good about the consumer in the U.S., but if you think about those three elements, we decided to have at least four as the guidance for the top line.
Operator: Thank you. [Operator Instructions] Our next question comes from Lauren Lieberman with Barclays. Your line is open.
Lauren Lieberman: Great, thanks. Good morning. Just kind of continuing on that thread perhaps a little bit focusing more on Frito. So, track channel data hasn't looked great, you know, the reported volume decline, you know, sort of bigger than what we've seen in some times of this business. But when I look at a multi-year stack, you know, things look kind of steadier sequentially when I look at the second-half. So just curious how much it may be these near-term results on Frito and looking into the beginning of the year is multi-year comps? Is it the consumer backdrop, the impact of pricing? But just thinking a little bit about your expectations for and plans, I guess, for driving greater units -- unit versus volume growth in ‘24. We're thinking about those two pieces.
Ramon Laguarta: Great, Lauren. I think it's a great question. Just to summarize, we're seeing the Frito business going back to profitable volume growth in ‘24. So that's how we're thinking about the business. If you think about the slowdown in Q4 and you link it to the elements that I was referring to, there is a units versus volume dynamic in the Frito business that is quite relevant. As you see consumption moving from in-home to away-from-home, the portion size is meaningfully different. So we're seeing growth in convenience stores, we're seeing growth in away-from-home in, you know, like 2 times to 3 times the retail growth, but obviously has an implication on volume. As we look at the ‘24, we have a very strong commercial plan for Frito. We have our core brands very well invested. You saw that in ‘23 we increased our A&M meaningfully. We're planning to do that as well in ‘24. So Lays has a big increase in A&M. Doritos has a big increase in A&M. All our permissible portfolio which -- if you think about a combination of SunChips, PopCorners, the whole Simply Line, Smart Foods, that part of the portfolio is growing almost 3 times the average of Frito. So we're putting a lot of emphasis on that particular part of the portfolio to make sure that it has -- is well executed in the store and now the supply chain is back to 100%, we're going to push that part of the portfolio even more aggressively. So we think that Frito will have a continuation of the share of market gains that it's been having for the last couple of years and we expect the category will rebound as well. Part of that because of what we'll do with our brands, which obviously have a lot of weight in the overall category, but also the fact that we think consumers will continue to feel better throughout the year, and that will recover the fleet of a topline with a more balanced, profitable volume growth and pricing versus what we've seen this year.
Operator: Thank you. [Operator Instructions] The next question comes from Bonnie Herzog with Goldman Sachs. Your line is open.
Bonnie Herzog: All right, thanks, [Technical Difficulty]. I guess I had a question on PBNA profitability. I believe you still have a goal to reach the mid-teen operating margin levels, but so far we really haven't seen much progress. So Ramon, I guess hoping you could touch on your plans to achieve this? And then maybe whether you're considering making bigger structural changes to your business as possible refranchising of your bottoming network. I know you've mentioned in the past that you do see some advantages with broadly owning your network, but just curious to hear if your thoughts on this have changed and I guess if not, what other initiatives do you plan to implement to improve profitability at PBNA? Thanks.
Ramon Laguarta: Yes. So, yes, listen, I would say we don't contemplate at this point any of the structural changes to our business. We continue to think that operating the business has advantages for us in terms of speed of execution and some other elements that as we see where the business is growing in e-commerce, away-from-home and some other channels of the future including direct-to-consumer. Within that, that's going to create an advantage for us. Now we've been making progress at a good pace in our margin improvement. If you think about the last three years, the net revenue for PBNA has grown over $5 billion, and the operating profit has grown a billion dollars. Core operating margin has expanded more than 150 bps. So we see the last few years a good improvement in the PBNA business. We think this will continue in the coming years, actually ‘24, that's the first step. We are optimizing the portfolio. We're eliminating parts of the portfolio that were less profitable. We've referred to bottled water. We've referred to some multi-serve parts of the portfolio that were not that profitable. We continue to optimize our efficiency of our supply chain. We're digitalizing our supply chain. We continue to extract, you know, eliminate waste from that. We continue to work on global business services that reduces the G&A. We're also optimizing A&M, trying to get to higher ROI on A&M and our trade investments. So we continue to think that optimizing all those elements in the different parts of the P&L will continue to drive a sustainable margin improvement, whilst we remain very competitive in the marketplace. And that's the balance that we're trying to strike with this business. So far we feel good. The business grew with the rest of the category. If you take everything that is in our system, grew in line with the category and we increased the operating margin. So that's how we're thinking at this point about the PBNA business and with a long-term perspective obviously in how we will achieve those two elements of growing with the category and increasing the margins.
Operator: Thank you. [Operator Instructions] Our next question comes from [Indiscernible] with Jefferies. Your line is open.
Unidentified Analyst: Hey, everybody. Good morning. Welcome back, Jamie. Well, I suppose you've gone nowhere, but welcome back to dealing with us, I guess. Can you maybe talk a bit more about international, particularly margins are picking up above the average now, it's scaling quite nicely, but also if there's anything we need to be aware of as it relates to hyperinflation, Argentina, anything like that?
Ramon Laguarta: No, listen, I'll start and maybe Jamie can add to this. The -- listen, the international opportunity continues to be by the most remarkable and exciting opportunity that we have as a company. As you're saying our international business is very scaled now. It's almost $40 billion between beverages and snacks. So that's, if you compare it to some of the consumer goods companies, it's much bigger than many of the consumer goods companies globally. So clearly a big opportunity, and we have just scratched the surface when you think about the per capita consumption that we have in many markets and the opportunity we have ahead of us. So here's your point you're right. As we scale it, some of those businesses are becoming more profitable and obviously you start the virtuous circle of scale, reinvestment, margin expansion, and getting to a much more profitable and advantage businesses across many markets. So this year is not going to be a different one. So ‘24, we continue to think that international will grow faster than the U.S. business. We're seeing good momentum as we start the year in many of our international businesses. Our position is of investment in those markets, so we're going aggressively with productivity and reinvestment for growth, reinvestment in the brands, reinvestments in systems, in capabilities that continue to drive the per caps and our share of market position. So you should think about our international business as a big opportunity for PepsiCo. And with regards to the Argentina situation, it's, yes, we've already taken that hyper accounting and you shouldn't expect any material impact on organic sales growth.
Operator: Thank you. [Operator Instructions] Our next question comes from Dara Mohsenian with Morgan Stanley. Your line is open.
Dara Mohsenian: Hey, good morning, guys, and Jamie, great to hear your voice again.
Jamie Caulfield: Hey, Dara.
Dara Mohsenian: So I wanted to drill down a bit more on Bonnie's question, but looking at PBNA top line more than profit, there's clearly been some market share struggles and pieces of the portfolio there, sports strength, CSDs, et cetera. So I guess can you just talk a little bit more about strategy changes from a top line standpoint. How you sort of manage the business by product category? And your thoughts around share trends as we look going forward? Thanks.
Ramon Laguarta: Hi there. Good, listen, we feel good about the overall portfolio of PBNA. You know, we manage the business as a full LRB business, not as a CSD or any particular subcategory. We're looking at, you know, the full portfolio and how it's always everywhere for consumers from the morning to the night in all the multiple locations. We continue to believe that we have an advantage portfolio. If you think about our positions in sports and hydration, our positions in coffee, tea, now the portfolio we have in energy, and our CSD position as well. So we continue to manage as a full LRB. Now, if you think about our priorities for the year, relaunch of Pepsi brand with a new image with focus on Zero. Zero has been growing very fast and continues to be an advantage proposition for us. We are putting a lot of additional investment in Mountain Dew, and we're launching Baja Blast as a permanent SKU. Baja Blast has been a success as an LTO, a limited time offer. For many years now, we're launching it. We're using the Super Bowl as a platform this weekend to launch Baja Blast. We continue to build a position in Lemon Lime with Starry. Starry, it's been a good first year. I think we had -- we're over indexing with Gen Z. We see the brand getting some good repeat. You will see also an investment around Super Bowl and continue during the year. So that's our CSD portfolio. We feel very good about Gatorade. Gatorade is, we're moving from historically a liquid for high performing athletes to an ecosystem of solutions in hydration and fuel for every type of active person. And we've seen a lot of traction. It's not only Gatorade per se, but it's Gatorlyte, it's GFit, it's Propel, it's Muscle Milk, all under one umbrella. And it's not only liquid solutions, it's powders, it's tablets, it's equipment, personalized equipment, bottles, and others. And now we're launching around the Super Bowl Gatorade ID, which is also an ecosystem of loyalty and I would say personalization for our consumers that will bring even more attention to the brand and more loyalty with younger consumers. On energy, we're very happy with our portfolio. Obviously the Starbucks coffee energy on one side, Rockstar, and obviously our collaboration with CELSIUS, which has been a great success, and it provides scale to our go-to-market and kind of a point of entry as well with some of our customers. And then our tea business continues to very well with Pure Leaf and our Starbucks collaboration now moving more into beyond coffee, I would say more refreshers and some other innovation that Starbucks is developing for their cafes and we bring it to ready to drink. So I think we have a beautiful portfolio. We continue to grow in retail and we're putting a lot of focus in away-from-home as we're seeing that the away-from-home channel is getting much more traffic as people go back to normal mobility and that will be a focus for us going forward. This year we think we'll continue to grow above the market and continue to gain share in what is a very profitable and high growth channel. So this is how we're thinking about the business there. Hopefully it gives you a good sense of the intentionality, how we're thinking about the broad portfolio and our willingness to compete with innovation, with brand investment and with great execution.
Operator: Thank you. [Operator Instructions] Our next question comes from Peter Grom with UBS. Your line is open.
Peter Grom: Thanks, operator, and good morning, everyone. Ramon, I just wanted to ask a follow-up based on your response to both Bryan and Lauren’s question on the organic growth. And I may have misheard or could be misinterpreting this, but you touched on some of the things that you are doing internally that will drive the improved performance. But I think you also mentioned some sort of assumption around maybe the U.S. consumer would feel better. I mean, if that doesn't happen, would that put the organic revenue guidance at risk or would an improved backdrop be more of a source of upside versus the greater than 4%? Thanks.
Ramon Laguarta: The current assumption is what I said. We think that the consumer will continue to improve in its confidence and its disposable income throughout the year. And that's the ongoing assumption. We have a very strong productivity program in the company, which gives us the fuel for investment, and it gives us also a lot of flexibility to manage a potential different consumer reality. But at this point, we think this is the ongoing assumption who will invest in our brands, who will invest in our innovation. And now that supply chain is in a very good place, compared to what it was a couple of years ago, even last year, we can rely on the tools that we're very good at, which is brand building, innovation, execution, distribution increases, strong commercial programs with our partners, and that's where we think we'll drive the growth of our top line here.
Jamie Caulfield: Yes, and I'd add just to remind you, 40% of our business is now international. So, you know, the U.S. is significant, but we've got a big business outside the U.S.
Operator: Thank you. [Operator Instructions] Our next question comes from Gerald Pascarelli with Wedbush. Your line is open.
Gerald Pascarelli: Great. Thanks very much. Ramon, I have a question on energy drinks. Can you just speak about your plans to maybe drive performance in Rockstar this year? It's kind of been a relative underperformer in energy drinks for some time and now you have bang coming back into the market, which could potentially result in some incremental disruption. So maybe just some color on how you're thinking about driving an improvement in Apron and then maybe broader thoughts on the competitive dynamics within energy drinks this year? Thank you.
Ramon Laguarta: Yes, I mean, it's a great question. The energy category continues to grow, as you see, above the LRB category. So continues to expand into new consumers and new consumer locations, which obviously creates growth for everyone that participates in the category. So we participate, as always said, with multiple vectors. We're proud of our Starbucks partnership and some of the products we offer, double shots, triple shots. We're proud of the Rockstar brand. Rockstar has been growing with the category. More or less, there are some parts of the country where it's well distributed and well preferred. Other parts of the country we're trying to get consumer penetration and consumer adoption. The areas where we've been successful with Rockstar, which we will double down, are the zero and are the recover parts of the portfolio. Both of them, if you think is energy with functionality and where we think our R&D can create advantage. So we're pushing those two platforms, Rockstar Zero and Rockstar Recover, and that will continue to be the focus of the brand. We've also been focusing on Hispanic consumer, and that also we've seen an increase in the penetration of the brand with Hispanic population, with Hispanic consumers will continue to drive that commercial activity. But we see this as a portfolio of solutions, including sales use and how the combined portfolio creates a very good point of execution for us, multi-brand, it gives us an entry into convenience stores and some other points of sale away-from-home and will continue to drive the portfolio as the unit of execution.
Operator: Thank you. [Operator Instructions]
Ramon Laguarta: I forgot, maybe I can say. The other thing we're doing with Rockstar, which we don't talk a lot about it, it's an important part of our growth, is we're launching Rockstar internationally in many markets around the world, from Asia to Europe to parts of Latin America, and we're having good success, again, as a portfolio of solutions that complements our Sting brand that we have in Asia or some other brands that we have in Europe as well.
Operator: Our next question comes from Robert Moskow with TD Cowen. Your line is open.
Robert Moskow: Hi. Thank you for the question. In your prepared remarks, you said that you expect less commodity inflation, but some agricultural inputs might be higher. Can you be more specific? And I was hoping you could focus a little on Frito, because there's a very big potato crop this past year. Vegetable oil costs are coming down. Do you see any relief on the horizon for Frito in that regard?
Jamie Caulfield: Hey, Rob, it's Jamie. Yes, that is a practice we comment on the basket of inputs. We don't comment on specific commodity movement, but you're absolutely correct that we do expect commodity inflation to moderate from what we had in ‘23.
Operator: [Operator Instructions] Our next question comes from Andrea Teixeira with JPMorgan. Your line is open.
Andrea Teixeira: Thank you, operator. Good morning to you all and great having you back, Jamie, on the investor facing mode. I have one question and then a clarification. First for Ramon, I was hoping to see if you can elaborate a little bit more on how you're going to be lapping and if you have a red lap, the mixed drags and the shift from away-from-home and where your market share is not probably as strong as in snacks as you have in at-home channels? And given your strong gross margin delivery in your experience negotiating with large box retailers, especially in Europe. Are retailers asking you to invest back in promo rollbacks given your gross margin delivery and productivity gains, in particular North American and Europe. And my clarification for Jamie is in terms of like your organic sales growth and EPS cadence for the year, anything we should be considering on your guide as far as cadence. Thank you.
Jamie Caulfield: Yes, so on the organic sales growth, first of all, Andrea, it's great to hear your voice again and look forward to interacting as we go forward. Organic sales growth cadence, I'd say back half, stronger than the first-half as we talked about before. We've got the impact of the Quaker recall is going to be front half loaded. The laps get easier as we get into the back half of the year. And then some of these consumer pressures that have existed with elimination of stimulus benefits, resumption of student loan payments. We'll lap those as we get into the year.
Ramon Laguarta: Yes, and listen, with regards to the customer, I think we're all trying to build win-win plans in the sense that we grow the business and we create profit growth for both our customers and ourselves. We normally -- we have always the consumer at the center, so it will be a combination of we generate growth through, as I said, innovation, and we have a few big innovations and brand relaunches this year. We'll put a lot of investment there together with our customers. We'll continue to try to expand our SKUs with the customers and there will be investments there. And there will be some investments in trying to give more value to consumers in a very holistic way, right? Through back priced, through promotions, through consumer events that eventually will drive preference for our brands. But that's the way we're thinking about creating this joint business planning with our large customers that create growth for the category, growth for our customers, and growth for us. With regards to away-from-home, sorry I forgot Andrea. The away-from-home we see it as an and, not as an or, we see it as an opportunity for us to continue to be in consumers’ lives always everywhere. And as consumers pivot away-from-home, we'll try to be there for them. It's been an area of investment for us, both in distribution and specific solutions for away-from-home for quite some time. And we're seeing our businesses in the large markets growing above the market in away-from-home. So clearly, this will be an opportunity for us for many years to come. And I think we're getting better at mixology. We're getting better at more food experiences, walking tacos, Doritos loaded. We're testing food trucks. We're testing many things that will make our brands available to consumers in the beyond what is a package bag or a can or a bottle. Now I think consumers are expecting from us away-from-home a much more holistic experience and that's what we're working on and I think we're making good progress.
Operator: Thank you. [Operator Instructions] Our next question comes from Robert Ottenstein with Evercore. Your line is open.
Robert Ottenstein: Great, thank you very much. A little bit more of a detailed question on PBNA and just want to talk about Gatorade and CELSIUS. So in terms of Gatorade, could you just remind us in terms of the timing of the move to DSD? And how that impacted your income statement? And then in terms of CELSIUS, obviously the brand has done phenomenally well. It's getting pretty big now. Can you talk about how CELSIUS impacts the income statement in the U.S.? And then how your relationship with the company has evolved? You talked about taking Rockstar internationally. CELSIUS is going international now. Are you part of that plan as well? Thank you.
Jamie Caulfield: Yes. So, on Gatorade, we're 90% through on the transition. Obviously, that move is positive to the financial results overall. That's what we did is to enhance performance and we're happy with the margins we have on that business. On CELSIUS, the way that works is we're sharing the system revenue with CELSIUS.
Ramon Laguarta: Yes, listen, we're happy with the collaboration with CELSIUS and that continues to be a part of our growth strategy. You know, there is an opportunity for us to collaborate in the international expansion as well. At this point it's not, I would say, a scaled opportunity. It's a market-by-market opportunity and very particular market. So yes, we are contemplating that as an option and we are having conversations with CELSIUS how we can leverage the PepsiCo system for a bigger expansion. Nothing short-term I would say at this point.
Operator: Thank you. [Operator Instructions] Our next question comes from Chris Carey with Wells Fargo. Your line is open.
Chris Carey: Hi. Good morning, everyone. So I just wanted to ask about SG&A over the past four years. We've talked about this before in this forum, but with the annual disclosure is now out. I thought it would be a good time to revisit the topic. Specifically, Ramon, can you help contextualize the increase that we've seen in SG&A over the past four years, specifically in distribution costs? I'm really curious about maybe how much of this is underlying inflation as opposed to discretionary investments that PepsiCo is making and not really looking for a specific number per se, I realize that's probably difficult, but distributions up 40% over the past four years, and I'm just wondering how much of this is within your control, maybe some of the capabilities that you've been able to build over this timeframe and maybe get a sense of how this line item should be trending going forward? So thanks.
Ramon Laguarta: Yes, so as you point out, selling and distribution is the biggest part of that. The A part is less so. And it's going to be a reflection of what you see is: one, you've got market mixed or sector mixed components in there. We've driven a lot of productivity in our OpEx, but at the same time, we're investing in OpEx to drive distribution and growth in the business.
Jamie Caulfield: One other thing, Chris, that you should be mindful of is, you know, we do have a big direct store delivery business, so we've had inflation in various things like labor and so forth, and that's what's gone up. A&M has gone up as well, which is also kind of all part of that SG&A bucket. We've made numerous capability investments in there as well. So it's all of the above. I wouldn't hone in just on the distribution costs, which I know you focus on from the 10-K. There's a lot of buckets that go in that are far deeper that we can't get into for competitive reasons.
Operator: Thank you. [Operator Instructions] Our next question comes from Filippo Falorni with Citi. Your line is open.
Filippo Falorni: Hey, good morning everyone. So Ramon and Jamie, you both mentioned the organic sales growth guidance is going to be more second-half weighted? And I know you don't provide breakdown and guidance on volumes, but given the importance of volume trends, can you give us a sense of how you see volumes evolving? Is there a possibility in your guidance where you see positive volumes in the second-half of the year? And then on the pricing front, maybe you can give us a sense of what are you assuming in terms of pricing? I assume in the U.S. or developed markets its limited and there's more pricing in emerging market, but any color on pricing will be also helpful. Thank you.
Ramon Laguarta: Yes, I think you should be thinking about we want to grow units next year. We will see profitable volume growth next year. And you'll see a more balance between pricing and volume that you have seen in previous years, obviously we had to cover a huge commodity increase and OpEx increase. As commodities kind of normalize and OpEx inflation normalizes, that lever will be less necessary outside of what has been a normal pricing levels of our category in the 2% to 3%. So you should be thinking about profitable volume growth and more of a normalized pricing, compared to what it was in the ‘18, ‘19 timeframes.
Operator: Thank you. [Operator Instructions] Our next question comes from Callum Elliott with Bernstein. Your line is open.
Callum Elliott: Hi, good morning. I wanted to build upon Chris's question, please, and ask you about the A&M buckets and the spending behind your brands. I think the case shows advertising up around 10% year-on-year, and that's around a 20 basis points increase as a percentage of sales. But we're still quite a long way below pre-pandemic levels as a percentage of sales and comfortably below the average of the last several years. So I guess the question is, are your brands getting enough support and do we need to see upwards pressure on advertising spend as a percentage of sales over the coming years? Thank you.
Ramon Laguarta: That's great, good point. Obviously in absolute terms, we have much more A&M. So I think we have increased, last year was $500 million. And if you think about a longer timeframe, a meaningful over $1 billion increase in absolute A&M. So that's absolute dollars that go against our business. We're thinking about continuing that trend, continuing to support both our large brands across multiple markets and then smaller brands where we take the portfolio into the future. So that should be a composition of our A&M. Now, when you look at the last few years, you should bear in mind we stopped advertising in Russia, which was a meaningful market for us. So that is reflected in our absolute numbers or relative numbers. So that you should contemplate that. But as a, you know, if you think about where and how we're going to create demand in the future, you should be thinking about A&M continue to increase. Obviously, we'll look at ways to optimize A&M, and we have very strong measures on ROI and best ways to invest in our brands, but you should be thinking about as a company that continues to build brands, continues to innovate, continues to create value through investment in consumer. And obviously we also create a lot of demand through our push model to some of the questions that were asked before. You should be thinking about our selling and distribution costs not only as a cost, but also as a way for us to execute very granularly across millions and millions of point of sale around the world where we reach the final point of sale and we create, I would say visibility for our brands and impulse for our brands, which are relevant if you think about the categories where we compete.
Operator: [Operator Instructions] Our last question comes from Steve Powers of Deutsche Bank. Your line is open.
Steve Powers: Oh, great. Good morning. Thanks, everybody. Jamie, add me to the list of people excited to work with you again. Hey, actually, this question may be for you. It probably is for you. On these calls for the last several years, we've been talking about on and off, just sort of the cashflow profile of the business and the capital investments that have been made in the business in the past, eventually back towards a higher level of pre-cashflow conversion. I guess acknowledging that you've been there in the room the whole time. Now as you assume the role of CFO, do you see any opportunities to speed that process of cash flow generation and a return to higher levels of pre-cash flow conversion from where we've been trending or is it more steady state? And if you could just give us a little perspective on how you're seeing those, that cashflow profile of the business evolving from here, that'd be great. Thank you.
Jamie Caulfield: Yes, so clearly cashflow continues to be a priority. I focus on CapEx and we've been very intentional about the levels of capital we've invested in the business. Part of that was to catch up on capacity. We're currently in the midst of big investments in IT and digitalization. But over time, I think you'll see the level of CapEx as a percent of sales begin to trend down and that will help with the cash flow conversion.
Ramon Laguarta: Great. So thank you, everybody. I'm glad everybody's happy that Jamie is back and I see a lot of bonding. Great, but obviously thank you for the confidence that you've placed in our investment and we look forward to seeing many of you at Cagny in a couple of weeks and having a longer conversation there. Thank you very much.
Operator: Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day. |
AMGN | 4 | 2,023 | 2024-02-06 22:40:10 | Operator: My name is Julianne, and I'll be your conference facilitator today for Amgen's Fourth Quarter 2023 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. There will be a question-and-answer session at the conclusion of the last speaker's prepared remarks. [Operator Instructions] I would now like to introduce Justin Claeys, Vice President of Investor Relations. Mr. Claeys, you may now begin.
Justin Claeys: Thank you, Julianne. Good afternoon, and welcome to our fourth quarter 2023 earnings call. Bob Bradway will lead the call and be followed by a broader review of our performance by Murdo Gordon, Vikram Karnani, Jay Bradner, I am pleased to welcome and he is joining us for the first time on our quarterly earnings call, and Peter Griffith, Dave Reese, will also be available during the Q&A session. Given the timing of these Horizon Therapeutics acquisition close, the results as shown in our press release and slides include contribution from the Horizon business from October 6 onwards. For the avoidance of doubt, this will also be the basis for our filed financial results. To supplement this information, Vikram will also provide sales information for these products for the full fourth quarter, including the first week of October as further context in his remarks. Through the course of our discussion today, we'll use non-GAAP financial measures to describe our performance and have provided appropriate reconciliations within the materials that accompany this call. We will also make some forward-looking statements, which are qualified by our safe harbor statement, and please note that actual results can vary materially. With that, over to you, Bob.
Robert Bradway: Okay. Thank you, Justin, and let me thank all of you for joining our call. 2023 was another year of performance and progress for Amgen, further positioning us to deliver attractive growth through the end of the decade and beyond. Last year, we delivered double-digit volume growth in all four quarters with balanced growth across products and geographies. 18 [ph] of our medicines generated record annual sales, including Repatha, Prolia EVENITY, TEZSPIRE, BLINCYTO, KRYSTEXXA and UPLIZNA. The acquisition of Horizon, which is completed on October 6, gives us a significant new rare disease business that now stands as a fourth pillar of growth alongside our leading general medicine, oncology and inflammation businesses. The medicines we acquired are all very early in their life cycles and by leveraging Amgen's world-class biologics manufacturing, decades of experience in inflammation and our extensive global presence, we believe these products have the potential to reach many more patients around the world. Last year, we also advanced the deepest and most diverse pipeline in our history with promising molecules at all stages of development across our four pillars of growth. We anticipate well over a dozen significant pipeline milestones this year. I'll touch on a few. In General Medicine, we'll generate Phase II data this year for our lead obesity molecule, MariTide, and we're excited, of course, to learn more about this asset. We're also advancing a number of early-stage assets in this space. In Oncology, we have a June 12 PDUFA date for the FDA to complete its priority review of Tarlatamab as a third-line treatment for small cell lung cancer. Tarlatamab is the first bispecific T cell engager shown to be effective in addressing a major solid tumor. In this case, one for which there has been no new treatment in decades and which today has a 5-year survival rate of just 3%. We're studying Tarlatamab in earlier lines of treatment and hope over the fullness of time to be able to serve the tens of thousands of patients diagnosed with small cell lung cancer each year in the U.S. and major markets around the world. We've done this very successfully now with our first BiTE BLINCYTO, which has steadily moved into earlier lines of treatment for acute lymphoblastic leukemia, and we'll take the same approach with yet another promising BiTE at being Xaluritamig in prostate cancer. In inflammation, we'll have Phase III data from Rocatinlimab in atopic dermatitis from the first of 1 are now 8 trials in the ROCKE program. And in rare disease, we'll have Phase III data for UPLIZNA and myasthenia gravis and IgG4-related disease. At a time when a rapidly aging global population needs more innovation, Amgen is delivering, both with the medicines we have in the market today and with the promising new medicines that are advancing in our pipeline. We're also excited by the rapid convergence of biotech and tech, which is enabling us to innovate more quickly and confidently. We've been preparing for this hinge moment for more than a decade and recently named Dave Reese as our first ever Chief Technology Officer to ensure that we're capitalizing on technologies like generative artificial intelligence, not just in R&D, but across the entire company. Succeeding Dave is Amgen's Head of R&D is Jay Bradner. Jay is a physician scientist and a seasoned R&D leader, having served for many years as President of the Novartis Institute for Biomedical Research. Jay previously also served as a faculty member at Harvard Medical School and prior to joining Amgen was a practicing oncologist at the Dana-Farber Cancer Institute. We're delighted to have Jay on board and excited by the work that he Dave and the rest of our team will do together to accelerate innovation at Amgen for the good of patients and for the long-term growth of our business. And with that, I want to thank our 27,000 employees around the world for their many contributions to our success. And let me now ask Murdo to talk about our commercial performance in 2023.
Murdo Gordon: Thanks, Bob, and I'm very pleased with our performance in 2023. Execution was strong across the business, resulting in record sales in the year for 18 brands and robust volume growth across the four pillars of our business. Full year product sales increased 9% year-over-year. Volume growth was 15% with strength across our regions. U.S. volume growth was 14% and volume growth in our Europe, Latin America, Middle East and Canada region was 10%. Asia Pacific continues to be our fastest-growing region with 41% volume growth. These results include $954 million of sales from the legacy Horizon portfolio from the period of October 6 through December 31. I'll start with our General Medicine business, which includes Repatha, Prolia EVENITY and Aimovig. Overall revenue for these four products grew 15% year-over-year in the fourth quarter and 17% for the full year, driven by 18% and 20% volume growth, respectively. Repatha sales increased 25% year-over-year in the fourth quarter with volume growth of 35%, partially offset by lower net selling price. Outside of the U.S., we saw 25% volume growth with strength across our regions. In the U.S., volume growth of 48% was driven by a 66% increase in the number of new patients starting treatment. We saw a decline in net selling price in the U.S., primarily driven by new formulary coverage. We expect this additional coverage to lead to strong volume growth, which will more than offset declining net selling price. In addition, some payers have recently removed prior authorization for some patients, which will further ease their access to Repatha. We remain committed to the urgent need to educate physicians and patients on the importance of LDL-C lowering to reduce the risk of cardiovascular events. In the U.S., we activated more than 20,000 new prescribing physicians in 2023 in both the primary care and cardiology settings. And while we're pleased with this progress, we'll continue to work tirelessly for the many, many more patients around the world who can benefit from Repatha. Transitioning to bone health, EVENITY had record sales of $318 million for the quarter, driven by 39% volume growth. Osteoporosis disproportionately impacts postmenopausal women and the diagnosis and treatment rates for these patients are low. In the U.S., only 6% of very high-risk patients with osteoporosis are treated with a bone builder, creating an urgent need for treatment with an effective therapy. EVENITY is an important therapy to address this unmet need as it is the only bone builder that works with the body's natural ability to increase bone formation and also decrease bone resorption. We see strong growth potential for EVENITY and we'll continue to apply our proven experience in bone health to ensure it reaches all the patients who need it. Prolia sales grew 12% year-over-year to a record $1.1 billion for the fourth quarter. Volume growth of 10% was supported by real-world evidence reaffirming Prolia superiority in reducing fracture risk when compared to alendronate in treatment-naive patients with postmenopausal osteoporosis at a high risk of fracture. Moving to our oncology business, which includes BLINCYTO, LUMAKRAS, Vectibix, KYPROLIS, Nplate and XGEVA. Sales of these six innovative products grew 5% year-over-year for the fourth quarter, with 3% volume growth. Full year sales grew 12% year-over-year, driven by 12% volume growth. BLINCYTO sales grew 47% year-over-year to a record $241 million for the fourth quarter. Volume growth of 55% was supported by broad prescribing to patients with acute lymphoblastic leukemia in frontline consolidation treatment. Long term, we see significant growth potential for BLINCYTO from utilization earlier in the front line as part of induction treatment. LUMAKRAS sales increased 8% year-over-year for the fourth quarter. We see future growth opportunities for LUMAKRAS coming from launches in new markets and additional indications. Vectibix sales increased 5% and KYPROLIS sales grew 8% year-over-year for the fourth quarter, both driven by volume growth. Nplate sales decreased 18% year-over-year for the fourth quarter, driven by volume decline related to timing of orders placed by the U.S. government, partially offset by volume growth across our regions. Full year sales increased 13%, primarily driven by volume growth, including U.S. government orders. Excluding U.S. government orders, Nplate sales grew 23% year-over-year for the fourth quarter and 8% for the full year. Transitioning to our inflammation business. Otezla sales increased 2% year-over-year for the fourth quarter, driven by favorable changes to estimated sales deductions and 3% volume growth, partially offset by lower inventory levels and lower net selling price. Full year sales decreased 4% driven by lower net selling price and lower inventory levels, partially offset by 2% volume growth. New patient starts for Otezla grew 6% in the fourth quarter, driven by strong execution and increased investment. Competitor free drug programs had a reduced impact in the quarter. Otezla is uniquely positioned to grow in 2024 and beyond, given its indication for all severities of psoriasis, combined with an established clinical profile, broad payer coverage, a lack of testing required for initiation and convenient oral administration. Enbrel sales decreased 8% year-over-year for the fourth quarter, driven by a 4% impact from unfavorable changes to estimated sales deductions and lower net selling price. U.S. volume grew 1% in the fourth quarter, supported by an increase in new patients starting treatment as a result of improved payer coverage. Going forward, we expect net selling price to continue to decline year-over-year driven by higher rebates to maintain broad first-line payer coverage and changes in patient mix. TEZSPIRE continues a strong launch trajectory with $177 million in sales in the fourth quarter and $567 million for the full year. Sales increased 10% sequentially, driven by volume growth. Our successful launch of a self-administered prefilled single-use pen allowed us to expand coverage with major pharmacy benefit managers to over 80%, contributing to higher new patient growth as the year progressed. Moving forward, we expect this expanded coverage will allow TEZSPIRE to help even more patients with severe uncontrolled asthma. Sales of TAVNEOS were $44 million in the quarter and $134 million for the full year. In the fourth quarter, we saw a 17% quarter-over-quarter volume growth in the U.S. Approximately 2,700 patients have now been treated with TAVNEOS by over 1,700 health care professionals. Looking forward, we will continue to leverage our expertise in nephrology and inflammation to bring TAVNEOS to even more patients with ANCA-associated vasculitis. Sales for our biosimilars portfolio grew 10% year-over-year for the fourth quarter and 5% for the full year, driven by 27% and 29% volume growth. This volume growth was partially offset by net selling price decline. Over time, we expect long-term growth in our biosimilars business to be driven by the addition of new molecules and additional launches. Overall, our execution is strong across the business, underscored by our foundational commitment to serve patients. The four pillars of our portfolio position us well to serve many more patients around the world who can benefit from our innovative therapies. And with that, I'll turn it over to Vikram, who will cover our rare disease portfolio.
Vikram Karnani: Thanks, Murdo. I am glad to share an update on our rare disease business now that we are 4 months past due close. We are now fully operating as part of Amgen with integration activities ongoing. As Bob has mentioned before, we are excited to be Amgen's fourth pillar of long-term growth. I wanted to make sure you're aware that we are not reporting the full quarter in press release and slides, which reflects sales from October 6 onwards and totaled $954 million. This excludes $41 million of sales that occurred in the first week of October prior to deal close. For the full quarter, our rare disease brands from Horizon delivered product sales of $995 million, representing 6% year-over-year sales growth. Throughout the remainder of my remarks, I will reference full quarter product sales. TEPEZZA, and IGF-1R monoclonal antibody for patients with thyroid eye disease generated $467 million of sales during the entire fourth quarter, representing 3% quarter-over-quarter growth. This is the third quarter in a row of quarter-over-quarter growth for TEPEZZA with the growth largely driven by the U.S. We saw a number of positive leading indicators, including a record number of unique TEPEZZA prescribers, total patient enrollment forms and patient starts in 2023. Additionally, thanks to our efforts, we've been able to generate favorable medical policy changes for greater than 50% of U.S. covered lives, and we expect to continue this momentum throughout 2024. We continue to see approximately 100,000 patients with moderate to severe disease in the U.S. who could benefit from TEPEZZA with the majority of these patients in low clinical activity score settings. Given positive leading indicators and high unmet need, we see a long-term growth opportunity for TEPEZZA in the U.S., while also recognizing there is some time lag between our execution efforts and the realization of increased patient numbers. International expansion also remains a meaningful long-term growth opportunity for TEPEZZA. TEPEZZA is approved in Brazil, and we are progressing towards approval in additional countries. Our expansion into both Japan and Europe is a high priority with regulatory review underway in Japan and filings in the EU throughout the year. KRYSTEXXA, a PEGylated uricase enzyme for patients with chronic refractory gout delivered a record $280 million in sales for the entire fourth quarter, representing 30% year-over-year growth, driven by continued strong commercial execution. Sales are now annualizing at $80 billion [ph] run rate. Performance was driven by execution across all phases of the patient journey, demand generation, stakeholder engagement and adherence to treatment. UPLIZNA, an anti-CD19 monoclonal antibody, which is now the fastest-growing biologic in NMOSD, delivered a record $70 million in sales for the entire fourth quarter, representing 68% year-over-year growth. International expansion is also underway with UPLIZNA now launched in multiple ex U.S. markets. Our remaining ultra-rare portfolio generated $178 million of sales for the entire fourth quarter, primarily driven by our ultra-rare medicines, RAVICTI, PROCYSBI and ACTIMMUNE. Looking ahead at 2024 by leveraging Amgen's world-class biologics capabilities, decades of experience in inflammation and extensive global presence, we are ready to reach more patients than ever before. I will now turn it over to Jay.
Jay Bradner: Thank you, Vikram, and good afternoon, everyone. I'd like to take a minute to convey how thrilled I am to join the Amgen R&D organization and its leadership team. The creativity of our discovery research, expert and expedited clinical development, most authoritative biomanufacturing organization in the industry, all were well known to me before joining. But now on staff at Amgen, I appreciate the strong sense of service, the patients facing serious illness, the like-minded commitment, growing the impact of our medicines and our business and the shared conviction in this remarkable portfolio of potential first-in-class and best-in-class medicines. In 2023, we executed with speed across our clinical pipeline, achieving excellent enrollment in key programs and setting up 2024 as the year with significant data readouts across the portfolio for medicines with the potential to transform patient care. Key highlights in 2023 included the delivery of promising data from four key oncology assets and the attainment of three breakthrough therapy designations in oncology. We initiated pivotal Phase III studies for Tarlatamab in small cell lung cancer, LUMAKRAS in non-small cell lung cancer and colorectal cancer, along with dazodalibep in Sjögren's syndrome. In General Medicine, as previously disclosed, top line 52-week data from the 592 patient MariTide Phase II study is expected by late 2024. Leveraging the durability of weight loss observed in Phase I and rapid enrollment enjoyed in Phase II, we recently added a part 2 to this study, which explores durable weight loss beyond 52 weeks. Our planning for a comprehensive Phase III program across multiple indications remains on track. Lastly, you may have seen that yesterday, Nature Metabolism published manuscript from Amgen R&D that provides the integration of MariTide preclinical and Phase I data. Beyond MariTide, our obesity strategy encompasses several assets with AMG 786 in Phase I and additional preclinical assets advancing. Our approach is tailored to meet the dynamic needs of obesity treatment, demonstrating a longitudinal commitment to innovation and patient care in this field. The Phase III outcome study of Olpasiran are potentially best-in-class Lp(a) targeting small interfering RNA molecule and atherosclerotic cardiovascular disease has enrolled more than 7,000 patients globally. This rapid enrollment accomplished in just 1 year across 34 countries and over 700 sites underscores the medical community's strong interest in and the potential impact of Olpasiran. We've deliberately expanded our initial enrollment target from 6,000 to over 7,000 patients to ensure comprehensive demographic representation and to satisfy regional regulatory requirements. We are on track to complete enrollment in the first half of 2024. In oncology, we're focused on approaching high conviction targets with differentiated therapies for large effect size. We're pleased to announce that the FDA granted priority review for BLINCYTO in early-stage CD19-positive B-ALL with a PDUFA date of June 21, 2024. The ongoing Phase III Golden Gate study is enrolling patients to evaluate the effectiveness of alternating BLINCYTO with low intensity chemotherapy here in older adults diagnosed with Philadelphia chromosome-negative B-ALL. We're also planning to amend this study to evaluate subcutaneous administration of blinatumomab with initiation anticipated in the second half of 2024 potentially allowing us to serve more patients in treating physicians. Lastly, we're pleased to announce that just today, the American Journal of Hematology published a manuscript highlighting data from the dose expansion phase of our ongoing Phase Ib study of subcutaneous blinatumomab as a single agent in adult patients with heavily pretreated relapsed/refractory B-cell ALL. Of 27 evaluable patients treated, we observed an 85% complete response rate, of which 75% were MRD negative. Subcutaneous blinatumumab is well tolerated with no observed grade 4 cytokine release syndrome. Turning to Tarlatamab, a first-in-class DLL3-targeting BiTE molecule, the FDA granted priority review following promising results from the Phase II DeLLphi-301 clinical trial and a PDUFA date of June 12, 2024. We are rapidly advancing Tarlatamab into earlier lines of treatment, where we have initiated two Phase III studies and plan to initiate a third in the first half of 2024. Xaluritamig, a first-in-class STEAP1 bispecific molecule being studied in metastatic castrate-resistant prostate cancer continues to progress following the presentation of encouraging Phase I data last fall. We are ahead of schedule with the monotherapy dose expansion and expect to complete enrollment in the coming weeks. We've opened a reduced monitoring cohort and are making significant progress in dose range finding studies in combination with novel hormonal therapy combinations. For AMG 193 in oral MTA cooperative PRMT5 inhibitor were encouraged by 9 responses we've seen across 7 MTAP-null solid tumors. MG 193 is a terrific example of a medicine targeting a genetically defined synthetic lethality and a first clinical translation of our induced proximity platform. We're now swiftly moving forward with dose expansion studies and plan to enter master protocols and thoracic and gastrointestinal malignancies, exploring combinations with standard of care in the first half of 2024. In our inflammation portfolio, we continue to explore TEZSPIRE and indications beyond severe asthma, including separate Phase III studies in chronic rhinosinusitis with nasal polyps, where top line data are expected in the second half of 2024 as well as in eosinophilic esophagitis. We also remain on track to present Phase II COPD data in the first half of 2024. Our ROCKET Phase III program for rocatinlimab, the first-in-class anti- OX40 -mon colonal antibody has successfully enrolled over 2,400 patients with moderate to severe atopic dermatitis. We're introducing an 8th study to the ROKET program to explore an auto-injector, and we are planning to initiate both the Phase III study in prurigo nodularis and a Phase II study in asthma this year as we seek to broadly explore the potential of rocatinlimab. Lastly, we are encouraged by the advancements of our rare disease pipeline with several mid to late-stage opportunities. In December, TEPEZZA received orphan drug designation in Japan where we've also recently submitted a new drug application for TEPEZZA in thyroid eye disease. To serve additional patients in Japan, we have a Phase III study underway in the study of chronic disease with a low clinical activity score. Beyond Japan, we are progressing TEPEZZA subcutaneous administration to drive increased adoption and improve patient experience and plan to initiate a Phase III study in thyroid eye disease this year. With UPLIZNA, we anticipate important Phase III data readouts this year in myasthenia gravis and IgG4-related disease. Both diseases with significant unmet need and where we have the potential to make a real difference for patients. Dazodalibep, an innovative CD40-ligand inhibitor fusion protein has entered Phase III for Sjögren's syndrome. This follows encouraging Phase II data with efficacy across patients with moderate to severe systemic disease and patients with high symptom burden. Dazodalibep is the first therapy to demonstrate efficacy in this latter patient population. Closing on our rare disease efforts, we're excited about Fipaxalparant, an LPAR1 antagonist being studied in idiopathic pulmonary fibrosis, on track for a Phase II proof-of-concept data readout in the second half of 2024. In closing, I'm delighted to report on the important progress we make advancing our innovative pipeline, and I'm looking forward to sharing more pipeline milestones through 2024. I'll now turn it over to you, Peter.
Peter Griffith: Thank you, Jay. We're pleased with our strong execution and performance in the fourth quarter and for the full year 2023. In the fourth quarter, total revenue of $8.2 billion grew 20% year-over-year and non-GAAP EPS of $4.71 grew 15% year-over-year. For the full year, we delivered total revenue of $28.2 billion, 7% growth year-over-year and non-GAAP EPS of $18.65, 5% growth year-over-year. As a reminder, both Q4 and the full year results include Horizon's results beginning October 6 when the acquisition closed. So our financial results will exclude approximately 1 week of Horizon's results from our fourth quarter results. I'll review the details of our fourth quarter and full year financial results before discussing our outlook for 2024. The financial results are shown on Slides 54 to 56 of the slide deck. Turning to our fourth quarter's total revenue of $8.2 billion. We saw product sales increased 20% year-over-year, driven by volume growth of 23%, offset by net selling price decline of 3%. Excluding the impact of Horizon, product sales increased 5% year-over-year driven by volume growth of 9%. Full year total revenues of $28.2 billion grew 7% year-over-year. Product sales increased 9% year-over-year, driven by 15% volume growth. Other revenues decreased 16% year-over-year, primarily due to lower profit and cost sharing from our COVID-19 collaboration with Lilly in 2022. Strong expense discipline resulted in a 50% non-GAAP operating margin as a percentage of product sales for the full year 2023. While we continue to focus on both internal and external innovation, investing $4.7 billion in our pipeline and $27.8 billion in our acquisition of Horizon. With product sales volume growth at 23% in Q4 and 15% for the full year, we still efficiently manage the operating expenses of the business. Q4 non-GAAP operating expenses increasing 18% year-over-year, while full year non-GAAP operating expenses increased 9%. Excluding the impact of Horizon, Q4 non-GAAP operating expenses increased 3% and full year non-GAAP operating expenses increased 5%. On a non-GAAP basis, Q4 cost of sales as a percentage of product sales was flat on a year-over-year basis at 16.3%. For the full year, cost of sales as a percentage of product sales increased by 1.1 percentage points to 17.0%. The full year increase was primarily driven by higher profit share and changes in our product mix, partially offset by the replacement of the Puerto Rico excise tax with an income tax beginning in 2023. Non-GAAP R&D spend in the fourth quarter increased 16% year-over-year and 8% year-over-year for the full year primarily due to higher spend on later-stage clinical program and marketed product support, including spend on programs acquired from the Horizon acquisition and continuing investment in our pipeline, including MariTide. Q4 non-GAAP SG&A expenses increased 20% year-over-year, primarily driven by commercial and G&A expenses related to the Horizon acquisition. Full year non-GAAP SG&A expenses increased 5% year-over-year, primarily driven by commercial and G&A expenses related to the Horizon acquisition, partially offset by a decline in other marketed product spend. Non-GAAP OI&E were about $635 million in expense in the fourth quarter, a $168 million increase year-over-year, primarily driven by increased interest expense related to the debt issued for the Horizon acquisition. Full year non-GAAP OI&E was favorable $279 million year-over-year, primarily driven by the change in accounting for the BeiGene investment to the fair value mark-to-market method and by gains related to early debt retirement, partially offset by higher net interest expense. Our non-GAAP tax rate increased 2.5 percentage points year-over-year to 15.9% in the fourth quarter and 2.7 percentage points year-over-year to 16.5% for the full year primarily due to the 2022 Puerto Rico tax law change mentioned previously. The company generated $7.4 billion of free cash flow in 2023 compared with $8.8 billion in 2022. The decrease is driven by the Horizon transaction and integration costs, higher repatriation tax payments and higher capital expenditures. We expect to continue to generate strong cash flows with the addition of Horizon and are on track with our deleveraging plans to return to our efficient capital structure by the end of 2025. In summary, we continue to execute on our multiple capital allocation priorities. First, we continue to prioritize investments in both internal and external innovation. Our increased spending in non-GAAP R&D of 8% in '23 over '22, coupled with the acquisition of Horizon Therapeutics, continues to broaden and strengthen our balanced portfolio across therapeutic areas. With our strong late-stage innovative pipeline moving forward through development, we expect our non-GAAP R&D to continue to increase in 2024. Second, we continue investing in our business for long-term growth, including our state-of-the-art manufacturing facilities in Ohio and North Carolina. Amgen, Ohio, our new advanced assembly and final product packaging plant has just received license from the FDA for commercial production in January, roughly 2 years after we broke ground and our innovative drug substance plan under construction in North Carolina is expected to be operational by 2026. In addition, we've positioned the organization to accelerate investments in innovation, including leveraging the power of generative artificial intelligence. And third, we returned capital to shareholders through growing dividends, including $2.13 per share in the quarter. This represented a 10% increase over that paid in each of 2022 four [ph] quarters. Turning to the outlook for the business for 2024. First, because this is the first full year incorporating the impact of Horizon, we're providing some additional granularity in our guidance, which we don't expect to repeat to the same extent in the future. For 2024, we're expecting revenue of $32.4 billion to $33.8 billion and non-GAAP earnings per share of $18.90 to $20.30. As we continue to integrate Horizon, we expect the acquisition to be accretive to non-GAAP EPS in 2024, and we're on track to meet the synergies target previously communicated of at least $500 million in pretax cost by year 3 after closing or in 2026. Our revenue range reflects our strong growth outlook driven by numerous opportunities across our four therapeutic area pillars. We will record a full year of legacy Horizon product sales, and we expect continued volume-driven growth in our priority products Repatha, TEZSPIRE, EVENITY, Prolia and BLINCYTO consistent with industry trends in our recent history, we expect mid single-digit price decline for our portfolio in 2024. As a reminder, as you model the first quarter of 2024 and consistent with our historical trends, we expect first quarter product sales to be the lowest quarter as a percentage of the full year due to benefit plan changes, insurance reverifications and increased co-pay charges. So we expect the first quarter of 2024 total revenue to grow roughly 20% year-over-year. For the full year, we expect other revenue to be in the range of approximately $1.3 billion to $1.4 billion. And we continue to efficiently run the business through our disciplined approach to managing operating expenses. In 2024, we're making incremental R&D investments to support our promising late-stage pipeline, including our rapidly advancing oncology programs as discussed following ESMO in October and other programs, including MariTide. Furthermore, the addition of Horizon has an impact on the 2024 operating margin given the timing of when synergies are realized. As a result, we project the full year non-GAAP operating margin as a percentage of product sales to be roughly 48%. Note that we expect non-GAAP operating margin growth to accelerate in each of the quarters following the first quarter. There are primarily three reasons for this. First, typical lower product sales in Q1, as I mentioned above, and in each of the following quarters. Second, increased spend on our commercial brands will continue building on the investments we made in the second half of 2023, including Repatha, Otezla, and our bone portfolio of EVENITY and Prolia And third, Q1 2024 reflects the addition of Horizon, for which we are just at the beginning stages of realizing synergies given the acquisition close date of October 6. So we expect non-GAAP operating margin to be roughly 43% in the first quarter. I would reiterate that we expect operating margin growth to accelerate in each of the quarters following the first quarter. We project non-GAAP cost of sales to be in the range of 17% to 18% as a percentage of product sales for the 2024 year. Taking into account the full year of Horizon related expenses, we expect non-GAAP R&D expenses in 2024 to increase approximately 20% year-over-year with investments also increasing to advance key pipeline assets, including AMG 193, MariTide, rocatinlimab and tarlatamab. We see significant potential in our innovative pipeline, and it is important that we strategically invest now to fully unlock the opportunities ahead to create long-term value for patients, staff and shareholders. And for non-GAAP SG&A spend, we expect 2024 full year amounts as a percentage of product sales to be between 21% and 22%. We anticipate non-GAAP OI&E to be in the range of $2.6 billion to $2.7 billion. As mentioned on our Q3 '23 call, the '24 guidance includes the interest expense related to the $28 billion of debt rates for the Horizon acquisition. We expect a non-GAAP tax rate of 16% to 17%. Our guidance is primarily being driven by two factors. The first is the jurisdictional mix of income, including the full year benefits associated with the Horizon transaction and the legal entity rationalization undertaken in the fourth quarter of 2023 in part to integrate the Horizon entities into our existing U.S. headquartered legal entity structure. The second is the benefit from a planned payment to the IRS as an advanced deposit as we've done in the past to stop the accrual of interest on uncertain tax positions. There is no change in our belief in the merits of our legal arguments with the IRS as we prepare for trial. Given the interest rate environment, although the deposit negatively affects our cash flow in '24, if any of the deposit is returned to us upon the resolution of our litigation, those funds would accrue interest income. Therefore, the makes this payment makes this payment a prudent use of our capital. Once again, out of an abundance of clarity, this represents no change in our belief in the merits of the tax court case. The guidance also includes the impact of the adoption of the OECD 15% minimum tax by certain jurisdictions. Based on our individual footprint, we don't anticipate any significant effects of the new rules in 2024, but we're closely watching the global tax landscape for future impacts as the framework continues to be considered by additional jurisdictions and new rules take effect. We expect governments around the world, including the United States to continue to look for more sources of tax revenue from large multinational corporations that could result in higher taxes in the coming years. Similar to 2023, we expect share repurchases not to exceed $500 million in 2024 we expect that we will continue to increase our dividend. We expect capital expenditures of approximately $1.1 billion in 2024, consistent with our capital allocation priority to invest in our business, including the Ohio and North Carolina facilities I mentioned ahead and into the rare disease pillar. In summary, we delivered another strong year of financial results in 2023. Our confidence in the long-term growth of Amgen is strong, and we believe that our new rare disease pillar, one of our four pillars will be an important additive source of growth for the company. This concludes the financial update. My thanks to my approximately 27,000 plus colleagues at Amgen around the world for their commitment to our mission of serving patients and their tireless efforts in 2023. I'll turn it back to Bob for Q&A.
Robert Bradway: Okay. Thank you. Let's open the line, and we'll take questions from our callers. And Julian, why don't you remind them of the procedures so we can get through these questions here efficiently for everyone.
Operator: Thank you [Operator Instructions] Our first question comes from Michael Yee from Jefferies. Please go ahead. Your line is open.
Michael Yee: Hey, guys. Good afternoon, and thanks for good results and good guidance. We had a question on obesity. On 133, of course, you had the publication yesterday I feel like it was the most scrutinized Phase 1 publication. But maybe you could just talk to - maybe Jay could talk to your interpretation of some of the markers, for example, lipids, A1C, blood pressure and all that kind of thing. And maybe talk about your confidence about the profile versus competitors? Thank you so much.
Jay Bradner: Yes. Thanks a lot, Michael. We really appreciate the consideration the Phase 1 paper is receiving from the community. It's exciting to report these data. For those who haven't seen it, this was a randomized, double-blind, placebo-controlled study, 49 patients, looking at safety, PK, PD, single ascending dose, 7 cohorts, multiple ascending dose 3 cohorts, 3 monthly doses, patients with obesity being migrated than 30. And we were quite pleased with the outcome. Looking at the 420-milligram dose as an example, which was the highest dose study, 14.5% weight loss at only day 85. And moreover, quite durable coming off of that medicine out to 150 days, all with relatively mild gastrointestinal side effects. And so to answer your last question first, we find the Phase I data, which we're pleased to share with the community to be quite supportive of our ongoing work to develop this medicine to the greatest possible benefit of patients suffering from obesity. Now you've asked questions around some of the measurements on this study, lipid, blood pressure and A1C. And I would just caution that this is a Phase I trial, the numbers are very small, that the duration of treatment is rather short. But even with all of those caveats, while hard to draw conclusions from such small numbers, especially labile measurements like blood pressure and lipids, all are directionally favorable. And so we have - we take no concern whatsoever from those measurements on the study.
Michael Yee: Okay. Thank you. Those are the questions. Yeah.
Operator: Thank you, Michael. Our next question comes from Salveen Richter from Goldman Sachs. Please go ahead. Your line open.
Salveen Richter: Good afternoon. Thanks for taking my question. Another one here on the obesity program. So post the published Phase I data, how are you thinking about differentiation on GI tolerability? Is the dose range being evaluated in the Phase II study similar to that in the Phase I? Thank you.
Jay Bradner: Yes. Thanks for the question. I'll take this one as well. As you may or may not know, the Phase II study, which is ongoing at present and going very well, explores 11 dosing cohorts with relevant placebo controls. And through that study, we'll have a chance to gain an experience with a longer exposure to MariTide dosed in different ways. We've recently added a part 2 to this study that will allow us to explore even more durable weight loss beyond 52 weeks enabled by just very rapid enrollment. And these four dosing cohorts will go on to test dose level and even less frequent dosing schedules than monthly. And so these Phase II data, even by end of year will be strongly instructive as to finding a safe and tolerated and efficacious dose to carry into Phase III clinical investigation.
Robert Bradway: Yes. The only thing I would add is we're starting from a basis of a monthly dosing cadence and schedule. And so the additional dosing cohorts would look at potential dosing schedule beyond monthly. And the data are pretty clear in the market right now that the GI toxicity or GI side effects are generally related to the day of dosing of the GLP-1s, which are dosed weekly. We see some of that same GI side effect profile in kind of the first dose part of the dose titration. But there's an opportunity here to potentially spread the dosing intervals out further and further improve tolerability in our program. And as Jay clearly described, we've got all of the different aspects of that being studied in the Phase II program.
Justin Claeys: Thanks, Julianne. We'll go to the next question.
Operator: Thank you, Salveen. Our next question comes from Jay Olson from Oppenheimer. Please go ahead. Your line is open.
Jay Olson: Hey, thank you so much for taking a question, and congrats on the progress. Another question on 133. Talk about whether or not that we see later this year will include patients from two of the study? And do you think it's possible that 133 could be dosed twice every 2 or 3 months? And also, if you could just comment on the rollover rate of patients from Part 1 to Part 2? Thank you.
Robert Bradway: Jay, could you catch all that some of what Jay asked was broken up at the beginning...
Jay Bradner: The third part was a little bit broken up of your question. I heard a better explanation of part two frequency of dosing. And then I did not hear your third part.
Jay Olson: If you just comment on the rate of patients rolling over from Part 1 to Part 2? Thanks.
Jay Bradner: Okay. Yes. Thank you for the question, Jay. Let me give a little bit of context on this Part 2 study that I think will help answer them. In part 2, the intent is to really look at durable weight loss beyond 52 weeks. And so by durable weight loss, patients eligible for Part 2, which begins at the end of 52 weeks, will be responding to this medicine. And then they'll be rerandomized to four cohorts that will test dose level. And again, this even less frequent dosing schedule. We have not disclosed the granularity on the dosing schedule. This is a competitive environment. But we're afforded this chance because the ADC, the antibody core of MariTide, like so many immunoglobulin therapeutics allows for the opportunity to use it much less frequently. The rate of patients rolling over to Part 2 will be established as the Phase II study continues to progress this year.
Justin Claeys: Thank you, Julianne. Next question.
Operator: Thank you, Jay. Our next question comes from Chris Schott from JPMorgan. Please go ahead. Your line is open.
Chris Schott: Great. Thanks very much. Just maybe to pivot over to TEPEZZA [ph] for a question. Can you just talk a little bit about the dynamics for 2024? It seems like the products come back to growth. But I'm just trying to get a sense of now that Amgen owns the asset and has more kind of time with it. What are your top priorities? And how do you think about continuing to kind of grow the new patient base here? Thank you.
Robert Bradway: Sure, Chris. Maybe we'll take it in a couple of parts. But Vikram, share your thoughts first.
Vikram Karnani: Yes. Thank you for the question. I think if you focus a little bit on what are the underlying factors that are driving TEPEZZA growth, we saw a record number of unique TEPEZZA prescribers. We saw an increase in patient enrollment forms and patient starts. In addition, we've made pretty significant progress on payer coverage, as we've seen our covered lives have now increased to greater than 50% of U.S. covered lives. And that's important, educating some of those stakeholders on the new clinical data updated indication, it continues to drive uptake across the full spectrum of TED patients. And finally, what holds all of this together is a really robust patient service model that supports patient access. I think we continue to make progress and execute towards each one of these important leading indicators. And we shouldn't forget that we - there is still low penetration of the approximately 100,000 patients that can be eligible for this medicine in the U.S. alone. Now, just one last point here is that as we've noted before, there continues to be a time lag between the execution of all of these efforts and the realization of increased patient numbers. As we said before, it can take up to 90 days once a patient is identified for therapy for that patient to actually get on therapy. But we're pretty happy with all of our leading indicators and the execution that we have seen coming out of last year.
Robert Bradway: And Chris, the only thing I would add is building on what Vikram said in his prepared remarks, we're excited about the international opportunity as well, and I think he characterized that well previously. And we're also excited about what we see as ongoing opportunities to invest in innovation for the benefit of TED patients. So all in all, I feel excited about the rare disease pillar that we've established and the role that TEPEZZA will play in that.
Justin Claeys: All right. Next question, Julianne?
Operator: Thank you, Chris. Our next question comes from Evan Seigerman from BMO Capital Markets. Please go ahead. Your line is open.
Evan Seigerman: Hi, guys. Thank you so much for taking my question. I wanted to touch on TEZSPIRE specifically in COPD. How are you planning to differentiate given the pretty competitive data we saw from Dupixent [ph] And how should investors be looking at this data from an efficacy bar? Are there nuances in this trial that need to be clarified that might make it harder to do an apples-to-apples comparison?
Robert Bradway: Yes, and thanks for the question. Murdo, why don't I start and then you add on. So it's a great and timely question. The Phase II COPD study of TEZSPIRE, we expect data in the first half of this year. This was a big study, 337 patients, moderate to severe COPD. They're having exacerbations despite being on triple therapy. And so reflective of the current unmet need inadequacy of therapy for patients with COPD. This is a slightly broader population than Dupi that we're studying here. We're totally on track for the readout. We quite like the mechanism here. You must know that TSLP [j works as a signaling factor upstream and by blocking it with our unique biotherapeutic, we block TSLP IL-25, IL-33 signaling. TSLP so many cell types modulating this airway Type 2 response. By hitting TSLP upstream, we think we can really have an impact on the disease biology. We see TSLP-elevated in the serum patients in bronchial mucosa [PH] and bronchoalveolar lavage fluid. It's released by airway epithelium. There's just a lot of signals from the basic biology of this disease pointing to a medicine of this nature. And by looking at the broader population than they did with Dupi, we have a chance to really figure out who the responder is. Murdo?
Murdo Gordon: I think you've covered all the bases. I would just add this, Evan, that with the unique and differentiated mechanism, as Jay described, we hope we can treat a broader population of patients than perhaps the currently available therapies. And we also recognize that there are patients who are refractory to those currently available therapies, and we would obviously want to understand if they would be responders to TEZSPIRE. I think we've got strong commercial capabilities, including with our partners at AstraZeneca and are well positioned to take a product like this into the market if we're successful in Phase III.
Justin Claeys: Okay. All right. Thank you, Julian. Next question?
Operator: Thank you, Evan. Our next question comes from Umer Raffat from Evercore ISI. Please go ahead. Your line is open.
Umer Raffat: Hi, guys. Thanks for taking my question. I wanted to touch up on AMG 133 as well, two parts question. First, on the discontinuations at the high dose, we know five out of eight did not finish the full duration of the study, but there was a second arm also of this high dose 420-milligram with 10 patients, which was not reported. This was the one with digital tools. Could you speak to the discontinuation rate in that arm? So this a 420 done separately, which is not part of paper? And secondly, I know there's a case of liver enzyme elevation of the 280-meg dose, but this patient also had COVID. Could you perhaps speak to the timing of liver enzyme elevation relative to the COVID episode? Thank you very much.
Robert Bradway: Yes. Thanks, Umer. I won't be able to provide patient level insights to the Phase I study at this time, but I do appreciate your question and your interest in the report. I'll speak to the dropouts of the Phase 1 at the 420-milligram dose, which was four out of the eight patients. First, it's notable to say that the high-dose cohort in the multiple ascending dose receiving the three doses of 420 experienced real weight loss, real benefit of 14.5% after these three monthly doses. This was the group that proved actually quite durable out to day 150. Four subjects decline to participate in this clinical study setting largely from logistical reasons. The AEs and other characteristics were comparable to all the other patients in the study. Now the second question around the digital group, I don't have insight into that. Dave, do you...
David Reese: No. I mean we can get back to you on that. I don't know that we reported that - those data and the discontinuation rate.
Justin Claeys: Julianne, next question.
Operator: Thank you, Umer. Our next question comes from Colin Bristow from UBS. Please go ahead. Your line is open.
Colin Bristow: Good afternoon and thanks for taking the questions. Maybe a couple more on MariTide. First, could you provide some insight into the dosing? I mean, obviously, these are pretty large doses. And if we look at like Repatha for 20 milligrams takes over 5 minutes by infusion or 3 infective injections. So I was wondering if you could give any insight there. And then in terms of the relative affinity for gip versus GLIP [ph] MariTide seams to have preferentially favor GLIP much more than competitor molecules. And so do you think the ultimate clinical profile is more closely going to resemble that of a long-acting glip-1 versus competitive git GLIPS [ph]? Thanks.
Robert Bradway: Yes. Thanks, Colin. I appreciate the deep consideration of the molecule, especially. I'd start by saying, I don't regard these doses as high. I'm new here, but 420 milligrams for biotherapeutic that's an antibody drug conjugate with a peptide antibody ratio 2:1 seems well in scope for a modern biotherapeutic product. I don't need to tell this community paying so close - such close attention to Amgen that this is a very sophisticated biotherapeutics organization. And on the manufacturing side, just every patient, every time. And we have all the capabilities necessary to deliver this medicine at whichever of these three or other dose and schedule we arrived at. So no concerns there for me whatsoever. Regarding the balance of the pharmacology, you do invoke a difference between our medicine and medicines developed by pure pharmaceutical companies. Namely mechanistically the core antibody of MariTide inhibits the GIP receptor, whereas these other peptide medicines agonize it. We feel very secure in our choice to inhibit that receptor supported by just the finest level of experimental data available experiments of nature that genome-wide association studies in very large populations have pointed to a need, an opportunity to inhibit the gift receptor to deliver lower BMI as observed with variance in that receptor and downstream signaling pathways that correlate with reduced body mass index in large populations. As to the balance, which you asked, between inhibition of GIP receptor and agonism of GLP-1, these are very difficult measurements to make in humans, but our modeling suggests that with the therapeutic doses and exposures that we observe that we're achieving both.
Murdo Gordon: And Colin, this is Murdo. I would just add that from a patient experience perspective, we've learned a lot from other biologics. And Amgen has a world-class process development, manufacturing and device team, and we've done a lot of work on this one, and we anticipate a very positive and simple patient experience on at least a monthly dosing schedule. And we've learned a lot from Repatha specifically, and there's more to follow on Repatha from that, but we continue to work to improve patient experience with our biologic injectables.
Jay Bradner: Just as we go to the next question, let me observe that we're almost up to the hour that we actually all to set aside, but I know we still have quite a few questions in the queue. So we'll try to get one question for a caller here and get through. We'll stay through the queue of calls or questions rather that's still waiting for us, but I know some of you may have to drop. So let's move forward, Justin.
Justin Claeys: Julianne. Next question please.
Operator: Thank you, Collin. Our next question comes from Yaron Werber from TD Cowen. Please go ahead. Your line is open.
Q – Unidentified Analyst: All right. Great, thanks. This is Brendan on for Yaron. Thanks for taking the question. Just a quick one from us. Actually, based on the data you've seen so far and maybe some feedback from physicians that you've heard, this is on UPLIZNA. Where do you kind of see UPLIZNA fitting into maybe the MG treatment paradigm given all the competition there, but maybe more to the point, how you're thinking about expansion opportunities given all the different autoimmune indications you could potentially pursue? Just trying to kind of understand how you see longer-term growth there?
Robert Bradway: First, why don't we ask Vikram, just to address the performance of the product right now in NMOSD. And then a combination of Jay and Dave can talk about the other activities or other potential applications.
Vikram Karnani: Yes. Thanks for the question. Yes, UPLIZNA is actually growing quite nicely and quite well in NMOSD. As you know, it is now the fastest-growing biologic in NMOSD. We continue to execute across a variety of fronts. I mean, we're - we see this product nicely positioned versus as it's appropriate for NMOSD patients and within the competitive environment that we operate in. We've continued to make significant progress over the last 18 months or so, maybe even longer of continuing to drive more growth with newer prescribers and even depth with existing prescribers. So the product continues to do well. And I think we hope to continue to deliver good execution on this medicine in NMOSD. Maybe, Jay, you want to talk about the second question?
Jay Bradner: Yes. No, I'm happy to. As you may know, on a hematologist, I think CD19 is a terrific target. It's expressed really on all B cells and spares plasma cells. And therefore, considering indication expansion, as you've asked, there's a large number of diseases that could potentially be approached with UPLIZNA to the real benefit of patients with unmet need, far beyond the application of the prevailing CD20s that target just a subset of B cells. This is not lost on our team, and we're working through indication expansion priorities presently.
Justin Claeys: Julian, let’s got the next question.
Operator: Thank you. Our next question comes from Mohit Bansal from Wells Fargo. Please go ahead. Your line is open.
Mohit Bansal: Great. Thank you very much for taking my question. I have a question regarding the subcutaneous delivery of TEPEZZA. You do have a plan to initiate a Phase III study. Can you talk a little bit about which technology you are using? Is this with the pre-existing Halozyme technology? Or are you using something else for this development? Thank you.
Robert Bradway: Sorry, I had trouble understanding your question.
Murdo Gordon: The question is what technology we're using for the subcutaneous injectable form of TEPEZZA?
Robert Bradway: Maybe I'll jump in. Mohit, we're not commenting at this point on the provider. We just said that we're going forward with the subcu.
Justin Claeys: Okay, Julian, we’ll go to next question.
Operator: Thank you, Mohit. Our next question comes from Geoff Meacham from Bank of America. Please go ahead. Your line is open
Geoff Meacham: Hey, guys. Thanks for the question. Another one on 133. When you think about the Phase III program, I just wanted to know what sort of informs the next indications you're going to go after? Is it unmet need? Is it the potential for differentiation on 133 and the timing of that, do you think that you'd want to have the Phase II data in hand? Or is this something that you could roll out sort of that risk? Thank you.
Robert Bradway: Yes. Thanks for the question, Geoff, really appreciate it. As you know, obesity is a major public health crisis, maybe 40% of Americans with a BMI over 30 massively costly. So a huge burden to the global third-party payers and societies. The obesity-related disease list is quite long and expanding from cardiovascular disease and heart failure, type 2 diabetes, obstructive sleep apnea, NASH and AFLD kidney disease. These are chronic conditions that really demand medicines that can deliver durable and chronic weight loss. And so we think we have a really strong offering for these obesity-related diseases rising in our Phase II program, as you know. And obesity has a strong genetic component and we locked on to gipper [ph] inhibition based on genetic insights. So the opportunity space is quite large. You asked the question what indications and perhaps even in what sequence. And when we have all the requisite data, we'll remark in due course. But we intend all indications where this dual mechanism can improve public health. And we are actively planning and on track for an expansive Phase III program.
Jay Bradner: And in terms of - Dave, you want to add the regulatory piece?
David Reese: Yes, I think -- Geoff, this is Dave Reese. I would just add that we're planning a very expansive Phase III program. So you can expect to see multiple indications move forward in parallel. And as Jay indicated, as we start to see data, we will begin launching those trials, and we'll discuss them. And then in addition, as you're aware, regulatory authorities around the world require a certain body of safety data before Phase III launches. And so of course, we will be compliant with that. But our goal is to launch Phase III as quickly as possible once we have the requisite data set and regulatory approval.
Justin Claeys: Great. All right. Julian, we'll go to the next question, please.
Operator: Thank you, Geoff. Our next question comes from David Risinger from Leerink Partners. Please go ahead. Your line is open.
David Risinger: Yes. Thanks very much. So I have another question on AMG 133, please. Could you add some more color on your expectations for the impact on blood pressure and lipids in Phase II, specifically whether you anticipate tirzepatide-like efficacy on those metrics? Thanks very much.
Robert Bradway: Yes. Thanks, David. I mean we're making all these measurements, and I'm not going to try to forecast the outcome of that pharmacology at this time. As you've seen in our Phase I program, the medicines very well tolerated, delivering durable weight loss and benefit without significant excursion of some of those measurements. I just think it's too early to try to answer your question, and we'll have all that data at the end of the first part of Phase II towards the end of this calendar year.
Jay Bradner: And the best extrapolation that you can have is from the preclinical data that were just published, I urge you to take a look at that.
Justin Claeys: Okay. Julian, we’ll go to next question, please.
Operator: Thank you, David. Our next question comes from Michael Schmidt from Guggenheim Securities. Please go ahead. Your line is open.
Q – Unidentified Analyst: It's Ege [ph] on for Michael. Thanks for taking our question. A quick one on [indiscernible] Can you talk about your plan of data disclosure this year and your current thinking on the potential registration path? How do you think about the positioning of this agent relative to some of the other emerging agents based on different mechanisms such as ADC or AR degradors in prostate cancer? Thank you.
Robert Bradway: Yes. Thanks for this outstanding question, Michael. And Zalaritamag [ph] is a very interesting and exciting molecule for those on the call. This is a steep on CD3 bispecific. We have been studying this in advance castrate-resistant prostate cancer. We have expanded a cohort in the Phase I monotherapy. We're opening to reduce monitoring as well as - as you invoke the existing and novel androgen receptor modulators integrators, we're exploring combinations with novel agents in that domain as well. The priorities for the program right now are to establish reduced monitoring. This will be important to reach just all the patients who can benefit. We're looking at the feasibility of reduced monitoring. We have a great experience with these T-cell engaging bispecifics as well as the plausibility of outpatient therapy. The approach to the regulatory path will present in due course. There'll be no surprises there. The path to bring medicines to patients with castrate-resistant prostate cancer alone and ultimately, in combination is well worn, thankfully, and we know how to deliver there. You asked about differentiation in other medicines. These are often apples to oranges comparisons. We have looked at that, of course, and we really like the offering of Zalaritamag. The patients treated on our study had quite advanced disease, even more advanced disease than the demographics of the patients as reported on other mechanism medicines such as radio ligand therapies.. And the response rates we're seeing are really clinically meaningful to patients. And that gives us great encouragement to develop the medicine more ambitiously in the next few years.
Murdo Gordon: Jay, in terms of the data sharing, do you want to share...
David Reese: For data availability - as Jay mentioned, we're nearly complete in terms of dose expansion enrollment. So as those data roll forward over the course of the year, we'll provide guidance as to when we might have the next look at that data. But that's probably the next meaningful set of data we'll get a look at either later this year or early into next year.
Justin Claeys: Julianne, next question, please.
Operator: Thank you, Michael. Our next question comes from Tim Anderson from Wolfe Research. Please go ahead. Your line is open.
Tim Anderson: Thank you very much. So Eli Lilly today made a couple of sets of comments about this topic of GIP agonism versus antagonism and they also weighed in on the data you published yesterday. And I'm wondering, in as much as you heard that or read those comments, is there any context to add or anything that's factually incorrect or anything to refute because they covered quite a few points, and they continue to express their view, which is agonism is the best way not antagonism?
Jay Bradner: Tim, this is Jay. I open it up to anyone else who wants to contribute to this. I don't believe that - yes, that engaging in the dialogue around this is as much to the narrative. Rather, I'd say that the argument for GIP receptor antagonism comes from just the highest level of scientific data, the human experience across populations with 1 million patients studied, among those who have variations in the genes associated with this pathway where that variation is directionally inhibitory, the BMI is lower. And so we're hoping to replicate that pharmacology with this medicine. We feel great about the offering in this domain.
Justin Claeys: Okay. Julianne, next question, please.
Operator: Thank you, Tim. Our next question comes from Robyn Karnauskas from Truist Securities. Please go ahead. Your line is open.
Q – Unidentified Analyst: Hi. Thanks so much for taking the question. This is Nicole on for Robin. So on Daxdilimab, targeting ILT7 business, can you talk about your level of confidence in this target in light of the competitive landscape? And would you expect to see near term from safety and efficacy?
Robert Bradway: Sure. Jay and Dave?
Jay Bradner: Yes. Well, it's very early days with this medicine. There is strong preclinical support from the published literature and our own preclinical work. It's nicely for patients, a very competitive landscape, but this is the earliest phases of clinical investigation. And so we're going to approach this with total aquapoise and bring the medicine to the patients that stand to benefit the best based on the biology underlying.
David Reese: Yes. I would say the target, as you mentioned, is one that helps control some of the central signaling that drives some of the autoimmune diseases that are being investigated here. And at this point, I think it's all efforts towards generating the clinical data.
Justin Claeys: Okay. Jullian, next question please.
Operator: Thank you, Nicole. Our next question comes from James Shin from Deutsche Bank. Please go ahead. Your line is open
James Shin: Thanks for taking our question. I have one for Jay. I just kind of want to piggyback on what Tim was alluding to. The GIP antagonism versus agonism, I'm looking at the Nature paper, it looks like 133 420-milligram dose has a slight blip in triglycerides that eventually fades, but it does seem like antagonism is behaving a little differently from the literature for agonism. Is it too early to chalk it up to antagonism versus agonism in your view? Just wanted to get your thoughts there.
Jay Bradner: The short answer is it's too early to talk it up to antagonism versus agonism. As I said before, and I meant it, that these lipids are labile and indirect biomarker of this pharmacology. This is an early stage study that had 1 or 3 monthly doses of the medicine. And so we are not reading anything into the lipids conclusively from this trial. We are making all these measurements in the active Phase I.
Justin Claeys: Great. Then I think we have time for one more, Julianne.
Operator: Thank you, James. Our last question will come from Carter Gould from Barclays. Please go ahead. Your line is open.
Carter Gould: Good evening. Thanks for taking the questions. Maybe just one on 786. Can you walk through exactly what's sort of driving - maybe let me take it back. Maybe first kind of if you could outline sort of how you're setting expectations there? And any color on what's driving the delay there? It seems like it's taking a long time to enroll 72 patients? Thank you.
Robert Bradway: Sure. No, thank you for your question. For the broader group, AMG 786 is an oral medicine being developed for obesity. It is not an increasing that we've not as yet disclosed this target or pathway. This study is progressing fine. The readout of the Phase I is on track for the first half of 2024. We've completed initial dose escalation cohorts, and we're just collecting and analyzing data, expecting the readout in the first half of this year.
Justin Claeys: And Julianne, we're going to turn it back to Bob for some closing remarks.
Robert Bradway: Okay. Thank you all for joining the call. As you heard, we're excited about the opportunities that we see for growing our business across all four of our pillars, general medicine oncology, inflammation in rare disease. Last October, we shared an in-depth look at oncology in connection with the ESMO medical meeting. And we plan to do an introductory review of rare diseases and our rare disease pillar in late February to give you more information about the medicines that we already have on the market as well as some of those that are advancing through our pipeline. So we're encouraged by the questions that we heard on this call about those molecules, and we're excited about them and their prospects. So we'll host a call, which IR will share with you here over the next few days and look forward to having that opportunity. In the meantime, again, thank you for your support, and we look forward to talking to you at the Rare Disease Day at our first quarter results call. Thank you.
Operator: This concludes our 2023 Q4 earnings call. You may now disconnect.+ |
GILD | 4 | 2,023 | 2024-02-06 20:24:07 | Operator: Good afternoon. Thank you for attending the Four Quarter and Full Year 2023 Gilead Sciences Earning Conference Call. My name is Victoria, and I'll be your moderator today. All lines will be muted during the presentation portion of the call with the opportunity for questions and answers at the end. I would now like to pass the conference over to your host, Jacquie Ross. Thank you. You may proceed, Jacquie.
Jacquie Ross: Thank you, Operator, and good afternoon, everyone. Just after market close today, we issued a press release with earnings results for the fourth quarter and full year of 2023. The press release, slides, and supplementary data are available on the Investors section of our website at gilead.com. The speakers on today’s call will be our Chairman and Chief Executive Officer, Daniel O’Day; our Chief Commercial Officer, Johanna Mercier; our Chief Medical Officer, Merdad Parsey; and our Chief Financial Officer, Andrew Dickinson. After that, we’ll open the call to Q&A, where the team will be joined by Cindy Perettie, the Executive Vice President of Kite. Before we get started, let me remind you that we will be making forward-looking statements, including those related to Gilead’s business, financial condition and results of operations, plans and expectations with respect to products, product candidates, corporate strategy, business and operations, financial projections and the use of capital, and 2024 financial guidance, all of which involve certain assumptions, risks and uncertainties that are beyond our control and could cause actual results to differ materially from these statements. A description of these risks can be found in the earnings press release and our latest SEC disclosure documents. All forward-looking statements are based on information currently available to Gilead, and Gilead assumes no obligation to update any such forward-looking statements. Non-GAAP financial measures will be used to help you understand the company’s underlying business performance. The GAAP to non-GAAP reconciliations are provided in the earnings press release, in our supplementary data sheet, as well as on the Gilead website. With that, I’ll turn the call over to Dan.
Daniel O’Day: Thank you, Jacquie, and good afternoon, everyone. The team and I are pleased you could join us today as we share the details of our full year and fourth quarter performance and the latest on our clinical portfolio. Starting with our full year performance, 2023 was a strong year for Gilead, with 7% growth in product sales, excluding Veklury, driven by HIV and Oncology. HIV grew by almost $1 billion, with Biktarvy sales growing 14% to almost $12 billion and increasing its market share in the US to 48%. Oncology grew 37% to almost $3 billion, an increase of almost $800 million in just one year. This growth was split evenly between our Kite cell therapies and Trodelvy. Veklury for COVID-19 contributed $2.2 billion in 2023, ahead of our expectations, but down year-over-year, as expected, given the evolution of the pandemic. In the last two years combined, Gilead’s base business has grown approximately $3.3 billion, or more than 7% annually, largely offsetting the decline in Veklury revenues over the same period. The consistent growth in our base business gives us a strong foundation as we continue into 2024 and look to deliver on our broad clinical portfolio. This is a catalyst-rich phase for Gilead with more than 20 updates this year and many more to come beyond 2024. Starting with Oncology, we expect at least 12 further updates by the end of 2024. These include Phase 3 updates for Trodelvy in bladder and triple-negative breast cancer, and results from the pivotal Phase 2 iMMagine-1 study for anito-cel in multiple myeloma, for which we saw encouraging Phase 1 data at the American Society of Hematology meeting in December. Also in Cell Therapy, we are very pleased to have shortened our manufacturing time for Yescarta by another two days in the US, reinforcing our industry-leading median turnaround time, which is now at an anticipated 14 days. As you know, we did not reach the primary endpoint for EVOKE-01, our Phase 3 trial for second-line plus metastatic non-small cell lung cancer. Merdad will go into detail on this later, but while we did not see the outcome we hoped for, the data are encouraging on a number of levels, namely, a numerical improvement in overall survival favoring Trodelvy, including in both squamous and non-squamous tumors, a safety profile consistent with our product label that could continue to differentiate Trodelvy versus other TROP2 ADCs, and while not statistically powered, a potential benefit for a pre-specified sub-population that saw more than three months’ median overall improvement. The team is evaluating next steps given the data and the significant unmet need and we look forward to discussing the data with regulators. Based on the totality of the results in both EVOKE-02 and EVOKE-01, we are confident in Trodelvy’s potential in patients with metastatic non-small cell lung cancer, including in earlier lines of therapy. In Virology, we are looking forward to a very important year for our HIV portfolio. Among the multiple updates we are expecting are the Phase 3 data for lenacapavir in HIV prevention and at least eight updates from our HIV treatment program. These are milestones that could bring us closer to our goal of helping to end the HIV epidemic, building on Gilead’s decades of leadership in HIV. In COVID-19, today we are announcing that our Phase 3 trial, OAKTREE, evaluating obeldesivir did not meet its primary endpoint. We conducted this study to explore whether obeldesivir could address the public health need that existed with COVID-19 for standard-risk patients. Again, Merdad will share details later, but essentially, because of the way things have evolved, the standard-risk population is now better able to fight COVID-19 without antiviral therapy. This made it more difficult for obeldesivir to show a benefit compared to the placebo. We know that the world needs to be equipped for other viruses and the broad antiviral activity of obeldesivir shown preclinically means it has potential for other viral infections. The updates we are expecting in 2024 have the potential to unlock multiple opportunities across Virology and Oncology. With a broad portfolio where the risk is balanced, we look forward to following the science and continuing to make a positive impact for patients and communities. Gilead has set an ambitious goal of delivering at least 10 transformative therapies by 2030, and we are driving confidently to that goal. Before I hand over to the team for their updates, I’ll move to Slide 6 and recap that we executed well in 2023 and achieved all the remaining targeted goals that we expected to in the fourth quarter. We’ll share our 2024 milestones later in the presentation, but it’s clear that it’s going to be a very busy year for Gilead. I’d like to thank the teams for their work in bringing us to this important catalyst-rich phase for the company, and for the strong commercial performance that gives us a firm foundation on which to build. With that I will hand it over to Johanna.
Johanna Mercier: Thanks Dan, and good afternoon, everyone. Beginning on Slide 8, total product sales for the full year were at the high-end of our guidance range at $26.9 billion, reflecting solid base business growth, with total product sales, excluding Veklury, up 7% year-over-year to $24.7 billion. This was almost entirely offset by the expected decline in Veklury sales. For the full-year, Veklury sales were $2.2 billion, reflecting the uptick in hospitalizations at the end of 2023, though still below levels seen in 2022. Turning to the fourth quarter on Slide 9, total product sales were $7.1 billion, down 4% year-over-year. Our base business sales were roughly flat year-over-year at $6.3 billion, primarily driven by higher Oncology sales, offset by lower HIV sales due to changes in channel mix that resulted in lower average realized price, in addition to the expected decline of our portfolio of non-promoted products. Moving to Slide 10, our HIV business delivered very strong results for the full-year, up 6% year-over-year to $18.2 billion and contributing almost $1 billion in base business growth, primarily driven by demand, as well as higher average realized price due to channel mix and inventory dynamics. More specifically, almost half of the full-year HIV growth was driven by higher demand, most notably by Biktarvy which delivered solid double-digit year-over-year growth of 14%, with annualized revenues now more than $12 billion. Already the clear market leader, Biktarvy continues to demonstrate impressive share gains, growing almost 3% year-over-year in the fourth quarter of 2023, to approximately 48% share in the US. This growth once again outpaced all other branded regimens for HIV treatment, and represented the 22nd quarter of consecutive year-over-year share gains. For the fourth quarter, as highlighted on Slide 11, HIV sales of $4.7 billion reflected strong demand in line with our expectations. On a year-over-year basis, this was offset by lower average realized price due to channel mix that was notably favorable in the fourth quarter of 2022, and resulted in a decline of 2%. Sequentially, sales were up 1%, similarly driven by strong demand as well as favorable inventory dynamics, partially offset by lower average realized price due to channel mix. As we have noted previously, the pricing tailwinds we saw in the second half of 2022 and the first half of 2023 are not expected to repeat, and will make year-over-year comparisons more challenging in the immediate term, as we saw in the fourth quarter. As a reminder, quarterly HIV growth is, in general, significantly more variable and less indicative of overall trends than the full year, particularly as certain quarterly pricing and inventory dynamics tend to normalize over the course of the year. Factors include, first, gross-to-net adjustments which can be difficult to forecast due to the lag between product sales and claim payments that frequently occur in different quarters. Second, the timing of bulk government purchases which contribute to overall demand but can have a significant, negative impact on pricing in the quarter in which they occur. For example, certain discounted government segments are unpredictable in terms of bulk order timing, and this impacts overall average realized price. And then finally, the inventory build by subchannel wholesalers and customers that typically occurs towards the end of the year. Historically, this happens in the fourth quarter. In 2023, we saw the build start in the third quarter and continue, albeit to a lesser extent relative to prior years, into the fourth quarter. Overall, despite these quarterly variables, we remain confident that overall demand trends are strong and unchanged. With our HIV treatment market share above 70% in US and above 40% in PrEP, Gilead remains well-positioned to continue delivering demand-driven growth. For 2024, we expect HIV sales to grow approximately 4%, reflecting, annual treatment demand growth of 2% to 3%, Biktarvy market share gains and continued double-digit growth in demand for HIV prevention. In terms of quarterly HIV revenue, keep in mind that the first quarter is always impacted by the reset of patient copays and deductibles. Additionally, we’ve historically seen inventory build-up in the fourth quarter that has led to notable draw-downs by wholesalers in the first quarter. In the first quarter of 2023, this contributed to HIV sales declining 12% sequentially, and we expect a similar decline in the 10% to 12% range for the first quarter of 2024. The continued strong performance of both Biktarvy and Descovy for PrEP are shown on Slide 12. Overall, Gilead’s leadership in HIV is unmatched, with a solid commercial portfolio and robust pipeline of potentially best-in-class regimens to serve the daily oral, long-acting oral, and long-acting injectable markets. And I can share that we are off to a strong start in terms of HIV demand, which gives us confidence in our full year expectations for 2024. Moving to Liver Disease portfolio on Slide 13. Sales of $2.8 billion for the full year highlight the consistently strong and stable contribution from our Liver Disease portfolio. In the fourth quarter, sales were $691 million, flat year-over-year and down 2% sequentially, primarily driven by unfavorable pricing dynamics, offset by higher HCV market share and our efforts to increase linkage to care, in addition to growing HDV demand in new and existing European geographies. In HCV, we continue to reinforce Gilead’s leadership with market share of over 60% in the US and over 50% in Europe. While we continue to expect the rate of HCV new starts to trend downwards over time, given the curative nature of our medicines, demand growth in both HDV and HBV is largely offsetting that headwind. Onto Slide 14. Veklury sales continue to be highly variable with the fourth quarter down 28% year-over- year, though up 13% sequentially due to higher COVID-related hospitalizations in the fourth quarter. For the full-year, Veklury sales of $2.2 billion exceeded the expectations we set out at the beginning of 2023. Turning to Slide 15, our Oncology business has achieved an annualized run-rate that now exceeds $3 billion with strong fourth quarter sales of $765 million, up 24% year-over-year. In just three years, Trodelvy revenue has grown to more than $1 billion, and we continue to see strong growth across our approved indications. And in Cell Therapy, sales approached $2 billion in 2023 and Kite remains firmly established as the leading provider of CAR T-cell therapies globally. Looking more closely at Trodelvy on Slide 16, sales for the full year were $1.1 billion, up 56% year-over-year. For the fourth quarter, sales were $299 million, up 53% year-over-year and 5% sequentially. With over 30,000 patients treated to date, Trodelvy’s solid demand trends continue to reinforce its robust clinical profile as the only TROP2-directed antibody-drug conjugate approved and available in multiple tumor types. Awareness and utilization continue to increase, driving notable share gains. In second-line metastatic triple-negative breast cancer, approximately one-third of patients are receiving Trodelvy, reinforcing its position as the leading regimen across the US and other major markets. In pre-treated HR+/HER2- metastatic breast cancer, we’re encouraged to see share growth overall, driven by increasing adoption in the IHC0 setting as well as continued use in HER2-low. Additionally, we look forward to potentially making Trodelvy more broadly available in metastatic bladder cancer. Data from the confirmatory Phase 3 TROPiCS-04 study in the first half of the year could enable global filings and subsequent launches, as well as potentially drive adoption in the US, altogether expanding Trodelvy’s potential reach to nearly 25,000 second-line plus patients with metastatic bladder cancer. Turning to Slide 17, and on behalf of Cindy and the Kite team, Cell Therapy sales of $1.9 billion in 2023 grew 28% from 2022, driven by impressive growth, particularly outside the US as we expanded our network of authorized treatment centers, and secured reimbursement following recent approvals. In the fourth quarter, Cell Therapy product sales were $466 million, up 11% year-over-year and down 4% sequentially, with strong growth in both Yescarta and Tecartus in Europe and other international markets, offset in part by near-term headwinds for Yescarta in the US, from both in-class and out-of-class competition. As previously discussed, CAR T class share of eligible second-line plus large B-cell lymphoma patients remains at roughly 15% in the US as growth continues to be slower-than-anticipated despite the compelling clinical data that suggests these therapies are potentially transformative for many patients. In Europe and other markets, CAR T class share in this same second-line plus setting continues to be stronger, at approximately 30%. Following a restructuring in November, the Kite team has been focused on extending the reach of cell therapies from primarily academic medical centers to community practices, especially in the US. In late 2023, we established partnerships with leading community networks, which include over 1,750 physicians nationally. We are certifying affiliated practices to become authorized treatment centers to provide Kite cell therapies. So far, we’ve made notable headway across centers in the southeast United States, for example, that operate over 40 locations to serve cancer patients. We expect to see the initial impact of these initiatives in mid-2024. In the meantime, we expect our Cell Therapy business to be flat to slightly up in the first quarter of 2024 compared to the fourth quarter of 2023. Importantly, alongside our 96% reliability rate, we’re also thrilled to share that we have shortened our manufacturing time in the US by two days for Yescarta, bringing our anticipated median turnaround time to 14 days. This further extends our industry leadership in terms of manufacturing, and the Kite team continues to innovate in this critical element of the cell therapy business. We look forward to inviting you to visit one of our manufacturing facilities later this quarter during an analyst and investor event. In conclusion, I would like to thank our teams for a strong 2023 performance and setting up such great momentum for continued growth in 2024. The team is excited to continue to make our medicines accessible to all those who can benefit from them. With that, I’ll hand the call over to Merdad.
Merdad Parsey: Thank you, Johanna. We’ve had a busy start to 2024, and I’ll begin by discussing the results of our EVOKE-01 study in second-line plus metastatic non-small cell lung cancer and our Phase 3 OAKTREE study of obeldesivir in standard-risk, non-hospitalized patients with COVID-19. While we are disappointed that these studies did not meet their primary endpoints, we are also encouraged by what we are learning from the data to inform our clinical programs and support our commitment to deliver innovative new therapies for patients. Let me cover each of these readouts in turn. First, on Slide 19, our Phase 3 study of Trodelvy in second-line plus metastatic non-small cell lung cancer, EVOKE-01, missed its primary endpoint of overall survival in this hard-to-treat setting. We plan to share the detailed data at the earliest opportunity. In the meantime, we’d like to highlight what we believe to be important set of observations from EVOKE-01 that give us continued confidence in Trodelvy as a pipeline-in-a product and its potential to benefit some patients with lung cancer: We saw a numerical improvement favoring Trodelvy, including in patients with both squamous and non-squamous histologies. This is encouraging for our ongoing Phase 3 EVOKE-03 first-line trial evaluating Trodelvy in PD-L1 high patients, in combination with pembrolizumab. Importantly, Trodelvy continues to demonstrate a potentially differentiated safety, efficacy, and tolerability profile, with an adverse event profile that is consistent with our label. Further, Trodelvy achieved more than three months of improvement in median overall survival in a pre-specified subgroup of patients non-responsive to their prior anti-PD-L1 therapy. This subgroup is defined as those who achieved stable disease or progressive disease as their best outcome to last prior I/O therapy, and represented more than 60% of the trial population. This analysis was not alpha-controlled for formal statistical testing, and we are continuing to analyze these data. We will discuss these data with regulators and KOLs to determine the best path forward. As a reminder, we required all patients to have received prior I/O therapy, regardless of driver mutation status, and responsiveness to prior I/O was a stratification factor. Additional analyses, including TROP2 expression, are ongoing and we will share these data as quickly as possible. Based on these observations and the data from the ongoing EVOKE-02 study, we remain confident in Trodelvy’s potential in patients with metastatic non-small cell lung cancer. For now, given these findings, we currently do not plan changes to our Phase 3 EVOKE-03 study that is enrolling as expected. Moving to Slide 20, our novel twice-daily, oral antiviral, obeldesivir, did not demonstrate statistically significant symptom relief in standard-risk, non-hospitalized patients with COVID-19 in our Phase 3 OAKTREE trial. Obeldesivir was well-tolerated in this large study population, and we will share the data at a future medical meeting. Overall, the OAKTREE results reflect the decreasing severity and duration of COVID-19 symptoms observed in standard-risk patients, driven by the evolution of variants and improved immunity to COVID-19 in our trial population. The time to symptom alleviation in untreated, standard-risk patients is now less than a week, as compared to almost two weeks at the peak of the pandemic. As a result, it was challenging for obeldesivir to show a benefit in the standard-risk population. We continue to assess whether obeldesivir could address other virologic infections given the broad antiviral activity that we have observed in preclinical data. Moving to another clinical update in Oncology, the Phase 3 ENHANCE-3 trial evaluating magrolimab in front-line unfit AML has been discontinued based on a futility analysis and a higher observed incidence of Grade 5 serious adverse events. Following the discontinuation of ENHANCE and ENHANCE-2 last year, we do not plan further development of magrolimab in hematologic cancers. Wrapping up on clinical updates, I want to thank all those who were involved with EVOKE-01, OAKTREE and ENHANCE-3. Every trial adds important advancements in our understanding of the treatment of these diseases and will inform our future development plans. We look forward to sharing more on that in due course. Transitioning to our HIV program on Slide 21, we expect the Phase 3 readout of PURPOSE-1 evaluating lenacapavir for HIV prevention later this year. Along with PURPOSE-2, expected in late 2024 or early 2025, PURPOSE-1 forms the basis of our potential regulatory filing. We continue to target our first approval for lenacapavir in prevention in late 2025, potentially making lenacapavir the first twice-yearly dosing regimen available for PrEP. Looking at our HIV program more broadly, you can see we will be sharing at least nine updates this year across our next generation daily, weekly, three-monthly, and twice-yearly programs, all based on lenacapavir, our novel, first-in-class long-acting capsid inhibitor. We are excited to have over 75 presentations at CROI this year across Gilead-led and supported studies. Among them, some notable updates from our treatment pipeline include, encouraging data from our Phase 2 ARTISTRY-1 trial evaluating our lenacapavir and bictegravir once-daily oral. We are exploring this combination as a potential additional option for virologically suppressed people living with HIV, Phase 1 data on GS-1720, our once-weekly oral integrase inhibitor, and Phase 2 data on lenacapavir plus islatravir, our once-weekly oral combination in development with Merck. In the second half of this year, we look forward to providing an update on the Phase 2 trial evaluating lenacapavir plus bNAbs as a twice-yearly regimen. Turning to Cell Therapy on Slide 22, you may have seen that FDA recently proposed safety label changes for all approved CD19 and BCMA CAR T-cell therapies, including Yescarta and Tecartus. There is no change to our confidence in the benefit-risk profile of Yescarta and Tecartus. Based on analysis of our Global Safety Database, with over 16,800 patients treated with Yescarta, there has been no causal link established between Yescarta and those reported to the FDA public safety dashboard. Additionally, no cases of T-cell malignancies have been reported with Tecartus. In the fourth quarter of last year, we presented 26 abstracts at the American Society of Hematology meeting in December, showing that Yescarta and Tecartus continue to generate some of the longest follow-up and most robust datasets for cell therapies with the potential to transform patient lives. Also at ASH, our partner Arcellx presented impressive, updated data from the Phase 1 trial evaluating anito-cel in 38 patients with relapsed or refractory multiple myeloma. At a median follow-up of 26.5 months, median progression-free survival was not yet reached, despite 70% of patients having one or more high-risk prognosis factors. Given its potentially differentiated safety profile, with notably no delayed neurotoxicity to date, including parkinsonism, anito-cel has the potential to become the best-in- class BCMA CAR T. We look forward to sharing an update from the pivotal Phase 2 iMMagine-1 study and initiating an earlier-line multiple myeloma trial later this year. In terms of manufacturing, while Kite is already the clear leader, we’re pleased to highlight that the FDA approved our updated process that reduces the turnaround time for Yescarta in the US from 16 days down to 14 days. This further extends our leadership in cell therapy and we continue to identify additional opportunities to reliably bring these much-needed therapies to more patients as quickly as possible. Beyond manufacturing, we have eight ongoing cell therapy trials, of which four are evaluating new indications and four are exploring earlier lines of therapy. As we formally wrap up 2023, on Slide 23, I would like to acknowledge the work of our clinical teams who executed on our ambitious and broad portfolio that extends far beyond the list shown, including, the advancement of eight new assets into the clinic, the delivery of 15 late-breaking oral presentations at major clinical congresses and the initiation of three new Phase 3 programs. For 2024, our targeted milestones laid out on Slide 24 include, an update on ASCENT-03 in first-line PD-L1 negative metastatic triple-negative breast cancer, an update on TROPiCS-04 assessing overall survival in second-line metastatic or locally-advanced bladder cancer, and an update on our Phase 3 PURPOSE-1 trial assessing lenacapavir in HIV prevention, as previously highlighted. We are also looking forward to the start of Phase 3 trials for Trodelvy in endometrial cancer, and the ARTISTRY trials evaluating lenacapavir and bictegravir oral combination for HIV treatment. Our commitment to develop innovative new therapeutic options is unchanged and we are confident that we will make progress on that commitment in 2024. And now, I hand the call over to Andy.
Andrew Dickinson: Thank you Merdad, and good afternoon, everyone. Starting on Slide 26, we closed the year with total product sales of $26.9 billion, at the top-end of our guidance range due to a strong contribution from Veklury. For the full-year, total product sales, excluding Veklury, grew 7%, driven by growth in both HIV and Oncology. HIV increased 6% year-over-year, driven by Biktarvy, which grew 14% from 2022 to $11.8 billion. And, Oncology grew to $2.9 billion for the full year, an increase of $792 million or 37% from 2022. Altogether, total product sales, excluding Veklury were $24.7 billion, modestly below the lower-end of our full-year guidance range largely due to quarterly pricing variability in HIV in the fourth quarter. Importantly, HIV volumes were in line with our expectations and we are confident in our full-year revenue growth expectations for HIV in 2024. Veklury revenue of $2.2 billion exceeded our guidance of approximately $1.9 billion, and reflected higher hospitalization rates in the latter part of 2023. Compared to 2022, full year Veklury revenue declined as expected, and represented a headwind of more than $1.7 billion to total product sales. This was largely offset by almost $1.7 billion in growth from our base business, resulting in roughly flat total product sales year-over-year. On Slide 27, our non-GAAP results were largely as expected, including gross margin and operating expenses, notably R&D which showed disciplined moderation as we progressed through 2023. Non-GAAP EPS was $6.72, and within our guidance range despite the incremental $0.10 cents of acquired IPR&D associated with the Arcellx and Compugen partnerships that we announced following our guidance revision in November 2023. A quick note that our GAAP results were impacted by some restructuring expenses, primarily related to our manufacturing strategy and our activities at Kite. As we discussed in the later part of 2023, we have been taking steps to evolve our business model and expense structure to set us up for a strong 2024. As a result, our GAAP results reflect approximately $500 million of associated expenses in 2023, or $0.40 per share, and contributed to GAAP EPS of $4.40 for the full year. Moving to our fourth quarter results starting on Slide 28. Total product sales, excluding Veklury, were $6.3 billion. Including Veklury, total product sales of $7.1 billion were down 4% from the same quarter in 2022. As expected, Veklury sales decreased year-over-year due to lower rates of COVID-19 related hospitalizations. On Slide 29, you can see that on a non-GAAP basis, product gross margin was 86%, down 66 basis points from the prior year. R&D expenses were $1.5 billion, down 6% year-over-year. Acquired IPR&D was $347 million, reflecting payments related to our collaborations with Arcellx, Assembly Biosciences, and Compugen and our XinThera acquisition. SG&A was $1.6 billion, down 21% year-over-year, primarily related to the 2022 charge for the termination of the Everest collaboration that did not repeat in 2023. Excluding this 2022 charge, non-GAAP SG&A was down 1%. Operating margin was 39%, up from 37% in the fourth quarter of 2022, and effective tax rate in the fourth quarter was 17%, flat compared to the prior year. Overall, our non-GAAP diluted earnings per share was $1.72 in the fourth quarter, compared to $1.67 in the fourth quarter of 2022. I’ll move now to Slide 30 and our guidance which assumes a generally stable macro environment including FX at current rates. For the full-year 2024, we expect total product sales in the range of $27.1 billion to $27.5 billion. We expect total product sales, excluding Veklury, in the range of $25.8 billion to $26.2 billion, representing growth of 4% to 6% for our base business year-over-year. Within total product sales, and as Johanna discussed, we expect HIV revenue to grow approximately 4%, and we expect Veklury sales of approximately $1.3 billion although, as always, we caution you that Veklury sales remain highly variable depending on hospitalization rates. We do not expect to update our Veklury guidance until our third quarter earnings call, absent a very clear trend in COVID-19 infections. Moving to the rest of the P&L, and on a non-GAAP basis, we expect product gross margin to range between 85% and 86%, modestly lower than the 86.1% reported in 2023 due to the growing contribution from our oncology portfolio. We expect R&D to grow by a low to mid-single digit percentage compared to 2023, highlighting the substantial moderation in expense growth as we approach a steadier state of active Phase 3 programs. We expect acquired IPR&D to be approximately $350 million. Consistent with our approach in 2023, we will highlight incremental acquired IPR&D expenses as we announce new transactions and update our guidance each quarter. And we expect SG&A to decline by a mid-single digit percentage compared to 2023. Excluding the $525 million legal settlement in 2023, we expect SG&A to grow in the low-to-mid single digit percentage range compared to SG&A of $5.5 billion in 2023, excluding this settlement. As a result, we expect our operating income for 2024 to be between $11.2 billion and $11.7 billion. We expect our effective tax rate to be approximately 19%. And finally, we expect our non-GAAP diluted EPS to be between $6.85 and $7.25 for the full year, and GAAP diluted EPS to be between $5.15 and $5.55. As a reminder, for the first quarter of 2024, we expect HIV to decline sequentially in the 10-12% range from Q4 2023, similar to what we saw in the first quarter of 2023, and Cell Therapy to be flat to slightly up from Q4 of 2023. Moving to capital allocation on Slide 31, our priorities have not changed. In 2023, we returned $4.8 billion to shareholders. This included $3.8 billion in dividend payments and $1 billion in share repurchases. Fourth quarter share repurchases were $150 million. For 2024, we announced today a 2.7% increase in our quarterly cash dividend to $0.77 per share and we remain committed to growing our dividend over time, in-line with earnings growth. You can also expect to see continued investments in our business both internally and externally through select partnerships and business development transactions. Finally, we will continue to utilize share repurchases to offset equity dilution, as well as additional repurchases on an opportunistic basis. With that, I’ll invite the Operator to begin the Q&A.
Operator: Of course, Andrew. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Tyler Van Buren with TD Cowen. Your line is now open.
Tyler Van Buren: Hey guys, good afternoon. Regarding the 2024 product sales guidance, I understand you guys are guiding to a near $900 million sales drop-off year over year for Veklury, but the guidance, ex- Veklury looks to be a 5% year-over-year growth at the midpoint versus 7% for this year. So what do you view as some of the levers to ex-Veklury product sales guidance in 2024 where we could see upside?
Daniel O’Day: Thanks, Tyler. Welcome. Let's have Andy start, please. Thanks.
Andrew Dickinson: Hey, Tyler. It's Andy. Thanks for the question. You're absolutely right. Our product sales guidance for products excluding Veklury implies 4% to 6% growth year-over-year, again continuing the trend of strong growth that you've seen over the last two years. I'd also highlight that it implies a substantial moderation of our operating expense growth, which is an important piece of the puzzle that we spent a lot of time talking about. To your question specifically on product growth, the growth drivers for 2024 are the same as the growth drivers last year. You continue to see strong growth in our HIV business. As you see in the quarter, you really need to focus on the full year for the HIV to see the growth trend. And we saw another year of very strong growth across our HIV business for the full year in ‘23. We expect the same thing in ‘24. And you heard on the call that we're expecting at least 4% growth for the HIV business next year. And then of course, the Cell Therapy business and Trodelvy are expected to continue to grow as well. So those are the key growth drivers. We look forward to updating you throughout the year, but we're excited about the set up as we move into 2024.
Jacquie Ross: Victoria, may we have our next question?
Operator: Thank you so much. Of course, Thank you so much for your question. Our next question comes from the line of Salveen Richter with Goldman Sachs. Your line is now open.
Salveen Richter: Good afternoon. Thanks for taking my question. On business development, you have noted the potential for a $5 billion to $6 billion deal in Oncology or [I&I] (ph). Where are you seeing the greatest opportunity to leverage your current clinical and commercial infrastructure? Thank you.
Daniel O’Day: Great. Thanks, Salveen. This is Dan. Maybe I'll start and then ask others to add, but appreciate the question. I think just to reinforce our M&A strategy, I mean, nothing has changed from a business development perspective. And particularly, that's against the context of the background of nearly doubling our clinical trials underway over the past four years, multiple late stage results. As you know, we're expecting more than 20 results still this year and against the backdrop of no significant patent expirations in our business until early parts of the next decade. So I think we'll continue to be opportunistic about pursuing business development in the three areas that we are focused on, which is obviously Virology, Oncology, and Inflammation. We'll be driven by the science. We continue to articulate that building our late research, early development pipeline is probably one of our biggest focuses and we'll continue to look at later stage deals as they fit into our portfolio and our range. It might also be important to note that we are back to pre-immunomatics levels now relative to our leverage ratios. And so we're comfortable with our ability to put capital to work. But nothing has changed and we feel we have everything within Gilead right now to achieve our ambitions over the second half of this decade.
Jacquie Ross: Victoria, may we have our next question, please?
Operator: Of course. The next question comes from a line of Carter Gould with Barclays. Your line is now open.
Leon Wang: Hi, this is Leon. Hi, this is Leon Wang on for Carter. Thanks for taking my question. So at this point, what conviction do you have anito-cel will differentiate on neurotox or parkinsonism versus your competitors? And if the lack of neurotox data recapitulate later this year, would that be a de-risking in your view and how important would that be in the market? Thank you.
Daniel O’Day: Thank you, Leon. So we've got Cindy Perettie here to handle that. Thanks.
Cindy Perettie: Thank you. Thank you for the question. I think with the anito-cel data, we expect to complete the enrollment of our IMAGINE-1 study this year, where we would have then 100 patients worth of data. And obviously, we're going to continue to look for safety signals, neurotox as you suggested but to date, we have not observed any. Your second part of that question was do we see that as a differentiator and I would definitely see that as a differentiator in the marketplace if we were to come forward with a differentiated safety profile. I think the other component to remind you of is we also believe it's possible to have a differentiated efficacy profile. And today, based on the D-domain and our transduction efficiency, we're able to use half the dose that we're seeing with our competitors, and that could play both with safety and efficacy. Thank you.
Jacquie Ross: Great. Victoria, we are ready for our next question, please?
Operator: Of course. Our next question comes from the line of Terrence Flynn with Morgan Stanley. Your line is now open.
Terrence Flynn: Thanks so much for taking the question. I was just wondering if you could speak to your confidence level in Trodelvy in the front line, non-small cell lung trial setting here, given the EVOKE-01 data, and if you're considering any potential changes to that frontline trial as a result? Thank you.
Merdad Parsey: Hi, Terrence, this is Merdad. I think when we have looked at the data so far, And we're looking forward to sharing it with everyone as quickly as we can, probably one of the most important things in that dataset that confirmed where we were before is that we have not seen a difference in response rates between squamous cell carcinoma and non-squamous cell carcinoma. I think that was a bit of an overhang in the fall. And as we had mentioned earlier, we had not seen that to date, and that has been bolstered by the results of EVOKE-01. So we do think that that increases our confidence that we don't need to think about -- look at that. Now there are other analyses we need to do to make sure that there are other predictors of response or not, and we'll be doing that and we'll be sharing that over time. But right now, our overall confidence in Trodelvy, broadly speaking, remains very high. We have three approvals and we have a broad development program against which we are executing really well. We continue to have additional trials that we'll read out this year in Phase 3, specifically the [TROPHY-U-04] (ph) study that we'll be looking at the bladder cancer confirmation study with hopefully an OS signal. That study could actually give us beyond confirmatory trial in the US. It allows us to open conversations with regulators outside the US. And then we have promised an update on ASCENT-03 in breast cancer, which we also think will broaden that. And then we now have a number of trials going on in a variety of indications, including ones we've mentioned in, for example, endometrial cancer. So overall, what we've seen EVOKE-01, and we're looking forward to sharing with you, really maintains our level of enthusiasm about Trodelvy’s term potential from an efficacy and safety standpoint across the board, and we have no plans to change EVOKE-03 at this time.
Operator: Our next question comes from a line of Umer Raffat with Evercore. Your line is now open.
Umer Raffat: Hi, guys. Thanks for taking my question. Look, it's very well understood for folks in the biopharma community that no one can truly understand the full safety profile of any new drug based on Phase 1 data. But this point has a lot of implications for your TAF litigation, obviously. So my question is, in a scenario where the Supreme Court takes up your petition, would that potentially be a venue where you could prove the level of evidence that's actually needed to make a decision on exception to duty and the type of decisions to make?
Daniel O’Day: All right. I think Andy is going to take this one.
Andrew Dickinson: Hi, Umer. Yeah, thanks for the question. Yes, of course, I mean, in front of the Supreme Court, just like the appellate court, we'll be able to present the facts and our arguments as you'd expect. If you look at some of the briefing documents in the appellate court, I think they spell that out very clearly in terms of what happened over time with the development of TAF and what we knew at different points in time. And that would be available, as you'd expect, not only to the appellate court, but to the Supreme Court. And of course, those same facts would be presented at any trial if we ever get to that point. One other update on the TAF litigation, again, Umer, nothing's changed from our perspective. We continue to have a lot of confidence. The one update I can provide is that the -- one of the very first trial in the federal court has been dismissed as of yesterday, I believe. So it now looks like, and again, this is consistent, as you know, with thousands of other cases. I think it's now over 5,300 cases that have been dismissed by the courts, over 4,300 in the California state courts and over 1,000 in the federal courts before they get to trial. So the first bellwether trial in the federal courts, Umar, would now be in November instead of April. So we'll keep you up to date and thanks for your question.
Operator: Our next question comes from the line of Olivia Brayer with Cantor Fitzgerald. Your line is now open.
Olivia Brayer: Hey, good afternoon. Thank you for the question. What were some of the dynamics that happened with Yescarta this quarter? And how should we be thinking about growth for 2024 from your Cell Therapy franchise, just in light of the sequentially down quarter in 4Q? Thanks.
Cindy Perettie: Thanks a lot, Olivia, for the question. This is Cindy. We continue to be the leaders in Cell Therapy. And I think the piece that Johanna mentioned is that we are looking at how do we expand beyond the existing ATCs. So the dynamics that we observed this quarter were capacity constraints within the existing ATCs that we have. We saw a little bit of in-class and out-of-class competition. And in parallel, we have been continuing to work on expanding our ATCs. So today we have over 400 ATCs globally. We are moving out of urban centers and those academic centers into the community to meet patients where they are. As Andy suggested, that -- bringing up those ATCs in the community is going to be really important part of our future strategy, but it does take a little bit longer than bringing an academic center up. So we expect to be flat to slightly up in quarter one, and you'll start to see that return to growth in the second half of the year.
Operator: Our next question comes from the line of Geoff Meacham with Bank of America. Your line is now open.
Geoff Meacham: Great, thank you. We have another one on Cell Therapy but more on the profitability. This is a franchise that's almost $2 billion in sales. You guys have improved the turnaround time. You've reached scale. You've treated a ton of patients. What can you tell us about the progress that you've made to making this a profitable franchise? I'm just thinking not for the current products, but also looking out five years plus. Thank you.
Andrew Dickinson: Hey, Geoff, it’s Andy. Thanks for the question. It's a great question. You're absolutely right. The Cell Therapy business has made tremendous progress over the last five or six years and evidenced most recently by the faster turnaround time in manufacturing that we talked about on our prepared remarks, going from 16 days to 14 days. And again, it's just the beginning from our perspective of what we can continue to do with this business. So while we don't provide specific guidance, we have said when we announced the Kite transaction that we expected to be profitable, breakeven or profitable and accretive by the end of year four. We got there shortly after that. All of the metrics that we look at on the business have improved over time. We've continued to make significant progress on our manufacturing efficiency, manufacturing costs, despite the fact that we've opened three global manufacturing centers. And each time you do that, when you move to commercial manufacturing, it impacts your gross margin. So I'm really proud of what the team has done. And same thing on the operating costs. You see in the fourth quarter, we announced some restructuring charges, Geoff, that hit our GAAP results. Part of that was a restructuring at Kite. Cindy and her team looked at the structure and made changes to the structure that we think will continue to drive growth and efficiency in the business over the long run. So maybe the last thing I'd say is that when we look at the business, this is a business that we have line of sight to biologics margins and profitability. We're really growing the business, Geoff, as you know, for long-term sustainability and growth and less near-term profitability, but it's certainly exciting that the business is doing as well as it is.
Cindy Perettie: I think the only thing I would add to Andy's comment is beyond the three manufacturing facilities, we also have our own viral vector facility. So given the fact that viral vector has had some supply challenges, That's something that we are not suffering from. So we own these sort of end-to-end cost of goods for our products.
Jacquie Ross: Can we have our next question please, Victoria?
Operator: Of course. Our next question comes from the line of Michael Yee with Jefferies. Your line is now open.
Michael Yee: Hey, guys. Thank you for the question. We have a HIV question. There were some comments around the dynamics of the channel mix as it relates to HIV pricing. And I was wondering if you could just remind us about what the driver of the benefit was in ‘22 and ‘23 and how that changed as we go into ‘24 and why the difficulty comps? Is that a change in mix between commercial and Medicaid [indiscernible] just explain that that would help us understand what's going on there for 2024? Thank you.
Johanna Mercier: Sure, Michael. Hi, it's Johanna. Let me take that one. So what you're referring to is actually we saw some pricing favorability in Q4 of ‘22 and the first half of 2023. That pricing favorability was namely driven by actually just the inflation being so high and therefore some of our rebates are actually based on that inflation rate. And so therefore there was actually upside during those quarters. We knew that that was not going to repeat itself. So we had kind of shared with you, I think, from Q3 on that this was going to normalize. And so that was kind of what happened in the first half of 2023. As we think about the second half of 2023, and mainly the fourth quarter, what we did see there is very strong demand, and that continued throughout the whole year, but we had some fluctuations, some quarterly variabilities, mainly due to channel mix and more government channels resulting in lower average realized price because of higher rebates. And so you really have to look at it on a full year basis. And so that's why it's so important to know that HIV performance on it will always have some quarterly variabilities. And we always need to look at the full year to really get the full picture of what's going on. HIV for the full year of 2023 grew 6% with nearly $1 billion in revenue growth driven by Biktarvy obviously growing at 14% and at 48% share with 3% share growth in that year outpacing all competitors. And so we're really proud of the demand driven results that we've seen in 2023. And as we think about 2024 and our predictions for ‘24, we believe that our expectations is going to be in line with HIV treatment, which is still about 2 to 3 points. Layer on top of that, the demand growth from Biktarvy and Descovy for PrEP, and that's why we're expecting about a 4% growth in HIV. So that gives you the full picture of what's going on and what happened in the past. So we don't expect that on a yearly basis, but on a quarterly basis we do expect that variability and I would expect that that will continue as we move forward.
Operator: Our next question comes from a line of Chris Schott with JPMorgan. Your line is now open.
Chris Schott: Great. Thanks so much for the question. Can you just talk about the TIGIT program and what drove the decision to step up your investments here? And maybe as part of that, can you elaborate a little bit more on the decision to de-emphasize the PD-L1 high population in favor of the [indiscernible]. So any color there would be appreciated. Thank you.
Andrew Dickinson: Hey, Chris, it's Andy. Maybe I'll start on the TIGIT program and the revised agreement with Arcus that we announced last week, and then Merdad can answer the second part of your question. It's relatively simple. If you step back, you've heard us say this before, but I'd reiterate that we value the partnership that we have with Arcus and the programs that their team has developed. And the recent updates to your question to the partnership really allow both companies to more efficiently deploy our teams and capital. We also focused on streamlining decision-making and the additional capital allows us to expand the overall clinical study footprint. So there are a number of things that both companies accomplish through the amendment. It does reinforce our support and belief in their programs broadly, not just TIGIT. There's a lot to be excited about there that you'll see play out over the coming years.
Merdad Parsey: And excuse me, this is Merdad. I think you're referring to the ARC-10 study. And as you may recall, we started that study together with Arcus back in 2021 outside the US with a chemo comparator arm. And at the time, there was really limited access to PD-1 -- PD-L1 inhibitors outside the US. And so, we subsequently updated that study march of last year to include PD-L1 inhibitors as the standard of care was evolving. It took us time to get this all going. And while that was happening, we had a number of competitors launch similar trials in the space with their TIGIT antibodies. So as a result of all that, the enrollment for the ARC-10 trial wasn't as robust as we had hoped for and as it had been. And STAR-121, which is the all-comer study, was recruiting very well. And so we decided to really prioritize our efforts for that all-comers population where we think we could be first or second in class. And it was really a prioritization to ensure that we could stay ahead and keep moving the molecules forward as quickly as possible.
Operator: Our next question comes from a line of Brian Abrahams with RBC Capital Markets. Your line is now open.
Brian Abrahams: Hi, good afternoon. Thanks so much for taking my question. I realize this is pending KOL and regulatory discussions, but I was wondering if you could frame the potential next steps for the PD-L1 poor responders. Do you think this is a fileable population for Trodelvy in second-line lung, or might you also consider running another study in that population? And along those lines, I'm curious what you're expecting to see from the updated EVOKE-02 data this year and how that might shape your overall plans for Trodelvy in lung? Thanks.
Merdad Parsey: Sure. This is Merdad again, Brian. So maybe I'll take the second part first. On EVOKE-02, as you can imagine, we showed last year ORR data and [Technical Difficulty] |
CHTR | 4 | 2,023 | 2024-02-02 11:49:03 | Operator: Hello, and welcome to the Charter Communications Q4 Conference Call. We ask that you please hold all questions until the completion of the formal remarks, at which time you will be given instructions for the question-and-answer session. Also, as a reminder, this conference is being recorded today. If you have any objections, please disconnect at this time. I would now like to turn the call over to Stefan Anninger.
Stefan Anninger: Thanks, operator, and welcome everyone. The presentation that accompanies this call can be found on our website ir.charter.com. I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, which we encourage you to read carefully. Various remarks that we make on today's call concerning expectations, predictions, plans and prospects, constitute forward-looking statements, which are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only and Charter undertakes no obligation to revise or update such statements. On today's call, we have Chris Winfrey, our President and CEO; and Jessica Fischer, our CFO. With that, let's turn the call over to Chris.
Chris Winfrey: Thanks, Stefan. In 2023, we added 155,000 Internet customers, and we added nearly 2.5 million Spectrum Mobile lines for growth of nearly 50%. At the end of 2023, we had more than 7.7 million total mobile lines. Only 13% of our Internet customers now have mobile service. And we expect mobile penetration to meaningfully grow over the next several years, as the quality and value of our converged connectivity services gains wider recognition. Revenue was up by 1% in 2023, while EBITDA grew by 1.3% and 2.5% when excluding advertising. While we are executing well on our long-term strategic initiatives and Spectrum One is working to drive mobile growth, Internet growth in our existing footprint has been challenging, driven by admittedly more persistent competition from fixed wireless and similar levels of wireline overbuild activity. Small changes in gross additions and churn in a low transaction environment have driven outsized impacts to net gains, which was clearly the case as we moved through the last quarter. I own that. So, let me start with what we believe on the competitive environment and then what we're doing to drive long-term growth by delivering high-quality products and service at a great price. Fixed wireless access: While an inferior product with limited capacity and geographic coverage which is fluid, is often marketed by the phone companies at a perceived lower-priced to their existing customers. We continue to believe the impact from fixed wireless is temporary. Our Internet product is faster and more reliable. Our pricing is lower when similarly bundled with mobile. Customer bandwidth needs continue to increase. And MNOs will face capacity challenges and will be required to allocate their Spectrum and capital to maintain profitable mobile services. While we can't promise when that happens, I believe bandwidth needs to increase and quality and value win. On the wireline overbuild front, we continue to compete well. Overbuild impact tends to be limited to a few percentage points of Internet penetration during the first year of a new overbuild vintage coming online. It's painful, but it's tied to the pace of overbuild. We don't see overbuilders reaching their penetration and ROI goals now -- within our footprint now or in the future. They don't have the same ubiquitous convergence capabilities as we do, their lower-cost passings have likely been built, some of the planned overbuild was duplicative between operators, meaning less opportunity, and incremental financing cost have increased, putting even more pressure on overbuilder returns. We also expect BEAD passings will provide better capital allocation and ROI for many of these operators. Our assumption is that our competitors are rational economic players with shareholders and balance sheets, which require adequate return on investment. That isn't within our control. So, we are focused on the key strategic initiatives that enhance our long-term competitiveness and growth capabilities, and we expect to return to a more normalized Internet growth over time. Just over a year from when we detailed those initiatives, I wanted to remind everyone of the rationale and update you on their status, as laid out in Slide 4. Our footprint expansion is beating our pacing, penetration, ARPU and ROI targets. New construction will help drive Internet customer growth despite the temporary challenges I mentioned within our existing footprint. 2023 subsidized rural customer growth was already over 100,000. Our penetration also continues to grow at a better-than-expected pace and we'll cover more -- we'll activate more subsidized rural passings this year, both of which Jessica will cover. BEAD will provide additional opportunities, although the potential is uncertain given our concerns regarding how states will apply NTIA guidelines. We'll focus BEAD investments in states where the rules are conducive to private investment. Outside of rural, we also have accelerated greenfield, market fill-in and serviceability builds, expanding our existing footprint in both residential and commercial passings. Penetration curves and returns here are similarly strong and predictable with a lower build cost. We also remain committed to prioritizing the customer experience via our execution initiative, which is intended to enhance frontline employees' tenure while simultaneously investing in digitization, all to drive better sales yields, higher-quality transactions, lower overall service transactions and higher levels of customer satisfaction. Our targeted investments in employees over the last two years resulted in a significant reduction in employee attrition in 2023. Our investments in the digitization of service is also driving efficiencies. In 2024, we have a number of new automated platforms that are launching to facilitate better service for customers and better digital and AI tools for agents to enhance service quality and the quality of their day-to-day jobs. And finally, our evolution initiative, which includes our network evolution project, our convergence efforts, and video product development all remain on course. We fully launched symmetrical speed tiers in two markets and currently launching in six more, completing our step one markets. We'll also begin to work in our step two markets with DAA later this year. Excluding the benefit of any savings that result from the project, we continue to expect our network evolution to cost a very low $100 per passing. And we expect to complete the project in 2026, so fast, ubiquitous, low-cost upgrade of our capabilities, which our competitors can't replicate. Our converged product offering also continues to evolve and grow. Spectrum One is performing well and offers the fastest connectivity with differentiated features like mobile speed boost and the Spectrum Mobile network. Spectrum One also offers significant savings for customers with market-leading pricing at both promotion and at retail. And Spectrum One customers reaching their first anniversary are performing ahead of our expectations. We'll continue to evolve our converged offering in 2024 with additional features and capabilities. Finally, turning to the evolution of our video product, in October, we launched the Xumo platform across our entire footprint. This industry-leading video platform allows our customers to access their linear and direct-to-consumer video content with unified search and discovery within one easy-to-use interface. Combined with our Spectrum TV app, the most viewed linear MVPD streaming service in the U.S., Xumo is our go-to-market platform for new video sales. We're approaching 1 million deployed Xumo boxes since launch and we've been getting great customer feedback, and we can keep improving our attach rates. In early January, Disney+ became available to all Spectrum TV Select customers nationwide at no additional cost. And in the next several months, ESPN+ and ViX, a Spanish language DTC product, will both become available to certain TV Select customers at no extra cost. This new hybrid distribution model is good for consumers and we plan to modernize all of our distribution agreements upon renewal. That means packaging flexibility, value and not asking customers or Charter to pay twice for similar DTC and linear programming. Our new hybrid distribution model, combined with Xumo's content-forward interface, provides a clear path to solve key customer issues of choice, value and utility with seamless linear, DTC and SVOD integration and advanced search and discovery functionality. When we reflect on our key initiatives and what we believe are the short-term market challenges, we're acting as long-term Charter shareholders to maximize value. So, we have a posture of expectancy and excitement for the opportunity to execute on initiatives that enhance our long-term growth rate and value for Charter shareholders. In the short term, we are leaving no stone unturned as it relates to our go-to-market approach. Ultimately, the speed at which we can return to a more normalized broadband growth rate hinges on the assumption that our competitors' capital is not limitless for poor ROI projects and, frankly, our execution on our strategic initiatives. So, we're keeping our heads down and executing on a clear strategy to ensure we can offer customers the best products and services across our entire footprint, all while saving customers money, not only now, but in the future. And with that, I'll turn the call over to Jessica.
Jessica Fischer: Thanks, Chris. Let's turn to our customer results on Slide 6. Including residential and SMB, we lost 61,000 Internet customers in the fourth quarter, while video customers declined by 257,000. In mobile, we added 546,000 mobile lines, and wireline voice customers declined by 251,000. Our Spectrum One product continued to perform well. Customers that signed up for our Spectrum One product in the fourth quarter of 2022 reached their 12-month anniversary this past quarter. Those promotional roll-offs didn't drive incremental Internet churn. In the quarter, we had slightly lower mobile line gross adds year-over-year tied to Internet gross additions with a lower churn rate year-over-year and flat sequentially. We continue to see healthy data usage at our Spectrum One promotional lines and remain confident that these lines will perform well as long-term customers. Turning to rural. We ended the year with 420,000 subsidized rural passings and grew those passings by 295,000 in 2023, in-line with our target, and by 105,000 in the fourth quarter alone, an acceleration from this 78,000 we activated during the third quarter. Customer growth in our subsidized rural footprint also accelerated, with 34,000 net customer additions in the quarter. As Slide 13 shows, we're generating customer penetrations of close to 50% in cohorts that have reached or passed the 12-month mark. In 2024, we expect to activate approximately 450,000 new subsidized rural passings, about 50% more than in 2023, with seasonality in the first quarter tied to the winter weather. Slide 12 shows that so far, with additional state bids that we expect, we will have committed to build approximately 1.75 million subsidized rural passings. We also expect our RDOF build to be completed by end of 2026, two years ahead of schedule. Moving to financial results, starting on Slide 7. Over the last year, residential customers declined by 0.3%, with video-only customer churn, partly offset by new customer growth driven by Internet. Residential revenue per customer relationship was up 0.1% year-over-year, given promotional rate step-ups, rate adjustments and the growth of Spectrum Mobile, mostly offset by a higher mix of non-video customers and growth of lower-priced video packages within our base. As Slide 7 shows, in total, residential revenue was flat year-over-year. Residential Internet ARPU grew by 2.2% year-over-year, but by 3.4% when excluding the impact of Spectrum One GAAP revenue allocation out of Internet into mobile. Turning to commercial, SMB revenue declined by 0.9% year-over-year, reflecting lower monthly SMB revenue per SMB customer, primarily due to a higher mix of lower-priced video packages and a lower number of voice lines per SMB customer. These factors were partly offset by SMB customer growth of 0.7% year-over-year. Enterprise revenue grew 3.8% year-over-year, driven by enterprise PSU growth of 6.5% year-over-year. Excluding all wholesale revenue, enterprise revenue grew by 6.1%. Fourth quarter advertising revenue declined by 23.4% or $130 million year-over-year due to less political revenue. Core ad revenue was down 0.7% year-over-year due to a more challenged advertising market, partly offset by our growing advanced advertising capabilities. Other revenue grew by 24.4% year-over-year, driven by higher mobile device sales. And in total, consolidated fourth quarter revenue was up 0.3% year-over-year and up 1.3% year-over-year when excluding advertising. Moving to operating expenses and adjusted EBITDA on Slide 8. In the fourth quarter, total operating expenses declined by 0.7% year-over-year. Programming costs declined by 10.6% year-over-year due to a decline in video customers of 6.8% year-over-year and a higher mix of lighter video packages. These factors were partly offset by higher programming rates. For the full year 2024, we expect programming cost per video customer to grow in the 1% to 2% range year-over-year with our video package mix being the largest variable. Other cost of revenue increased by 15%, primarily driven by higher mobile device sales and other mobile direct costs, partly offset by lower ad sales costs. Cost to service customers increased by 2.1% year-over-year, driven by additional activity to support the growth of Spectrum Mobile, partly offset by productivity improvements, including from 10-year investments, and lower service transactions per customer. Looking forward, I would note that our previous investments related to job structure, pay and benefits to build a more skilled and longer-tenured workforce are now largely complete and service transaction trends are back on trajectory after the programming dispute in September. Sales and marketing costs declined by 1.6%, primarily driven by lower labor costs. Finally, other expenses grew by 1.5%, driven by labor costs. Adjusted EBITDA grew by 1.6% year-over-year in the quarter and by 3.6% when excluding advertising. Turning to net income on Slide 9, we generated $1.1 billion of net income attributable to Charter shareholders in the fourth quarter, down from $1.2 billion last year, driven by a pension remeasurement loss and higher interest expense, partly offset by a gain on the sale of towers and higher adjusted EBITDA. Turning to Slide 10, capital expenditures totaled $2.9 billion in the fourth quarter, just below last year's fourth quarter spend. Line extension spend totaled $978 million, $50 million higher than last year, driven by our subsidized rural construction initiative and increased residential and commercial greenfields and market sell-in opportunities. Fourth quarter capital expenditures, excluding line extensions, totaled $1.9 billion compared to $2 billion in the fourth quarter of 2022, driven by lower spend on scalable infrastructure and lower spend on CPE due to purchase timing, partly offset by higher spend on upgrade/rebuild, primarily network evolution. For the full year 2023, we spent $11.1 billion. Looking ahead at full year 2024, we expect capital expenditures to total between $12.2 billion and $12.4 billion, including line extensions of approximately $4.5 billion and network evolution spend of approximately $1.6 billion. On Slide 11, we've provided our current expectations for capital spending through the year 2027, excluding any possible line extension spend associated with the BEAD program. The slide divides our spending into three categories: line extensions, network evolution and core CapEx spend. As the slide shows, we expect CapEx spend of just over $12 billion in 2024 to fall to approximately $8 billion by 2027. Our line extension CapEx includes spending for greenfield, market sell-in and serviceability builds from our legacy footprint, driving continued expansion of residential and commercial passings. In turn, our non-rural passings growth should continue to be robust and similar to 2023 growth, subject to the pace of overall housing growth. These passings are natural extensions or pocket fill-ins to our network and have a long track record of low cost per passing and reliable penetration trends to contribute to growth at attractive ROI. We've not included the potential impact of BEAD in the passing figures on Slide 12 or in our CapEx outlook on Slide 11, given the regulatory and bidding uncertainty associated with the program. We don't expect any potential BEAD build subject to acceptable guidelines, as Chris mentioned, to begin until 2025. And similar to our peers and competitors, our success in BEAD will be an overlay to our capital expenditure outlook. Turning to network evolution, where our long-term capital expenditures outlook remains essentially unchanged, we continue to expect to spend approximately $100 per passing to evolve our network to offer multi-gigabit speeds. Finally, core capital expenditures, which excludes line extensions and network evolution, has remained consistent as a percentage of revenue since 2021. And following the completion of our network evolution initiative, capital expenditures, excluding line extensions as a percentage of revenue, should decline below 2022 level, which has important long-term cash flow implications. Turning to free cash flow on Slide 14. Free cash flow in the fourth quarter totaled $1.1 billion, a decrease of $75 million compared to last year. The decline was primarily driven by less favorable change in accrued expenses related to capital expenditures, partly offset by an increase in net cash flows from operating activities and a decrease in capital expenditures. Just a brief comment on cash taxes for 2024 before turning to the balance sheet. We currently expect our calendar year 2024 cash tax payments under current legislation to land between $1.5 billion and $1.9 billion, depending on a number of factors. We finished the quarter with $97.6 billion in debt principle. In the first weeks of 2024, we redeemed all of our outstanding 2024 senior secured floating rate notes and paid in full all of our outstanding 2024 senior secured notes. So, we no longer have any significant debt maturities due in 2024. Our current run rate annualized cash interest is $5.2 billion. Given our long-dated and 86% fixed rate debt structure, our sensitivity to higher rates is relatively low. If we refinanced all of our debt in the next three years at current rates, the impact to our run rate interest expense would be less than $90 million or 2% of that run rate interest expense. As of the end of the fourth quarter, our ratio of net debt to last 12-month adjusted EBITDA was 4.42 times, and we intend to stay at or just below the high end of our 4 times to 4.5 times target leverage range. During the quarter, we repurchased 3.2 million Charter shares and Charter Holdings common units totaling $1.3 billion at an average price of $419 per share. Before turning the call over to Q&A, I want to make a few comments regarding the Affordable Connectivity Program for Internet and mobile customers. While we still hope the ACP program will be allocated additional funding, we're well aware that the program could end this spring, and we're designing programs to assist those that are on the ACP program. There is no doubt that the end of the program would be disruptive for many. Nonetheless, we will have the full benefit of our high-quality sales and retention force as well as our mobile product, which saves customers hundreds of dollars to preserve connections. With the continued temporary impact from fixed wireless and the potential end of ACP, we may continue to face short-term customer growth headwinds as we enter 2024. Despite those short-term challenges, we are competing well and are focused on driving healthy EBITDA growth in 2024. A component of that has been to reflect inflation in our pricing while preserving value to our customers. We're also actively managing expenses, and we believe we can do so without impacting our sales, service and broader growth initiatives. But most importantly, we remain focused on long term and a return to more normalized Internet growth. We have what we believe are the best products at the best prices in our industry and we remain underpenetrated relative to our long-term potential. Taking advantage of that opportunity is what will ultimately create the most shareholder value. Operator, we're now ready for Q&A.
Operator: [Operator Instructions] Our first question will come from Jonathan Chaplin with New Street Research. Your line is now open.
Jonathan Chaplin: Thanks, guys. One for Chris and one for Jessica. For Chris, I'm wondering if you can give us some context on whether there was a change in competitive dynamics in the fourth quarter. As we look out across the fixed wireless guys and the fiber guys, it seemed pretty steady over the course of the last few quarters, sort of competitive pressures that seem to stabilize. And I'm wondering if there was just a bigger focus on -- from fixed wireless or potentially fiber in newer markets specifically? And then, for Jessica, the cash tax guidance is great. If bonus depreciation is expanded -- extended this year, how much of that cash tax go down by? Thank you.
Chris Winfrey: Good. So, in terms of the competitive environment in the fourth quarter, as you mentioned, we saw some continued expansion of fixed wireless footprint within the quarter. We also saw heavier competitive marketing and some aggressive promotions from both fixed wireless and from the overbuilders. And as you know, Jonathan, slight impacts to gross adds and churn, in this case, it was particularly on the gross adds front, can drive what appear to be outsized changes to net adds, especially when net adds are slightly positive or slightly negative, really has an outsized impact. As you know, we're, of course, focused very much on the long term, but that doesn't mean that we're not focused on the short term either, particularly what was going on inside of the fourth quarter. And so, as I mentioned in the prepared remarks, we're really leaving no stone unturned on potential ways to improve go-to-market in the short term, particularly addressing gross adds in the existing footprint. We're doing all that though, looking at all aspects, but trying to make sure that we do that in a controlled fashion and don't overreact either given that it is small changes that are driving an outsized impact here.
Jessica Fischer: Yeah. And I'd add on, the environment wasn't consistent through the quarter. Early on, we had some carryover from the Disney dispute in the August rate event that we talked about in last quarter's call. We had expected November and December to recover to the levels that we had seen going into that event, and they didn't. But as we exited the quarter, we saw December slightly negative, and January net adds are consistent with what we saw in December. So that environment does continue. On the cash tax side, Jonathan, it's not just bonus, it's also R&D and interest expense deductions that will impact us. But I would say the reforms that are being considered support the economics of our investments in connecting rural America and upgrading the network. And so, we are fully in support of them. I think it's a little premature to adjust our guidance. But given the investments that we're making, we do expect there to be a material benefit to cash taxes if the legislation were to go through.
Jonathan Chaplin: Great. Thanks, guys.
Stefan Anninger: Thanks, Jonathan. Luke, we'll take our next question, please.
Operator: Our next question will come from the line of Craig Moffett with MoffettNathanson. Your line is now open.
Craig Moffett: Hi, thank you. A couple of questions. Jessica, thank you for the comments you made about ACP. I'm wondering if you can just try to quantify a little bit more for us the number of ACP subscribers that you have, and if you have insight into how many of those are new subscribers versus previously were paying subscribers. And then, I wonder if you could also just comment about T-Mobile indicated that they expect 100,000 to 150,000 fewer net adds per quarter in fixed wireless. How do you think about that flowing into your footprint? And does that inform the way you think about the broadband growth rate going forward?
Chris Winfrey: So maybe I'll start off with ACP and just take a step back, and then Jessica can answer what you were requesting. ACP program, I think as everybody knows, it really has brought Internet connectivity to customers who would not have been able to have access to broadband otherwise. But more importantly, it's allowed customers who would have been coming in and out of the broadband marketplace given affordability issues to remain connected consistently. So, we really think, as you know, it's been an effective program. We're proud to be the largest ACP provider in the country. We still -- we're hopeful that the ACP can be refunded in order to keep households that are in the program today connected to the Internet. But if it's not refunded, Craig, we're going to work very hard to keep customers connected. And we've been working on this possibility for some time. We have significant tools to save customers hundreds or even thousands of dollars, as Jessica mentioned. And I'd highlight that, keep in mind, most of our ACP customers were Internet customers before the ACP program began. And in the meantime, having said all that, it's actually pretty challenging for us to predict the impact that a potential end of the program is going to have to our customer disconnects, but we're going to report that consistently over time.
Jessica Fischer: Yeah. So, on the numbers side, Craig, we have a little over 5 million households that received the ACP benefit, all for wireline Internet. Very few of those customers used ACP to upgrade to higher speeds or take more PSUs when they began receiving the benefit. But many do have our flagship speed or higher or do take other services from us. And I guess, the funding will continue through April. We'll try to keep people informed as we move through the process. But from our perspective, there's not a lot of visibility at this point as to anything that might happen when the program ends.
Chris Winfrey: In the end, we're still focused on trying to make sure that ACP is refunded, and I still think there's a strong possibility that could be the case.
Jessica Fischer: Yes. Do you want to talk to the fixed wireless lower net add guidance?
Chris Winfrey: Sure. So, we noted the same thing that you saw, Craig. I think the bigger point there is that there is a rational approach to the marketplace and the utilization of Spectrum. And I believe a recognition that there's a limited amount of capacity, the bandwidth needs are increasing. I think that was the bigger takeaway from us. It's very difficult for us to sit back and take a look at the geographic footprint of fixed wireless access because it almost changes by the day in terms of sector availability on radius in terms of capacity and where they're actively marketing and where they're not. And then, you have the additional rural footprint versus urban and suburban, and what would be off-footprint for us versus on-footprint and the split between residential and commercial, which makes it pretty difficult to mathematically cascade that into an impact for us. But I thought it was rational what we said, and I thought it made a lot of sense, and I think it's consistent with what we've always thought. Frankly, the piece that's been more difficult is just the timing in terms of where that capacity is reached, and it's been a little bit harder to predict than we would like. But I took that as the same way that you did that it should have some positive impact on our existing footprint.
Craig Moffett: Thank you.
Stefan Anninger: Thanks, Craig. Luke, we'll take our next question, pleas.
Operator: Our next question will come from the line of Benjamin Swinburne with Morgan Stanley. Your line is now open.
Benjamin Swinburne: Good morning. Chris, question for you on CapEx, and then I want to ask Jessica about sort of EBITDA growth. Chris, you've been around the cable industry for a long time. So, I know you are aware that kind of investment priorities can change over time. And I'm just curious why you felt it made sense to sort of guide out to 2027, just because you're in a competitive dynamic industry and want to evolve your strategy over time. And it did seem like you guys have -- and you can disagree, but it seems like you've prioritized the line extensions over getting network evolution done by '25. So, I know we thought it might slip into '26, but now it's definitely slipping into '26. Just wanted to understand your thought process there. If that was tied to kind of equipment availability or just a strategic decision? And then, Jessica, there's an expectation that '24 is a good EBITDA growth year for Charter given the investments you've made in OpEx. I think you cited 3.5% growth in Q4 ex advertising. Anything you can tell us to help us think about financial performance for the business in '24 would be appreciated. Thanks everyone.
Chris Winfrey: Sure. So, Ben, I think leading into the last earnings call, we had been listening to shareholder feedback about the difficulty people were having of projecting long-term CapEx trends given the significant capital investment opportunities that we have. And you're right, typically, we would never provide a multiyear outlook and we've -- about the only guidance that we've historically provided is in-year CapEx guidance. But these are unique opportunities that don't come around very often. The opportunity to have subsidized rural build, having the largest expansion of broadband and cable footprint really since the 1980s is unique and it's generational. And I think we felt that investors needed to see, A, the size and magnitude of what we were already committed to, and B, to have a very articulated outline of the returns of those investments, which Jessica has provided. We've been providing that, all that information is essentially what we provided over the past two years, but to do it in a single spot so people could wrap their heads around both the quantum that exist, the investment returns that are attached to that investment and that it doesn't go on into perpetuity, and that there is a real nice setup for what this is all about, which is free cash flow growth. And so, while we typically like to keep our cards close to our chest to preserve both flexibility and to maintain our competitive posture, I felt there was a trade-off here to make sure that our shareholders were with us and that people understood the value of the returns to the investment that we're making. And so, there's a balance here between, on one hand, having the flexibility to always make the right decisions to generate long-term free cash flow, and making sure that we're responsive to shareholder feedback along the way and that we can demonstrate the long-term value, so people take comfort with that. In terms of the prioritization of line extensions over the DAA or DOCSIS 4 upgrade, it wasn't so much about prioritization. It was really about certification of the DAA equipment taking a little bit longer, which was pushing out the timeline for the rollout. And so, the trade-off we had is could you do it the 1.2 gigahertz high-split upgrade under, what we call, an integrated CMTS environment. And do more of that footprint to keep the original pace or should we slow it down just a tad to make sure that we allowed for a catch-up of the DAA certification process so that you can move to high split with distributed access architecture as well as the 1.8 gigahertz and the rollout of DOCSIS 4.0, we chose the latter to make sure that we were having as much of the footprint with the full capabilities of DOCSIS 4.0 over time. The caveat is, if we get into couple of years from now, we see opportunities to pull capital forward. We'll of course do that, but this is our best view of where we're going to spend capital. And we thought it was worthwhile to show that to make sure people understand that it doesn't -- that higher level of capital expenditure doesn't go on into perpetuity.
Benjamin Swinburne: Thank you.
Jessica Fischer: Yeah. On the EBITDA performance inside of 2024, I guess -- I'm not going to give EBITDA guidance, but I think we can talk about the few things. So, you do have a political advertising year, that is a tailwind. We have -- so we've fully lapped the investments that we made in the employee population. And from an expense outlook perspective, I think my expectation is that we'll be able to keep cost to serve essentially flat on an absolute basis. And in sales and marketing, you might have some growth, but it will be small in the 2% to 3% range. And we continue -- as I said in my remarks, we're taking a look at expenses all across the business to identify areas where we can be more efficient and reduce costs without impacting our service levels and our sales capability. And so, we fully understand that we need to maintain EBITDA growth in this environment and strong EBITDA growth coming into what, as you note, should be a stronger year in order to be able to continue focusing on what we want for the long term, which is to be able to invest to grow in the long term and to return to that sort of Internet customer growth in the long term. So, I think the dynamics in the background are happening to make that growth happen. That's where we are.
Benjamin Swinburne: Okay. Thank you.
Chris Winfrey: Thanks, Ben.
Stefan Anninger: Thanks, Ben. Luke, we'll take our next question, please.
Operator: Our next question will come from the line of John Hodulik with UBS. Your line is now open.
John Hodulik: Great. Thanks for that color, Jessica. Just a follow-up on EBITDA growth and one of the components, revenue per customer. It's been relatively flat for the last couple of quarters and there's a lot of moving parts in terms of pricing and customers rolling-off Spectrum One. But, how should we think about progressing through '24, especially with the -- I think the most recent data price increase in August? And do you believe your pricing power in the broadband market has changed given the new sort of competitive landscape we have, or can you continue to push pricing as that lapse mid-year? Number one. And then, on the mobile strategy, anything you can tell us about what mobile is doing in terms of lowering churn in the broadband market? Is it also helping you in terms of new connection and driving new subscribers or just really churn reduction? And then, anything we should expect to change as you sort of proceed with some of the build out measures you're taking to add your own capacity?
Jessica Fischer: Yeah. So, I'll start with ARPU. When you look at average revenue per customer overall, John, the biggest factor that's keeping it flat is the rate of video penetration. So, what matters there is the extent to which we can retain video customers with some of the package and pricing strategies that we have. If you isolate and you sort of pull out Internet ARPU, you can see even in the remarks that I made on the quarter that Internet ARPU continues to grow, and when you pull out the Spectrum One Mobile allocation, continues to grow at a rate that's consistent or even a little higher than historical level. On the mobile side, I talked about it on the last call. As you have -- so because we've sort of lapsed the free line offer, the number of free lines that we have in the system over the course of 2024 is more steady than it was in 2023. So, you'll also see that the impact of that mobile allocation over to the Internet should steady over time. And you'll have, just as a matter of math, more paying customers in the base as a proportion relative to the free lines. So, I think that's the piece there. I don't know, Chris, do you want to talk about pricing power?
Chris Winfrey: Sure. In broadband, our fundamental view hasn't changed that in the long term, keeping your prices as low as you can both enhances your ability to grow, and that's still our long-term objective, it reduces churn, and it reduces the likelihood that somebody views you as an attractive overbuilt candidate. So, our fundamental views haven't changed. Having said that, we've had inflationary pressures, and we've been passing that through to the best of our ability. To the extent that our pricing is lower and it is for the most part across the industry, I view that as a positive long-term capacity question and from an ability to grow. But it doesn't mean that we're immune to inflation. It doesn't mean that we're not willing to pass-through increases as we need to. And there's a balance here as well that in an environment where we're investing so much into expansion and making sure that we do maintain EBITDA growth rate so that we can keep that engine going, it matters to us and it matters to our shareholders, and we're focused on that in parallel. So, there's a balance that's taking place. And I think we're in a not only in a good position overall, but I think a very good relative position. In terms of the overall market, you've seen different operators across the sector moving their prices up over time as well. And I think that demonstrates that there's real value to the product, and there's a need to recover cost along the way. It's a capital-intensive business. And then, your last question on -- John, is mobile churn. The contribution of mobile to the broadband business, the biggest factor so far as you highlighted really has been a significant and a very material amount of churn reduction that takes place on those customers who attach mobile, as I mentioned, it's only 13% of our base today. And I'd offer you two pieces. One is on the positive side, it is dramatic, the churn reduction. On the -- just to be balanced, there's still self-selection that exists inside that base. So, I want to be careful that we don't overplay the benefit there on what's still a relatively small portion of our Internet base and growing and has big upside. The new connects, those new Internet connects who take mobile, a percentage of our mobile acquisition mix that comes from new customers has risen over the years. Is that because we do a better job of selling it to call center and attaching or is it because mobile is actually driving gross adds? In this environment, we have so many different moving parts. I'm not comfortable telling you that it's been a big driver as of yet of new sales. But I think that's the opportunity, not only for churn reduction, but as convergence continues to take hold as these products work together in a way that our competitors can't replicate, the ability to use Spectrum One, a combination of broadband, Internet, WiFi and 5G is our backup radio. It's the slowest portion of our network, and have the fastest overall connectivity service and seamless connectivity, I think, it's powerful. And I think it has the ability not just to reduce churn, which it's already doing today, but to actually drive acquisition over time. And so, we're early on, but still very exciting.
John Hodulik: Okay. Thank you.
Stefan Anninger: Thanks, John. Luke, we'll take our next question, please. Thanks. Luke?
Operator: Our next question will come from the line of Peter Supino with Wolfe Research. Your line is now open.
Peter Supino: Good morning. I have a couple of questions on the subject of growth investment. Slide 11 discusses cost per core passing in your forecast of $2,000 to $2,500 and that struck me as high relative to historical core passings and even relative to fiber expansion. So, I wanted to see what you could share about your assumptions for penetration and ARPU in that footprint. And then, on a related note, again, on core growth investment, but moving over to BEAD, we've seen big increases over the last couple of years since the money for BEAD was allocated in the availability and uptake of fixed wireless services over midband. We expect more increases in the availability of LEO satellite services, not just Starlink, but Amazon's product. And so, I'm wondering if your outlook for penetration in that potential BEAD footprint is moderating and if that affects your appetite at all. Thank you.
Jessica Fischer: Yeah. So, I'll start on the cost per passing question. What you see there is related to the mix between commercial and even enterprise passings and residential passing. So, the cost per resi passing that lives inside of that is closer to $1,500. What's happening is that there are, I'm going to say, a smaller number, but a larger dollar amount of commercial passings that are included in the mix that drive the average cost per passing to be a little bit higher. And we're just trying to give enough information there to get you to a reasonable passings estimate so that -- so you can model off of that what gains you would generate from the build.
Chris Winfrey: And then, in terms of the penetration, Peter, there's very different types of build that sits in there. I mean, serviceability, which is where a customer calls us effectively for a one-off or two or three additional line extensions, the penetration on that is 85%, as it should be. And other areas where greenfield or market fill-in where penetrations can range anywhere between 45% and 70%, at a lower cost per passing, as Jessica highlighted, than some of the other extension build that we do. So, the returns are very, very attractive. They always have been. There's nothing really new there. And somewhat tied to that, you asked about our views on penetration generally, but in the context of BEAD with fixed wireless access or low Earth orbit satellite, LEO. I think the -- let me start with LEO. This is an expensive offering on a month per month basis, expensive from a CPE standpoint. And it needs to be because the -- if I told you our network was going to fall to the ground every six to eight years and burn up, you'd tell me that's a pretty capital-intensive business that needs to be priced appropriately, and it is. I think LEO has a really good use in certain cases, but it's typically not going to be where our fiber-based network is deployed. And so, it's not something that really has risen too much in terms of our thinking in penetration. Fixed wireless access, it's shown us that you can have lower quality and inferior service at a low price or low incremental price, and there's a market for that. But our penetration expectations for RDOF and for subsidized rural and what will feed into BEAD were already low in terms of what we've built into our models compared to what I think ultimately we'll achieve. And so, I think that's already reflected inside of our penetrations. If you think about just at the 12-month mark, where we're approaching close to 50% in the subsidized rural passings, our initial thoughts were we'd be at half of that within a year. And so, we're way ahead of that. And I think the terminal penetration will be higher than what we thought at RDOF, despite the fact that there's an admittedly stronger fixed wireless access presence now than there was three, four years ago when we made those commitments. So, all a big roundabout way to say, I think it's factored into all of our thinking. And I don't think it changes our view in terms of where we'll ultimately get to for terminal penetration, because we weren't overly aggressive in what we assumed.
Jessica Fischer: Yeah. And...
Peter Supino: That's helpful. Thank you.
Jessica Fischer: We mentioned the less than 50% -- or the 50% or so at about the 12-month-plus mark. But as you can see and what we provided and all of the cohorts that we are seeing, we're still growing at a good rate at that point. So, it's not as though you've reached the customers who are going to get your product and then we're not seeing additional growth. We're still seeing good growth in those markets even at that vantage.
Chris Winfrey: It's early. It's going well.
Stefan Anninger: Operator, we'll take our next question, please.
Operator: Our next question comes from the line of Sebastiano Petti with JPMorgan. Your line is now open.
Sebastiano Petti: Hi, thanks for taking the question. I just wanted to follow-up on the competitive environment, just based upon the previous response. Just any help on thinking about the fixed wireless impact in terms of your -- is that just isolated or the competitive environment that has perhaps shifted in 4Q and persisted into January? Is that isolated in your non-fiber overlap territories or you're seeing that as well be somewhat impactful in terms of share as well in the 1-gig market? And a quick follow-up to that. Any update we can get on overlap for fiber as it stands exiting the year? And then, on the CBRS build out, obviously, your peer Comcast has been testing along with you for quite a while, but they're live in Philadelphia as perhaps as well as some other markets. Any update on how the team is thinking about CBRS and how you'll perhaps offload strategy over the next several years? Thank you.
Chris Winfrey: There's a lot there, Sebastiano. But here we go. So, fixed wireless impact, it is where they've deployed and it's in both fiber and non-fiber overlap. It's more acute in the non-fiber overlap, because it's the first time that somebody's had what they view as an alternative other than DSL. And so, it has a novelty factor in the non-overbuild footprint that is similar to a fiber overbuild that has an immediate short-term impact when it's new into the marketplace. So, it has a more pronounced impact there. But I think the overbuilders, the wireline overbuilders would tell you that fixed wireless access probably has had an impact on them as well. So, it's not that it doesn't have an impact in an overbuild territory. It's just much more pronounced in an area where the overbuild doesn't exist. Our overbuild percentage, in our 10-K today, I think, we disclosed as well that it's roughly 50% in terms of overbuild. And then, as it relates to CBRS, we are fully deployed and active with thousands of radio access networks out on the strand and MDUs in one large market today, and we're expanding into another market at some point this year. And that's going very well. And the pacing of that really is dictated by a few things. One is, our relationship with Verizon is good and strong. The economics are great. And this is an ROI-based deployment. So, it'll be there -- the returns will be there when we deploy. But interestingly, the more penetrated we become, the more attractive the returns get. And so, from a deployment of capital perspective, CBRS is very exciting. It's a very clear mathematical return. But in an environment where we're deploying as much capital as we are and we have so much active activity on the outside plant in terms of high-split upgrade and construction of new networks, we're just pacing it along the way to manage all those factors in the way that we think about deployment of CBRS. But we're going to fully deploy it. It's exciting. It has a great return. The depth at which we employed in each market, it really is a function of utilization on a geographically specific area, and the attractive agreement and the great relationship that we have with Verizon today. So, that's strategic to us. So, all those factors play into the timing.
Sebastiano Petti: Thank you.
Operator: Thank you. That was our last question. I'll now turn the call back over to Stefan Anninger.
Stefan Anninger: Thanks, operator. Thanks, everyone. We'll see you next quarter.
Chris Winfrey: Thank you very much. |
AMZN | 4 | 2,023 | 2024-02-01 21:04:04 | Operator: Thank you for standing by. Good day everyone and welcome to the Amazon.com Fourth Quarter 2023 Financial Results Teleconference. [Operator Instructions] Today's call is being recorded. For opening remarks, I will be turning the call over to the Vice President of Investor Relations, Mr. Dave Fildes. Thank you, sir. Please go ahead.
Dave Fildes: Hello and welcome to our Q4 2023 financial results conference call. Joining us today to answer your questions is Andy Jassy, our CEO, and Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2022. Our comments and responses to your questions reflect management's use as of today, February 1, 2024, only and will include forward-looking statements. Actual results may differ materially, additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures. In our press release slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You'll find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic and geopolitical conditions and customer demand and spending, including the impact of recessionary fears, inflation, interest rates, regional labor market constraints, world events, the rate of growth of the internet, online commerce, cloud services, and new and emerging technologies, and the various factors detailed in our filings with the SEC. Our guidance assumes, among other things, that we don't include any additional business acquisitions, restructurings or legal settlements, it's not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. And now, I'll turn the call over to Andy.
Andrew Jassy: Thanks, Dave. Today we’re reporting $170 billion in revenue, up 13% year-over-year excluding the impact of foreign exchange rates, $13.2 billion in operating income, up 383% year-over-year, or $10.5 billion and $35.5 billion in trailing 12-month free cash flow adjusted for equipment finance leases, up $48.3 billion year-over-year. While we've made meaningful progress in our financial measures, what we're most pleased about is the continued customer experience improvements across our businesses. These results represent a lot of invention, collaboration, discipline, execution, adjusting and reimagining from teams across Amazon. Looking back at Q4, I'll start with our stores business where customers responded to our continued focus on selection price and convenience. We continue to have the broadest retail selection with hundreds and millions of products available and added tens of millions of new items last year alone, including fashion selection from Coach, Victoria's Secrets Fashion, Pit Viper, and Beyonce’s Renaissance to our Merge to cosmetics from Lancome, Urban Decay, cosmetics and No Beauty by Vanessa Hudgens, to consumer technology and services from Boost, Infinite, and Woop to homewares for Martha Stewart. Being sharp on price is always important. But particularly in an uncertain economy where customers are careful about how much they're spending. We kicked off the holiday season with Prime Big Deal Days, an exclusive event for Prime members to provide an early start on holiday shopping. This was followed by our extended Black Friday and Cyber Monday holiday shopping event, which was open to all customers and ended up being our largest event ever. These events also helped attract new customers and Prime members. Throughout the quarter customers saved nearly $10 billion across millions of deals and coupons almost 70% more than last year. In addition to offering great deals, we continue to improve delivery speeds. In 2023, Amazon delivered to Prime members at the fastest speeds ever, with more than 7 billion items arriving same or next day including more than 4 billion in the U.S and more than 2 billion in Europe. In the U.S this result is the combination of two things, one is the benefit of regionalization, where we’ve architected the network to store items closer to customers. The other is the expansion of same day facilities, where in the U.S in the fourth quarter, we increase the number of items delivered the same day or overnight by more than 65% year-over-year. As we're able to get customers items this fast. It increases the number of occasions that customers choose Amazon to fulfill their shopping needs. And we can see that in all sorts of areas including how fast or everyday essentials business is growing. Our regionalization efforts have also brought transportation distances down which has helped lower our cost to serve. In 2023, for the first time since 2018, we've reduced our cost-to-serve on a per unit basis globally. In the U.S alone, cost-to-serve was down by more than $0.45 per unit compared to the prior year. Lowering cost-to-serve allows us not only to invest in speed improvements, but also afford adding more selection at lower average selling prices or ASPs and profitably. We have a saying, that it's not hard to lower prices, it's hard to be able to afford lowering prices. The same is true with adding selection, it's not hard to add lower ASPs selection, it's hard to be able to afford offering lower ASPs selection and still like the economics. Like improving speed, adding selection puts us in the consideration set for more purchases. As we look toward 2024 and beyond, we're not done lowering our cost to serve. We've challenged every closely held belief for our fulfillment network and reevaluated every part of it, and found several areas where we believe we can lower costs while also delivering faster for customers. Our inbound fulfillment architecture and resulting inventory placement are areas of focus in 2024, and we have optimism there's more upside for us. Alongside our stores business, our advertising growth remains strong, up 26% year-over-year, which is primarily driven by our sponsored ads. We've recently added Sponsored TV to this offering in the U.S. a self-service solution for brands to create streaming TV campaigns with no minimum spend, putting this advertising within reach of any business. While still early days, streaming TV advertising continues to grow quickly. Brands are using our capabilities to reach engage viewers on Twitch, Freevee, Fire TV and Prime Video shows and movies, which just launched in the U.S., as well as Thursday Night Football. Shifting to AWS. Revenue in the quarter grew 13% year-over-year in Q4 versus 12% year-over-year in Q3. And we're now approaching an annualized revenue run rate of $100 billion. We watched the incremental revenue added each quarter and in Q4 AWS added more than $1.1 billion an incremental quarter-over-quarter revenue, which on an FX neutral basis is more than any other cloud provider as far as we can tell. While cost optimization continued to attenuate larger new deals also accelerated, evidenced by recently inked agreements with Salesforce, BMW, NVIDIA, LG, Hyundai, Merck, MUFG, Axiata, Cafe, BYD, Arcore, Amgen, and SAIC. Our customer pipeline remains strong, as existing customers are renewing larger commitments over longer periods and migrations are growing. 2023 also was a very significant year of delivery and customer trial for generative AI or Gen AI in AWS. You may remember that we've explained our vision of three distinct layers in the Gen AI stack, each of which is gigantic, and each of which were deeply investing. At the bottom layer, where customers who are building their own models run training and inference on compute with a chip is the key component in that compute, we offer the most expansive collection of compute instances with NVIDIA chips. We also have customers who would like us to push the price performance envelope on AI chips, just as we have with Graviton for generalized CPU chips, which are 40% more price performance than other X86 alternatives. And as a result, we built custom AI training chips, named Trainium, and inference chips, name Inferentia. At re:Invent we announced Trainium2, which offers four times faster training performance and three times more memory capacity versus the first generation of Trainium, enabling advantageous price performance versus alternatives. We already have several customers using our AI chips including Anthropic, Airbnb, Hugging Face, Qualtrics, Ricoh and Snap. In the middle layer where companies seek to leverage an existing large language model, customize it with their own data, and leverage AWS’ security and other features all as a managed service. We've launched Bedrock which is off to a very strong start with many 1,000s of customers using the service after just a few months. The team continues to rapidly iterate on Bedrock, recently delivering capabilities including guardrails to safeguard what questions applications will answer, knowledge bases to expand models knowledge base with retrieval augmented generation or RAG and real time queries, agents to complete multi step tasks and fine tuning to keep teaching and refining models. All which will help customers applications be higher quality and have better customer experiences. We also added new models from Anthropic, Cohere, Meta with Llama2, Stability AI and our own Amazon Titan family of LLMs. What customers have learned at this early stage of Gen AI, is it there's meaningful iteration required in building a production Gen AI application with the requisite enterprise quality at the cost and latency needed. Customers don't want only one model, they want different models for different types of applications, and different size models for different applications. Customers want a service that makes this experimenting and iterating simple and this is what Bedrock does, which is why so many customers are excited about it. And to top layer of the stack is the application layer, one of the very best early gen AI applications is a coded companion. At Reinvent, we launched Amazon Q, which is an expert on AWS, writes code, debugs code, tests code, does translations like moving from an old version of Java to a new one and can also query customer’s various data repositories, like Internet, Wickes or from over 40 different popular connectors to data in Salesforce, Amazon S3, ServiceNow, Slack, Elastin or Zendesk, among others. And answer questions, summarize this data, carry on a coherent conversation and take action. It was designed with security and privacy in mind from the start, making it easier for organizations to use generative AI safely. Q is the most capable work assistant and another service that customers are very excited about. By the way, don't underestimate the point about Bedrock and Q inheriting the same security and access control as customers get with AWS. Security is a big deal, an important differentiator between cloud providers. The data in these models is some of the company's most sensitive and critical assets. With AWS' advantaged security capabilities and track record relative to other providers, we continue to see momentum around customers wanting to do their long-term Gen AI work with AWS. We're building dozens of Gen AI apps across Amazon's businesses, several of which have launched and others of which are in development. This morning, we launched Rufus, an expert shopping assistant trained on our product and customer data that represents a significant customer experience improvement for Discovery. Rufus lets customers ask shopping journey questions like what is the best golf ball to use for better spin control or which are the best cold weather rain jackets and get thoughtful explanations for what matters and recommendations on products. You can carry on a conversation with Rufus on other related or unrelated questions and retains context coherently. You can sift through our rich product pages by asking Rufus questions on any product features and will return answers quickly. We're at the start of what Rufus will do with further personalization and expansion coming, but we're excited about how it will make discovery even easier on Amazon. Gen AI is and will continue to be an area of pervasive focus and investment across Amazon, primarily because there are a few initiatives, if any, that give us the chance to reinvent so many of our customer experiences and processes, and we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years. In addition to our stores and AWS businesses, we continue to make progress on newer business investments that have the potential to be important to customers and Amazon long term. Touching on two of them. In October, we had a major milestone in our journey to commercialize Project Kuiper, which is our low earth orbit satellite initiative that aims to provide broadband connectivity to the 400 million to 500 million households who don't have it today. We launched two end-to-end prototype satellites into space and successfully validated all key systems and subsystems, made a 2-way video call, streamed a Prime Video movie in Ultra HD 4K and made an Amazon purchase over our end-to-end communication network. It's rare to be able to exercise all these elements in an initial launch like this. We're on track to launch our first production satellite in the first half of 2024 and started beta testing in the second half of the year. We've still got a long way to go, but are encouraged by our progress. During the quarter, we also completed our second season of Thursday Night Football, which was a rousing success by all accounts. The customer experience continued to improve as our talent, production, streaming quality, analytics, unique AI features like Prime Vision and defensive alerts, all took big leaps forward on top of the very good start last year. We launched a new NFL tradition with the inaugural Black Friday football game and our continuous innovation resonated with viewers as the number of people watching increased 24% year-over-year and with advertisers as we made dramatic year-over-year gains in ad sales. We have increasing conviction that Prime Video can be a large and profitable business on its own, and we'll continue to invest in compelling exclusive content for Prime members like Thursday Night Football, Go To The Rings, Reacher, Mr. & Mrs. Smith, Citadel and more. And with the ads in Prime Video, we'll be able to continue investing meaningfully in content over time. I'll close by reiterating that 2023 was a really good year. I'm grateful to all of our teams who delivered on behalf of customers. Yet I think every one of us at Amazon believes this is just the start of what's possible. We have a long way to go in every one of our businesses before we exhaust how we can make customers' lives better and easier, and there is considerable upside in each of the businesses in which we're investing. With that, I'll turn it over to Brian.
Brian Olsavsky: Thanks, Andy. Overall, we saw strong performance in the fourth quarter. Worldwide revenue was $170 billion, representing an increase of 13% year-over-year, excluding the impact of foreign exchange and approximately $3 billion above the top end of our guidance range. Saw our highest quarterly worldwide operating income ever, which was $13.2 billion for the quarter, an increase of $10.5 billion year-over-year and $2.2 billion above the high end of our guidance range. For the full year 2023, we had a meaningful improvement across our financial results. Revenue was $574.8 billion, an increase of 12% year-over-year, excluding the impact of foreign exchange. Operating income tripled year-over-year to $36.9 billion. Trailing 12-month free cash flow adjusted for equipment finance leases was $35.5 billion, up $48.3 billion versus last year. These financial outputs are a result of a lot of improvements in our key input metrics such as stores' cost to serve, which decreased year-over-year for the first time since 2018 and our ability to deliver to customers at our fastest speeds ever. I want to thank our customers, our partners and our teammates around the world for a very strong 2023 performance. Focusing on the fourth quarter, North America revenue was $105.5 billion, an increase of 13% year-over-year and an acceleration of 200 basis points compared to Q3. International revenue was $40.2 billion, an increase of 13% year-over-year, excluding the impact of foreign exchange, also an acceleration of 200 basis points compared to Q3. During the quarter, we remained focused on the inputs that matter most to our customers, price, selection and convenience. Our shopping events throughout the quarter included Prime Big Deal Days in October and our extended Black Friday and Cyber Monday shopping event helped to attract new Prime members and deliver billions in savings for customers. We made meaningful progress on delivery speeds in the United States and globally, which helped strong sales throughout the quarter, including notable strength in the last-minute gifting where our ability to provide fast shipping helped our Prime members ensure that they got their gifts before the holidays. These improvements in delivery speed have led to increased purchase frequency by our Prime members across all of our major geographies. It also strengthened demand for our everyday essentials. Categories like beauty and health and personal care, where speed is even more important to customers. Third-party sellers were a big part of our success over the holidays with worldwide third-party seller services revenue growing at 19% year-over-year, excluding the impact of foreign exchange. And worldwide third-party seller unit mix was 61%, its highest level ever. We also saw strong performance in worldwide advertising, which grew 26% year-over-year, excluding the impact of foreign exchange. The strength in advertising was primarily driven by sponsored products as our teams worked hard to increase the relevancy of the ads we show customers by leveraging machine learning. Advertising only works if the ads are helpful to customers and there's a lot of value in tailoring sponsored products, so they are relevant to what a customer is actually searching for. We're also continually focused on improving our measurement capabilities, which allow brands to see the payback of their advertising spend. Shifting to profitability. North America segment operating income was $6.5 billion, an increase of $6.7 billion year-over-year, resulting in an operating margin of 6.1%, up 120 basis points quarter-over-quarter. Since North America operating margins were at their recent low levels in Q1 of 2022, we have now seen seven consecutive quarters of improvement resulting in a cumulative improvement of 800 basis points over these past seven quarters. In addition to the strong top line growth, which helped to drive improved leverage throughout our businesses, we continue to make progress on reducing our cost to serve. The fourth quarter is our busiest time of year, supported by an increasingly large and integrated operations network. Overall, our teams executed extremely well, yielding strong efficiency gains with minimal disruptions. We were pleased with the performance of our regionalized network during the holiday period, where we saw benefits from improved inventory placement helping drive faster speeds and also lowering costs. We also continue to see benefits from lower transportation rates, which include linehaul, ocean and rail and from a more stable labor market, resulting in improved staffing levels. In our International segment, we had an operating loss of $419 million, an improvement of $1.8 billion year-over-year. This improvement was primarily driven by lowering our cost to serve through increased units per box, lower transportation rates and leverage across our fixed costs as we continue to focus on customer inputs and improve efficiencies within our operations. The International segment represents more than 20 countries of varying degrees of growth and our largest established countries like the U.K., Germany and Japan, relatively strong revenue growth contributed to the year-over-year improvement in profitability. Additionally, we saw good progress in our emerging countries as they continued to expand their customer offerings, while seeking to invest wisely. Moving to AWS. Revenues were $24.2 billion, an increase of 13% year-over-year. On a quarter-over-quarter basis, we added more than $1.1 billion of revenue in AWS as customers are continuing to shift their focus towards driving innovation and bringing new workloads to the cloud. Similar to what we shared last quarter, we continue to see the diminishing impact of cost optimizations. And as these optimization slow down, we're seeing more companies turning their attention to newer initiatives and reaccelerating existing migrations. Customers are also excited about our approach to generative AI. Still relatively early days, but the revenues are accelerating rapidly across all 3 layers and our approach to democratizing AI is resonating well with our customers. We have seen significant interest from our customers wanting to run generative AI applications and build large language models and foundation models, all with the privacy, reliability and security they have grown accustomed to with AWS. AWS' operating income was $7.2 billion, an increase of $2 billion year-over-year. Our operating margin for the quarter was 29.6%, up more than 500 basis points year-over-year and effectively flat on a quarter-over-quarter basis. This margin improvement reflects our headcount reductions from earlier in the year and a slowdown in the pace of hiring. Shifting to free cash flow. On a trailing 12-month basis, free cash flow adjusted for finance leases was $35.5 billion, an improvement of $48.3 billion year-over-year. The largest driver of the improvement in free cash flow is our increased operating income, which we are seeing across all three of our segments. We're also seeing improvements in working capital, notably in inventory efficiency driven by our regionalization efforts. Next, let's turn to capital investments. We define our capital investments as a combination of CapEx plus equipment finance leases. In 2023, full year CapEx was $48.4 billion, which was down $10.2 billion year-over-year, primarily driven by lower spend on fulfillment and transportation. As we look forward to 2024, we anticipate CapEx to increase year-over-year, primarily driven by increased infrastructure CapEx, support growth of our AWS business, including additional investments in generative AI and large language models. One thing I'd like to highlight in our first quarter guidance is that we recently completed a useful life study for our servers and we are increasing the useful life from 5 years to 6 years beginning in January 2024. We will have this anticipated benefit to our operating income of approximately $900 million in Q1, which is included in our operating income guidance. As we turn the calendar to 2024, we are excited to continue upon the great work the teams have been able to deliver in 2023. We remain focused on streamlining and prioritizing projects in an effective way that reduces costs and also allows us to continue innovating and inventing for customers. With that, let's move on to questions.
Operator: [Operator Instructions] Our first question comes from the line of Eric Sheridan with Goldman Sachs. Please proceed with your question.
Eric Sheridan : Thank you so much for taking the questions. I'm just going to do a 2-parter on AWS. If we take a step back, can you talk a little bit about the contribution from backlog conversion, AI workloads and some elements that allowed you to reaccelerate revenue at AWS in Q4 and how we should think about those components from an exit velocity standpoint into 2024? And then against your broader comments on CapEx, any color on how we should be thinking about AI-driven CapEx within the AWS initiatives against the broader CapEx commentary? Thank you.
Dave Fildes: Yes, that's right. This is Dave. Just to give you that -- the balance was $155.7 billion as of 12/31. So that's up more than $45 billion year-over-year and $20 billion quarter-over-quarter.
Brian Olsavsky: And then if you look back at the revenue growth, it accelerated to 13.2% in Q4 as we just mentioned. That was an acceleration. We expect accelerating trends to continue into 2024. We're excited about the migrate -- continuous their resumption, I guess, of migrations that companies may have put on hold during 2023 in some cases and interest in our generative AI and products, like Bedrock and as Andy was describing that. On the CapEx side, let me talk in total for the company. We had $48 billion in 2023 was down $10 billion year-over-year. We talked about during the year quite a bit. A lot of the mix of investment in 2023 was tied to infrastructure, mostly supporting AWS but also supporting our core Amazon businesses was about 60% of our spend. So it reached a very high percentage. We anticipate those trends continuing into 2024. CapEx will go up in 2024. I'm not giving a number today, but we do -- we're still working through plans for the year, but we do expect CapEx to rise as we add capacity in AWS for region expansions, but primarily the work we're doing with generative AI projects. In the fulfillment center and logistics area, I would say it's more incremental capacity at this point based on additional demand, although we are seeing some additional investments for same-day delivery sites and automation, robotics. But the trend for most of the large percentage of the spend will be in infrastructure is going to continue into 2024.
Andrew Jassy: I’ll add a few things to what Brian said. I think just as it relates to the first part of the question, just the way to think about backlog conversion is just these are deals that we've signed that are long-term deals typically with customers. And then there's some amount of time it takes where we work with those customers to migrate those workloads. And so some of the trends that we have seen over the last quarter. First of all, I think that the lion's share of cost optimization has happened. It's not that there won't be any more or that we don't see anymore, but it's just attenuated very significantly. And at the same time, what we've seen is that migrations and this speaks to some of the backlog, migrations that were proceeding, but maybe not at the pace that we saw before, have started to pick up again. We've also seen that a number of the deals that typically signed more quickly, but were signing more slowly in more uncertain environments. A lot of those got done in the last quarter, and you heard in my opening remarks some of the examples, but that was some of several, and we're continuing to see that trend. And then on the Gen AI side, it's -- if you look at the Gen AI revenue we have, in absolute numbers, it's a pretty big number, but in the scheme of a $100 billion annual revenue run rate business, it's still relatively small, much smaller than what it will be in the future, where we really believe we're going to drive tens of billions of dollars of revenue over the next several years. But it's encouraging how fast it's growing and our offering is really resonating with customers.
Operator: And the next question comes from the line of Brian Nowak with Morgan Stanley. Please proceed with your question.
Brian Nowak : Thanks for taking my questions. I have two. Andy, the first one is sort of on the cost to serve comments coming down for the first time since 2018. As you sort of look into '24 and '25, can you just sort of walk us through some of the key operational blocking and tackling this to happen to continue to drive down that cost of serve back to 2018 levels? Or however you're thinking about your North Star from that perspective? And then the second one is on sort of philosophical about capital returns. It looks like the cash balance could start building pretty nicely here. How do you think about the idea of buybacks, share repurchases or some type of capital return programs to sort of help shareholders out?
Andrew Jassy: Thank you, Brian, I appreciate it. I'll take the first, and I'll let Brian take the second. On the cost to serve coming down, as I mentioned in my opening remarks, I don't think that we feel like where we're going to ultimately be. I think we feel like we have meaningful upside there. And I think one thing that it's easy to make as large a change as we made in regionalization in the U.S. and saying, check, we got that done. But the reality is, we still have several improvements and a bunch of ways that we can hone the regionalization improvements that we made in 2023 and in 2024. And so when the team speaks about the areas where they believe they have opportunities, there's still opportunities just in regionalization as we continue to hone that, but I also think, in many ways, it was very useful for us to go through what was a pretty significant change we went through during the pandemic, where we doubled the size of our fulfillment center network in 18 months and built out a last mile transportation network, the size of UPS in 18 months, it was disruptive to get that optimized. But one of the things that was very useful was, it really caused us to relook at everything we were doing with fulfillment network. And we looked at it really a beginner's eye and we have found so many areas that we believe that we can evolve that I think will both help our cost to serve and even more importantly, deliver faster delivery speeds for customers. And I mentioned one area which, in particular, which you'll see us focus on over the next year or two is just, we think there are real opportunities in our inbound network and our inbound processes. And then where we locate inventory in association with that, which will accomplish both of those tasks. But for us, I don't believe that we believe that 2018 is the North Star in cost to serve. I think we believe we can keep evolving it and being better than that.
Brian Olsavsky: Yes, I'd just add a couple of other items there. We've gotten a lot better at fixed cost controls, as we scale. And I think you're seeing that as part of our ability to lower cost per serve not only in operations, it's actually throughout the company. And we're seeing a reduction in some of the inflationary factors that hit us in -- especially hard in 2021 and 2022, things like transportation services, fuel and others. So not totally out of the woods there, but coming down, and we still see some more upside. On your share repurchase question, first of all, just really excited to actually have that question. No one's asked me that in three years and appreciate it. But we have come through a tumultuous period where, as Andy just said, we doubled the size of our logistics footprint and invested heavily in -- we saw that negative free cash flow, at least on our all two calculation for the period 2021 to 2022. So we're glad to see the improvement in the bounce back in free cash flow. A lot of -- and we do debate and discuss capital structure policies annually or more often. And I have nothing to announce today, but again, we primarily think we have a lot of strong investments in front of us. We're good -- we're glad to have the liquidity -- better liquidity at the end of 2023, and we're going to try to continue to build that.
Operator: And our next question comes from the line of Doug Anmuth with JPMorgan. Please proceed with your question.
Doug Anmuth : Thanks for taking the questions. Brian, you've seen very good improvement in International profitability over the last several quarters. Can you just talk about some of the levers here that you're thinking about just as you look to move into positive operating income and then how International could potentially approach North America levels over time? And then just a follow-up there. Are you seeing any shipping disruptions currently related to the Red Sea and does that factor into your outlook at all for 1Q? Thanks.
Brian Olsavsky: Yes. Let me start with the second one first. So we're mindful of the geopolitical issues around the world, especially as you say in the supply chain and how that might impact shipments both to the U.S. and to Europe. We're just working very hard to make that not back up on customers, and we'll continue to work that. It's not a material impact into the -- it estimated in our guidance in Q1. But again, as I said, we're vigilant on that, and we'll work to take steps where we need to, to make sure that customer experience is not impacted. On the International segment, operating income, yes, we're very pleased with the results, especially over the last few quarters. We improved operating income by $1.8 billion year-over-year. And I would attribute it to the steady progress that Andy was saying about the U.S. is, again, cost of serve down, advertising is stronger, a lot of attention to cost, a lot of attention to investments, and we are going to invest and other fixed cost control. So a lot of that is what we're seeing in the established countries of Europe and Japan. I would divide the segment a bit into a couple of buckets. First, there's that International segment, excuse me, European established country segment. And that's -- it behaves a lot like you would see in North America. If you look at the emerging countries, and again, we've launched 10 countries in the last 7 years. They're all on their own trajectory of journey to profitability and significance with customers, and we're pleased with that. I think they're all growing nicely and again, leveraging their cost structure, investing wisely and Prime benefits, but all on a curve to breakeven and then be a contributor to income and free cash flow. The other thing I'd point out is that we have advanced loaded, I would say, price benefits in our International markets. We think it's a very good source of customer acquisition and customer retention. The investment in those areas can fluctuate quarter-to-quarter. We had a bit of a higher spend in -- excuse me, in digital content in Q4 as we had a number of marketing and content, especially around live sports, English Premier League and Champions League in Germany and Italy, for example. But we like those benefits in those investments, different proven vehicle for customer acquisition, as I said, and it gets people shopping at our sites and engaging with benefits is always positive for the relationship with Amazon.
Operator: And the next question comes from the line of Mark Mahaney with Evercore ISI. Please proceed with your question.
Mark Mahaney : Okay. Thanks. Two questions, please. I think you mentioned, Brian, that the North American margins have improved for 7 quarters in a row or something like that, a significant number. I would assume that most of the factors like rising capacity utilization given your CapEx commentary about retail, the regional center efficiencies and then overall, moderation in shipping and logistics costs, labor costs, I mean, all these factors probably mean that we'll continue to get an improvement in North American margins, but if you would comment on that. And then secondly, on the Primetime Video -- Amazon Prime video, I know we just launched. But could you provide any color or context on expectations around that? You've got a massive number of Prime users who are coming in with a reasonable CPM with low ad load, but it seems like there should be a substantial opportunity for you. So if you want to try to size that for us or how you think about the upside, that would be really appreciated. Thank you.
Brian Olsavsky: Sure, Mark. Thank you. I think Andy laid it out pretty well a few minutes ago on the cost structure, the regionalization, the -- growing into the assets that we added during the pandemic, great efficiency and work with productivity across really all of our operations network fixed -- attention to fixed cost and lowering costs where we can, maintaining costs where we can, the increase in advertising, success in advertising revenue growth that's outpaced our traffic growth rates. So all of those trends we expect to continue, and we're going to work hard to make sure they continue. And as we said, we have one guidepost is maybe pre-pandemic profitability, but we are working to -- we're not putting a limit on our improvement. We're going to continue to look for ways to lower the cost to serve. And I might add, at the same time, increase the customer experience because we did that -- we had that cost improvement at the same time when we at first got back to our shipping speeds from pre-pandemic and then exceeded them. So we're happy with that, and we'll continue to do both to improve the customer experience and also to lower our costs and leverage our cost structure. Yes, your second question on ads. I can't scale it right now. I mean what I would say for ads in videos is that advertisers are excited to access our Prime customer base. We are looking for ways to increase our advertising in our streaming properties, including Fire TV, but also -- and Prime Video, but also things like Freevee and Twitch. And it's an important part of the total business model, and we expect it will allow us to have a healthy business to continue to invest in content and to continue to grow that. And we feel good about it, and the way we anticipate the ads progressing, we will not have heavy ad loads relative to see other network TV and other things. And like all of our advertising, we're trying to be useful for customers.
Operator: And our next question comes from the line of Scott Devitt with Wedbush Securities. Please proceed with your question.
Scott Devitt : Thanks. I have one on grocery and one on healthcare. First, on grocery, I was wondering if you could talk a bit about the progress that you're making in unifying the offering between Dotcom, Fresh and Whole Foods. And as it relates to reverse logistics and using the grocery facilities, how that's lowering the cost of logistics and whether there is a significant opportunity there in terms of driving traffic and revenue in the grocery business? Then secondly, on health care, in such a poor -- notoriously poor customer experience industry, you've made significant efforts now within acquisition and offering primary care. Just be curious if you could talk a little bit more about the longer-term vision in healthcare. Thank you.
Andrew Jassy: Yes. On grocery, we're pleased with the progress we're making there. When we think about our grocery business right now and kind of, I'll call it, 3 big macro segments. The first is nonperishables where these are things like consumables and canned goods and pet food and health and beauty products and pharmaceutical. And we -- it's a big business and it's continuing to grow at a very healthy clip, and we're really pleased with that business. And it's really the way the most mass merchandisers got into the grocery business a few decades ago. So that continues to grow at a very healthy clip. We have a physical presence along with online, but Whole Foods market, which is really the pioneer and the leader in organic grocery and that's continuing to grow at a very good clip. We also made a number of changes in the business last year on the profitability side, where we really like the profitability trajectory we see there. And so again, you'll see that keep growing and expanding and feel very good about that as well. If you want to serve as many grocery needs as we do, you have to have a mass physical presence. And that's what we've been trying to do with Fresh over several years. We have tested -- we've been testing a V2 of our Fresh format in a few locations near Chicago, in a few locations in Southern California. It's very early. It's just a few months in, but the results thus far are very promising and on almost every dimension. And so we need to see it for a little bit longer time, but the results appear like we have something that's resonating. And if we continue to see that, then the issue becomes how fast and what's the best way to expand. We have also been spending increasing amounts of time and efforts here trying to make it easier for customers to be able to shop between the nonperishables and then our selection of Whole Foods as well as Fresh, I think you can expect to see that over time, both in the user experience on the app and on the website as well as how we're able to better leverage between the different business segments and their logistics capabilities, being able to get better leverage there, better economics and then allowing people to order in one conservative place to be able to pick up in multiple -- pick up for multiple types of grocery products in one place. Just seeing us already do more of that, and I think you can expect that in the future. In the healthcare space, I -- if you think about what we do on the retail side, adding a pharmacy capability is a pretty natural extension. It's something that customers had asked us for many years, and it's got more complexity to it than the rest of our retail business. So we have to think carefully about whether we wanted to pursue it, but customers so badly wanted it and the experience we thought could be better and we could be a meaningful part of changing that, that we pursued it. And I really like the momentum that we're seeing in our Amazon Pharmacy business. It's growing really quickly. But even more important with how fast it's growing, if you've used it and you've paid attention to the customer experience over the last 12 to 15 months, it's just substantially improved from where it already was pretty good. People really love the experience. And I think that when -- the healthcare experience, particularly in the U.S. is a pretty frustrating one and not a very good one. And I think that when we tell our grandkids that the way we used to have to go get primary care was to make an appointment 3 weeks in advance and then drive 20 minutes to the doctor, park, wait in the reception for 15 minutes, get put into an exam room for 15 minutes. Doctor comes in, talks to you for 5 to 10 minutes and then you got to drive 20 minutes to the pharmacy. People are just not -- our grandkids will not believe that was the experience and it's not going to be, and you already see that changing. And its part of what attracted us in such a significant way to on medical. It's just their application, their app is so easy to use. You have all your healthcare data in one spot. You can do chats with medical practitioners. You can do video calls, if you need to see someone, there's physical locations and lots of metropolis cities where you can get in the same day, if you need to see a specialist, they're probably into specialists and all the cities in which we operate, where you can get in a day or two later, like just it's a very different experience. Now if you actually need medication, you can get that sent to you in a day or two, either through Amazon pharmacy or other pharmacies that we work with. And that experience is so much better than what we've been accustomed to seeing. And so I think it's -- again, it's still early days. We're excited, we launched for Prime members the ability to get one medical subscription for $9 a month or $99 a year, which is 50% off, the typical price and that saw a very good take-up. So it's still early days, but we think we have an opportunity to be a meaningful part of changing that experience. And if we are helpful in changing what that primary care experience is and what it looks like to get pharmaceutical items, there's a lot of other things that we might be able to help customers with over time that whether it's wellness or whether it's diet, there's a bunch of areas that I think we can help over time.
Operator: And our final question will come from the line of Colin Sebastian with Baird. Please proceed with your question.
Colin Sebastian : Thanks very much. I just wanted to follow up on AWS for a moment. You outlined the generative AI stack, which I think is -- which is very clear. So I'm just curious maybe how you're going to market within the application layer given sort of the competitive dynamics of that. And then maybe expand, if you could, Andy, a little bit on the strategy for Gene AI on the consumer-facing side of the business. I know you launched Rufus today. Is that an area that you think could materially improve conversion rates and the overall consumer engagement on retail apps or what's your vision there? Thank you.
Andrew Jassy: Yes. So Colin, I would say a few things on -- first on generative AI. It's -- when we talk to customers, particularly at enterprises as they're thinking about generative AI, many are still thinking through at which layers of those 3 layers of the stack, I laid out that they want to operate in. And we predict that most companies will operate in at least 2 of them. But I also think even though it may not be the case early on, I think many of the technically capable companies will operate at all 3. They will build their own models. They will leverage existing models from us, and then they're going to build the apps. And I know one of the other interesting things that we see early on right now in generative AI is that -- it's a very iterative process and real work to go from posing a question into a chat bot and getting an answer to turning that into a production quality application at the quality you need for your customer experience and your reputation and then also getting that application to work at the latency and cost characteristics that you need. And so what we see is that customers want choice. They don't want just 1 model to rule the world. They want different models for different applications. And they want to experiment with all different sized models because they yield different cost structures and different latency characteristics. And so Bedrock is really resonating with customers. They just -- they know they want to change all these variables and try and experiment and they have something that manages all those different transitions and changes so they can figure out what works best for them, especially in the first couple of years where they're learning how to build successful generative applications is incredibly important for them. So it's part of why we see Bedrock resonating so much. In the same way, what's attractive to enterprises when they think about coding companions like Q, is just if you can get 30%, 40% better productivity for your developers, which in many cases, for companies is their most scarce resource, it's a game changer. And they won't roll out every bit of code that comes from a coding companion. But if it can assist them to get 80% plus the way there quickly, that's a big deal. And one of the things that's unique about Q is it's not just a coding companion, yes, it's an expert on AWS. It will help you -- it helps you write the code, but it also helps you debug the code and it helps you test the code, helps you do transformations and it helps you figure out how a multistep implement features. There's a lot of -- helps you troubleshoot. If there's something in your application that's you write, you can find it and help you fix it. And so -- and then it also lets you look at all your data repositories, whether it's Internet or Wickes or the 40-plus data connectors like Salesforce, Alassian, and Zendesk and Slack. And let you have an intelligent conversation to get answers and take action. So it's a pretty differentiated capability there. And when enterprises are looking at how they might best make their developers more productive, they're looking at what's the array of capabilities in these different coding companion options they have. And so we're spending a lot of time -- our enterprises are quite excited about it. It created a meaningful stir at reinvent. And what you see typically is that these companies experiment with different options they have and they make decisions for their employee base, and we're seeing very good momentum there. The question about how we're thinking about Gen AI in our consumer businesses. We're building dozens of generative AI applications across the company. It's every business that we have has multiple generative AI applications that we are building. And they're all in different stages, many of which have launched and others of which are in development. So if you just look at our -- some of our consumer businesses, on the retail side, we built a generative AI application that allowed customers to look at summary of customer review, so that they didn't have to read hundreds and sometimes thousands of reviews to get a sense for what people like or dislike about a product. We launched a generative AI application that allows customers to quickly be able to predict what kind of fit they'd have for different apparel items. We built a generative AI application that in our fulfillment centers, that forecasts how much inventory we need in each particular fulfillment center. And so the start of the rollout of Rufus today is really just another step, but we think one that's pretty meaningful in being a generative AI powered shopping assistant and it's trained on our very expansive product catalog as well as our community Q&A and customer reviews and the broader web. But it lets customers discover items in a very different way than they have been able to on e-commerce websites. So if you want buying advice, like what should I look for in a pair of headphones or if you are doing purpose buying, like what should I buy for cold weather golf or comparisons, what's difference in lip-gloss or lip oil or you want recommendations of the best Valentine's Day gifts or you're on a detailed page with bridge product info, where you don't want to go through the whole page, you want to ask is this pickle ball rack that's good for beginners. All those questions you can pull in and get really good answers. And then it's seamlessly integrated in the Amazon experience that customers are used to and love to be able to take action. So I think that that's just the next iteration. I think it's going to meaningfully change what discovery looks like for our shopping experience and for our customers. And I could kind of step through every one of those consumer businesses. Our advertising business is building capabilities where people can submit a picture and ad copy is written and the other way around. And you kind of think about Alexa, where we're building a very large -- expansive large language model is going to make Alexa even more productive and helpful for customer. Every one of our consumer businesses has a significant number of generative AI applications that they either have built and delivered or they're in the process of building. And I don't see that changing for many years. We have a lot of ideas.
Dave Fildes: Thanks for joining us today on the call and for your questions. A replay will be available on our Investor Relations website for at least 3 months. We appreciate your interest in Amazon, and we look forward to talking with you again next quarter.
Operator: And ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
META | 4 | 2,023 | 2024-02-01 20:27:03 | Operator: Good afternoon. My name is Krista and I'll be your conference operator today. At this time, I would like to welcome everyone to the Meta Fourth Quarter and Full Year 2023 Earnings Conference Call. [Operator Instructions]. Ken Dorell, Meta's Director of Investor Relations, you may begin.
Ken Dorell: Thank you. Good afternoon and welcome to Meta Platform's Fourth Quarter and Full Year 2023 Earnings Conference Call. Joining me today to discuss our results are Mark Zuckerberg, CEO; and Susan Li, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's earnings press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The earnings press release and an accompanying investor presentation are available on our website at investor.fb.com. And now I'd like to turn the call over to Mark.
Mark Zuckerberg: All right. Hi, everyone. Thanks for joining us. This was a good quarter, and it wrapped up an important year for our community and our company. We estimate that there are more than 3.1 billion people who use at least one of our apps each day. 2023 was our year of efficiency, which focused on making Meta a stronger technology company and improving our business to give us the stability to deliver our ambitious long-term vision for AI and the metaverse. And last year, not only did we achieve our efficiency goals, but we returned to strong revenue growth, saw strong engagement across our apps; shipped a number of exciting new products like Threads, Ray-Ban Meta smart glasses and mixed reality in Quest 3; and of course, established a world-class AI effort that's going to be the foundation for many of our future products. I think that being a leaner company is helping us execute better and faster, and we will continue to carry these values forward as a permanent part of how we operate. Now moving forward, a major goal, we'll be building the most popular and most advanced AI products and services. And if we succeed, everyone who uses our services will have a world-class AI assistant to help get things done, every creator will have an AI that their community can engage with, every business will have an AI that their customers can interact with to buy goods and get support, and every developer will have a state-of-the-art open-source model to build with. I also think that everyone will want a new category of computing devices that let you frictionlessly interact with AIs that can see what you see and hear what you hear, like smart glasses. And one thing that became clear to me in the last year is that this next generation of services requires building full general intelligence. Previously, I thought that because many of the tools were social-, commerce- or maybe media-oriented that it might be possible to deliver these products by solving only a subset of AI's challenges. But now it's clear that we're going to need our models to be able to reason, plan, code, remember and many other cognitive abilities in order to provide the best versions of the services that we envision. We've been working on general intelligence research and FAIR for more than a decade. But now general intelligence will be the theme of our product work as well. Meta has a long history of building new technologies into our services, and we have a clear long-term playbook for becoming leaders. And there are a few key aspects of this that I want to take some time to go through today. The first is world-class compute infrastructure. I recently shared that, by the end of this year, we'll have about 350,000 H100s, and including other GPUs, that will be around 600,000 H100 equivalents of compute. We're well positioned now because of the lessons that we learned from Reels. We initially underbuilt our GPU clusters for Reels. And when we were going through that, I decided that we should build enough capacity to support both Reels and another Reels-sized AI service that we expected to emerge so we wouldn't be in that situation again. And at the time, the decision was somewhat controversial, and we faced a lot of questions about CapEx spending, but I'm really glad that we did this. Now going forward, we think that training and operating future models will be even more compute-intensive. We don't have a clear expectation for exactly how much this will be yet, but the trend has been that state-of-the-art large language models have been trained on roughly 10x the amount of compute each year. And our training clusters are only part of our overall infrastructure, and the rest, obviously, isn't growing as quickly. But overall, we're playing to win here, and I expect us to continue investing aggressively in this area. In order to build the most advanced clusters, we're also designing novel data centers and designing our own custom silicons specialized for our workloads. The second part of our playbook is open-source software infrastructure. Our long-standing strategy has been to build an open-source general infrastructure while keeping our specific product implementations proprietary. In the case of AI, the general infrastructure includes our Llama models, including Llama 3, which is training now, and it's looking great so far, as well as industry standard tools like PyTorch that we've developed. And this approach to open source has unlocked a lot of innovation across the industry, and it's something that we believe in deeply. And I know that some people have questions about how we benefit from open sourcing, the results of our research and large amounts of compute. So I thought it might be useful to lay out the strategic benefits here. The short version is that open sourcing improves our models. And because there's still significant work to turn our models into products because there will be other open-source models available anyway, we find that there are mostly advantages to being the open-source leader, and it doesn't remove differentiation for our products much anyway. And more specifically, there are several strategic benefits. First, open-source software is typically safer and more secure as well as more compute-efficient to operate due to all the ongoing feedback, scrutiny and development from the community. Now this is a big deal because safety is one of the most important issues in AI. Efficiency improvements and lowering the compute costs also benefit everyone, including us. Second, open-source software often becomes an industry standard. And when companies standardize on building with our stack, that then becomes easier to integrate new innovations into our products. That's subtle, but the ability to learn and improve quickly is a huge advantage. And being an industry standard enables that. Third, open source is hugely popular with developers and researchers. And we know that people want to work on open systems that will be widely adopted. So this helps us recruit the best people at Meta, which is a very big deal for leading in any new technology area. And again, we typically have unique data and build unique product integrations anyway, so providing infrastructure like Llama as open source doesn't reduce our main advantage. This is why our long-standing strategy has been to open source general infrastructure and why I expect it to continue to be the right approach for us going forward. The next part of our playbook is just taking a long-term approach towards the development. While we're working on today's products and models, we're also working on the research that we need to advance for Llama 5, 6 and 7 in the coming years and beyond to develop full general intelligence. It's important to have a portfolio of multiyear investments in research projects, but it's also important to have clear launch vehicles like future Llama models that help focus our work. We've worked on general intelligence in our lab, FAIR, for more than a decade, as I mentioned, and we produced a lot of valuable work. But having clear product targets for delivering general intelligence really focuses this work and helps us build the leading research program. Now the next key part of our playbook is learning from unique data and feedback loops in our products. When people think about data, they typically think about the corpus that you might use to train a model upfront. And on Facebook and Instagram, there are hundreds of billions of publicly shared images and tens of billions of public videos, which we estimate is greater than the common crawl data set. And people share large numbers of public text posts and comments across our services as well. But even more important in the upfront training corpus is the ability to establish the right feedback loops with hundreds of millions of people interacting with AI services across our products. And this feedback is a big part of how we've improved our AI systems so quickly with Reels and Ads, especially over the last couple of years when we had to re-architect it around new rules. Now that brings me to the last part of our playbook for building leading services, which is our culture of rapid learning and experimentation across our apps. When we decide that a new technology, like AI-recommended Reels, is going to be an important part of the future, we're not shy about having multiple teams experimenting with different versions across our apps until we get it right. And then we learn what works and we roll it out to everyone. And there used to be this meme that we'd probably launch Stories on our Settings page at some point. And look, I think it's kind of funny because it gets to a core part of our approach. We start by learning and tuning our products until they perform the way we want, and then we roll them out very broadly. And sometimes, occasionally, products will blow up before we're ready for them to, like Threads, although I'll note that Threads now has more people actively using it today than it did during its initial launch peak. So that one is, I think, on track to be a major success. But normally, we learn and we iterate methodically. And we started doing that with our AI services in the fall launching Meta AI, our assistant; AI Studio, which the precursor to Creator AIs; our Alpha with Business AIs; and the Ray-Ban Meta smart glasses. And we've been tuning each of these, and we're getting closer to rolling them out more widely. So you should expect that in the coming months. From there, we'll focus on rolling out services until they reach hundreds of millions or billions of people. And usually, only when we reach that kind of scale do we start focusing on what monetization will look like. And although in this case, the way the business AIs will help business messaging grow and WhatsApp, Messenger and Instagram is pretty clear. But that's our basic approach, and I'm really excited about pointing our company at developing so many of these awesome things. Now we have 2 major parts of our long-term vision, and in addition to AI, the other part is the metaverse. We've invested heavily in both AI and the metaverse for a long time, and we will continue to do so. These days, there are a lot of questions more about AI that I get, and that field is moving very quickly. But I still expect that this next generation of AR, VR and MR computing platforms to deliver a realistic sense of presence that will be the foundation for the future of social experiences and almost every other category of experiences as well. Reality Labs crossed $1 billion in revenue in Q4 for the first time with Quest having a strong holiday season. Quest 3 is off to a strong start, and I expect it to continue to be the most popular mixed reality device. With Quest 3 and Quest 2 both performing well, we saw that the Quest app was actually the most downloaded app in the App Store on Christmas Day. I want to give a shout-out to Asgard's Wrath2, which was developed by one of our in-house studios and received IGN's 10 out of 10 masterpiece rating, making it one of the best-rated games out there, not just in VR, but of any game on any platform ever. So it's a really good sign that we're able to deliver that quality of work at Meta. Horizon is growing quickly, too. It is now on Top 10 Most Used Apps on Quest, and we have an exciting road map ahead. This is another example of applying the long-term playbook that I discussed earlier with AI but in another area. We take the time to build up the core technology and tune the experience. And then when it's ready, we're good at growing things. Now our focus for this year is going to be on growing the mobile version of Horizon as well as the VR One. Ray-Ban Meta smart glasses are also off to a very strong start, both in sales and engagement. Our partner, EssilorLuxottica is already planning on making more than we both expected due to high demand. Engagement and retention are also significantly higher than the first version of the glasses. The experience is just a lot better with Meta AI in there as well as there's a higher resolution camera, better audio and more. And we also have an exciting road map of software improvements ahead, starting with rolling out multimodal AI and then some other really exciting new AI features later in the year. I said this before, but I think that people are going to want new categories of devices that seamlessly engage with AIs frequently throughout the AI without having to take out your phone and press a button and point it at what you want to see. And I think that smart glasses are going to be a compelling form factor for this, and it's a good example of how our AI and metaverse visions are connected. In addition to AI in the metaverse, we're continuing to improve our Apps and Ads businesses as well. Reels and our discovery engine remain a priority and major driver of engagement, and Messaging continues to be our focus for building the next revenue pillar of our business before our longer-term work reaches scale. But since I went a bit longer in the other areas today, I'm just going to mention a few highlights here. Reels continues to do very well across both Instagram and Facebook. People re-share Reels 3.5 billion times every day. Reels is now contributing to our net revenue across our apps. The biggest opportunity going forward is unifying our recommendation systems across Reels and other types of video that will help people discover the best content across our systems no matter what format it's in. WhatsApp is also doing very well. And the most exciting new trend here is that it is succeeding more broadly in the United States, where there's a real appetite for a private, secure and cross-platform messaging app that everyone can use. And given the strategic importance of the U.S. and its outsized importance for revenue, this is just a huge opportunity. Threads is also growing steadily with more than 130 million monthly actives. And I'm optimistic that we can keep the pace of improvements in growth going and show that a friendly, discussion-oriented app can be as widely used as the most popular social apps. All right. That's what I wanted to cover today. Our communities are growing, and our business is back on track. Once again, a big thank you to all of our employees, partners, shareholders and everyone in our community for sticking with us and for making 2023 such a success. I'm looking forward to another exciting year ahead. And now here's Susan.
Susan Li: Thanks, Mark, and good afternoon, everyone. Let's begin with our consolidated results. All comparisons are on a year-over-year basis, unless otherwise noted. Q4 total revenue was $40.1 billion, up 25% or 22% on a constant currency basis. Q4 total expenses were $23.7 billion, down 8% compared to last year. In terms of the specific line items, cost of revenue decreased 8%, 0driven mainly by lower restructuring costs that were partially offset by higher infrastructure-related costs. R&D increased 8% driven primarily by higher head count-related costs from Family of Apps and Reality Labs as well as higher non-head count-related Reality Labs operating expenses, which were partially offset by lower restructuring costs. Marketing and sales decreased 29% due mainly to lower marketing spend and restructuring costs. G&A decreased 26% due mainly to lower restructuring expenses. We ended the fourth quarter with over 67,300 employees, down 22% from a year ago while up 2% from Q3 as our hiring efforts have resumed. Fourth quarter operating income was $16.4 billion, representing a 41% operating margin. Our tax rate for the quarter was 17%. Net income was $14 billion or $5.33 per share. Capital expenditures, including principal payments on finance leases, were $7.9 billion, driven by investments in servers, data centers and network infrastructure. Free cash flow was $11.5 billion, which reflects a $1.6 billion payment of income taxes deferred from prior quarters of 2023. We ended the year with $65.4 billion in cash and marketable securities and $18.4 billion in debt. In the fourth quarter, we repurchased $6.3 billion of our Class A stock, bringing our total share repurchases for the full year to $20 billion. We had $30.9 billion remaining on our prior authorization as of December 31. And today, we announced a $50 billion increase in our stock repurchase authorization. Moving now to our segment results. I'll begin with our Family of Apps segment. In Q4, we saw continued community growth across the Family of Apps as well as Facebook, specifically. We're sharing today that as previewed when we first introduced our family metrics, we are transitioning away from reporting Facebook-specific metrics. As part of this transition, we will no longer report Facebook daily and monthly active users or family monthly active people. In Q1, we will instead begin reporting year-over-year changes in ad impressions and the average price per ad at the regional level while continuing to report family daily active people. For full year 2023, Family of Apps total revenue was $133 billion and ad revenue was $131.9 billion, each up 16% year-over-year. The largest contributors to year-over-year ad revenue growth were the online commerce, CPG, entertainment and media and gaming verticals. The online commerce and gaming verticals benefited from strong demand by advertisers in China reaching people in other markets. In 2023, revenue from China-based advertisers represented 10% of our overall revenue and contributed 5 percentage points to total worldwide revenue growth. Turning back to Q4 results. Q4 total Family of Apps revenue was $39 billion, up 24% year-over-year. Q4 Family of Apps ad revenue was $38.7 billion, up 24% or 21% on a constant currency basis. Within ad revenue, the online commerce vertical was the largest contributor to year-over-year growth, followed by CPG and gaming. On a user geography basis, ad revenue growth was strongest in Europe and Rest of World at 33% and 32%, respectively, followed by Asia Pacific at 23% and North America at 19%. Foreign currency was a tailwind to advertising revenue growth in all international regions. In Q4, the total number of ad impressions served across our services increased 21%, and the average price per ad increased 2%. Impression growth was mainly driven by Asia Pacific and Rest of World. Pricing growth was driven by advertiser demand and currency tailwinds, which were partially offset by strong impression growth, particularly from lower-monetizing services and regions. Family of Apps other revenue was $334 million in Q4, up 82%, driven by business messaging revenue growth from our WhatsApp Business platform. We continue to direct the majority of our investments toward the development and operation of our Family of Apps. In Q4, Family of Apps expenses were $18 billion, representing approximately 76% of our overall expenses. Family of Apps expenses were down 13% due to lower restructuring expenses. Family of Apps operating income was $21 billion, representing a 54% operating margin. Within our Reality Labs segment, Q4 revenue was $1.1 billion, up 47%, driven by Quest 3 sales during the holiday season. Reality Labs expenses were $5.7 billion, up 14% year-over-year due primarily to higher head count-related expenses and non-head count-related R&D spend. Reality Labs operating loss was $4.6 billion. Turning now to the business outlook. There are 2 primary factors that drive our revenue performance: our ability to deliver engaging experiences for our community and our effectiveness at monetizing that engagement over time. On the first, we remain pleased with engagement trends and have strong momentum across our product priorities. We're seeing sustained growth in Reels and Video overall as daily watch time across all video types grew over 25% year-over-year in Q4, driven by ongoing ranking improvements. In-feed recommendations of posts from accounts you're not connected to also continue to drive incremental engagement as we increasingly personalize recommendations, and we expect to deliver further improvements this year. On Instagram, we're making strong progress increasing the freshness of recommended content. And a big focus for Facebook this year will be unifying our video experiences and ranking across the app, which should create a more seamless user experience and deliver increasingly relevant video recommendations. On WhatsApp, community growth remains strong, and we're seeing good traction with our Channels product, which has quickly scaled to over 500 million monthly active users since we rolled it out globally in September. We are also making good progress in areas that have the potential to grow people's engagement with our products in the longer term, such as Threads and generative AI. On Threads, we're coming into 2024 with strong product momentum and remain focused on introducing additional valuable features and further scaling the community this year. With generative AI, we fully rolled out our Meta AI assistant and other AI chat experiences in the U.S. at the end of the year and began testing more than 20 GenAI features across our Family of Apps. Our big areas of focus in 2024 will be working towards the launch of Llama 3, expanding the usefulness of our Meta AI assistant and progressing on our AI Studio road map to make it easier for anyone to create an AI. For the experiences in our apps, we'll follow our typical approach of making them great before we lean into growth and eventually monetization. But this continues to be an exciting area that has the potential to transform how people engage on our services in the years ahead. Now to the second driver of our revenue performance, increasing monetization efficiency. There are 2 parts to this work. The first part is growing the level of ad inventory within organic engagement. Our approach to optimizing ad levels in our apps has become increasingly sophisticated over the years as we've developed a better understanding of the optimal place, time and person to show an ad, which has enabled us to adopt a more dynamic approach to serving apps. We expect to continue that work going forward, while services with relatively lower levels of monetization like video and messaging will serve as additional growth opportunities. The other part to increasing monetization efficiency is improving marketing performance. To do this, we're focused on 3 areas. The first is AI. We continue to leverage AI across our ad systems and product suite. We're delivering continued performance gains from ranking improvements as we adopt larger and more advanced models, and this will remain an ongoing area of investment in 2024. We're also building out our Advantage+ portfolio of solutions to help advertisers leverage AI to automate their advertising campaigns. Advertisers can choose to automate part of the campaign creation setup process, such as who to show their ad to with Advantage+ audience, or they can automate their campaign completely using Advantage+ shopping, which continues to see strong growth. We're also now exploring ways to apply this end-to-end automation to new objectives. On the ads creative side, we completed the global rollout of 2 of our generative AI features in Q4, Text Variations and Image Expansion, and plan to broaden availability of our background generation feature later in Q1. Initial adoption of these features has been strong, and tests are showing promising early performance gains. This will remain a big area of focus for us in 2024. The second area of our work is helping businesses connect their marketing data and measure results. Here, we're continuing to invest in conversions API to make it easier for advertisers to not only adopt but maximize its impact. The last area is investing in new and engaging on-platform ad experiences. Business messaging remains a priority here. Click-to-message ads continue to grow, and we're seeing advertisers increasingly use these ads to drive down funnel conversions. Paid messaging is growing quickly, and we are focused on broadening adoption in 2024 by making it easier for businesses to buy marketing messages and more easily adopt our Flows product to develop richer in-Thread experiences for consumers. We're also progressing with our early testing on WhatsApp and Messenger of AIs for businesses that can provide conversational support in chat. We'll take our time to get these experiences right, but we think this will be a compelling opportunity that we're well positioned to deliver on. Outside of business messaging, we're making strong progress with our shops' ads products, which crossed a $2 billion annual run rate in Q4. Next, I would like to discuss our approach to capital allocation. We are in the fortunate position of being able to invest in many organic opportunities to improve the performance of our core business in the near term while also making 2 significant longer-time horizon investments in AI and Reality Labs. AI is a growing area of investment for us in 2024 as we hire to support our road map. We are also investing more in our AI infrastructure capacity this year. And given many of our ambitious forward-looking plans will rely on having sufficient compute capacity, we expect this to be an area we invest more aggressively in over the coming years. Reality Labs is the other long-term initiative we continue to invest heavily in as we progress on our efforts to develop the next computing platform. Aside from organic investments, returning capital to shareholders remains important to us. We believe our strong financial position and performance will enable us to invest in the business while also continuing to return capital to investors over time. We've historically done so through share repurchases. And while we expect to maintain an active share repurchase program, we are modestly evolving our approach going forward by returning a portion of capital through a regular dividend subject to quarterly Board approval. In addition, we continue to monitor the active regulatory landscape, including the increasing legal and regulatory headwinds in the EU and the U.S. that could significantly impact our business and our financial results. Of note, the FTC is seeking to substantially modify our existing consent order and impose additional restrictions on our ability to operate. We are contesting this matter, but if we are unsuccessful, it would have an adverse impact on our business. Turning now to the revenue outlook. We expect first quarter 2024 total revenue to be in the range of $34.5 billion to $37 billion. Our guidance assumes foreign currency is neutral to year-over-year total revenue growth based on current exchange rates. Turning now to the expense outlook. We expect full year 2024 total expenses to be in the range of $94 billion to $99 billion, unchanged from our prior outlook. We continue to expect a few factors to be drivers of total expense growth in 2024. First, we expect higher infrastructure-related costs this year. Given our increased capital investments in recent years, we expect depreciation expenses in 2024 to increase by a larger amount than in 2023. We also expect to incur higher operating costs from running a larger infrastructure footprint. Second, we anticipate growth in payroll expenses as we work down our current hiring underrun and add incremental talent to support priority areas in 2024, which we expect will further shift our workforce composition toward higher-cost technical roles. Finally, for Reality Labs, we expect operating losses to increase meaningfully year-over-year due to our ongoing product development efforts in AR/VR and our investments to further scale our ecosystem. Turning now to the CapEx outlook. We anticipate our full year 2024 capital expenditures will be in the range of $30 billion to $37 billion, a $2 billion increase of the high end of our prior range. We expect growth will be driven by investments in servers, including both AI and non-AI hardware, and data centers as we ramp up construction on sites with our previously announced new data center architecture. Our updated outlook reflects our evolving understanding of our AI capacity demands as we anticipate what we may need for the next generations of foundational research and product development. While we are not providing guidance for years beyond 2024, we expect our ambitious long-term AI research and product development efforts will require growing infrastructure investments beyond this year. On to tax. Absent any changes to U.S. tax law, we expect our full year 2024 tax rate to be in the mid-teens. In closing, this was a pivotal year for our company. We increased our operating discipline, delivered strong execution across our product priorities and improved advertising performance for businesses who rely on our services. We will look to build on our priorities in each of those areas in 2024 while advancing our ambitious longer-term efforts in AI and Reality Labs. With that, Krista, let's open up the call for questions.
Operator: [Operator Instructions]. And your first question comes from the line of Brian Nowak from Morgan Stanley.
Brian Nowak: I have two. I appreciate, Mark, the color about sort of the learnings and the data feedback loop. Let me ask you one about sort of the advertising business and all of the new machine learning and new GenAI ad tools that you built and rolled out the last year or so. Can you just talk about some of the largest areas of improvement your advertisers say is really driving this inflection of advertising? And what are the areas where you still get the most feedback on for further areas of improvement in the ad business that we should think about? And then, Susan, maybe, one, the first quarter guide, specifically on the acceleration implied. Anything on -- more color on which surfaces or ad units or regions are sort of giving you confidence in that type of acceleration at this point in the quarter?
Susan Li: Thank you, Brian. I can take both of those. On your first question, what is driving strength in the Ads business, we certainly believe that we've been continuing to drive ad performance improvements and year-over-year conversion growth remains strong. And we see this reflected in the feedback that we hear from advertisers also. There are really three areas of our work here that we're very focused on and have been and will continue to be in 2024. First, just creating engaging on-platform ad experiences. We see that with formats like click-to-message ads, where we continue to see good momentum. Shops ads, we talked about the $2 billion annual run rate in Q4 after we just opened availability to all U.S. advertisers in Q2. Lead generation ads, another example. So we're really focused on creating engaging on-platform ad experiences. Second, we're really making it easier for advertisers to connect with their marketing data. We're continuing to invest in features like conversions API, like AEM and making these features easier to adopt, enhancing reporting and other performance. And we've seen, again, that those are -- we get very positive feedback on advertisers who use those tools. And then finally, continuing to really use AI in important ways across our ads platform. For a long time, we have invested in building larger and more advanced models that have resulted in more Accurate predictions of relevant ads for people and improved performance for advertisers. And then, of course, we're investing a lot in AI-powered tools and products. So we're really scaling our Advantage+ suites across all of the different offerings there, which really helped to automate the ads creation process for different types of advertisers. And we're getting very strong feedback on all of those different features, advantage+ Shopping, obviously, being the first, but Advantage+ Catalog, Advantage+ Creative, Advantage+ Audiences, et cetera. So we feel like these are all really important parts of what has continued to grow improvements in our Ads business and will continue to going forward. On your second question, which is about the Q1 year-over-year -- sorry, the Q1 revenue guide. This really just reflects a lot of the trends we saw in Q4, which is strong, broad-based advertising demand across verticals, particularly within online commerce and gaming. I'll also note that we get the benefit from having February 29 in this quarter. And again, just the improvements that we continue to accrue to the business from all of our investments in improving ad performance over time.
Operator: Your next question comes from the line of Eric Sheridan from Goldman Sachs.
Eric Sheridan: Maybe two questions, if I can. Mark, coming out of a year like you had with the year of efficiency, what do you see as the key messages you want to share with investors about what you learned during the year of efficiency and how it might inform running an organization with the scale of ambition and just your organizational scale that Meta has on a long-term basis? That would be number one. And then Susan, I went back and looked, I don't think you've ever raised the high end of your CapEx guidance before, unless I'm mistaken. But with a wide range like that in CapEx, what should we be monitoring for what would push you towards either the lower end or the higher end of that CapEx guidance as you move through 2024?
Mark Zuckerberg: I'll take the first one. So the themes for the year of efficiency were to make us a stronger technology company by becoming leaner and more balanced towards our engineering work and more streamlined and to improve our financial performance, primarily with the goal of providing stability so we can invest in these long-term, ambitious visions around AI and metaverse over what we see as the coming decade or more as these things play out. And I think a lot of people looked at what we were doing as if it might have been some kind of short-term thing, which that's never really our focus. But the part about making the company leaner, I think, is the more important part to take forward, right? Because obviously, we're in a place now where the business is performing well. And I think the obvious question would be, okay, well, given that, should we just -- should we invest a lot more in things? And the biggest thing that's holding me back from doing that is that at this point, I feel like I've really come around to thinking that we operate better as a leaner company. So even though it's always -- there's always questions about like adding a few people here or there to do something. And I guess I just have more of an appreciation about how all of that adds up and in the near term, maybe makes you go a little bit faster. But over the long term, the discipline to kind of hold things to a more streamlined level actually improves the overall company performance. So I'm really focused on that. In 2024, we do have a big recruiting backlog from last year because part of the layoffs that we did included teams basically swapping out certain talent profiles for others. And we still need to hire some of the other talent profiles that we swapped people out for, and that will be ongoing through this year. But in terms of new head count that we added to the plan, it's relatively minimal compared to what we would have done historically. And I sort of expect that for the next period of time going forward, Even beyond 2024. My operating assumption is that we will also try to keep it relatively minimal because I think that -- until we reach a point where we're just really underwater on our ability to execute, I kind of want to keep things lean because I think that's the right thing for us to do culturally. So that's kind of the best window into how I'm thinking about this. The other piece that, I guess, somewhat dovetails into what Susan is going to talk to you next is that a big part of why I wanted to improve our profitability is to give ourselves the ability to go through what is a somewhat unpredictable and volatile period over the next 5 or 10 years. There are different risk factors that are geopolitical or regulatory or different things, but also the technology landscape is somewhat unknown. And we want the ability to be able to surge investment on things like building out larger training clusters or just making different investments where that's necessary. And in order to make sure that we have the flexibility to do that, we want to make sure that we keep our cost structure to a point where we sort of have some extra space built in. So those are really the 2 points. That was the theme that I laid out at the beginning of the year of efficiency last year: make us a stronger technology company and give us the flexibility and stability to execute the long-term goals. And those remain, I think, the big focuses going forward on that.
Susan Li: And I can take the second question, Eric. So we're really continuing to evolve our AI road maps and ambitions and our understanding of the capacity demands that we might have as we train next generations of foundation models and to support all of the associated product development going forward. So the increase in the top end of the range really reflects that evolving understanding of how much demand we may need. And we're also continuing to keep a close eye on supply availability. Where we land in that range is a function of both the supply and demand factors I mentioned. And this continues to be a pretty dynamic planning process for us. And there are also certainly other factors that drive uncertainty. How quickly can we execute on the new data center architecture? How the supply chain turns out to unfold over the course of the year? But our expectation is, generally, that we will need to invest more to support our AI work in the years ahead, and we're seeing some of that reflected in 2024.
Operator: Your next question comes from the line of Mark Shmulik from AllianceBernstein.
Mark Shmulik: Mark, you mentioned at the top of the call this vision, kind of everyone having a Meta AI assistant to kind of get things done. Previously, when we were talking about the metaverse from a time horizon perspective, we were looking at a decade to kind of get there. But given kind of the pace of innovation around AI that you've seen, has that time line changed? And like do you think we'll get there quicker? And then second question for Susan. Just quickly on shop ad. I appreciate the color. Obviously, we've had the Amazon partnership news intra-quarter. We know Meta has made a few attempts that are getting kind of more integrated into shopping over the last few years. Can you hear some of the learnings and, I guess, what's different this time around?
Mark Zuckerberg: Sure. I can take the first one. I do think that AI is going to make all of the products and services that we use and make better. So it's hard to know exactly how that will play out. But for the work in Reality Labs, specifically, there's a bunch of areas. Like if you take smart glasses, before, we thought that we would have to build like full displays and holograms and deliver the sense of presence before that became a mainstream product. And now it seems quite possible that smart glasses that have AI assistance built in will be the killer app, and that the holograms and sense of presence will come later as a -- maybe on the same time horizon we were talking about before but could end up being just as important as we expected. But there could be a big market here even before that. So I think we'll figure that out over the next few years. But yes, I mean, overall, I think the 2 go together pretty hand-in-hand. I would have predicted that a lot of the parts of Reality Labs -- I guess the sequence in technology is sometimes surprising. We always kind of expected that as part of building glasses or any of these platforms that having an AI assistant would be a foundational part of it. But the fact that that's -- that there have just been big strides in that over the last year or 2 is just -- is a big opportunity for these products sooner. So I think it's still unknown exactly how that will play out, but I think we'll know more over the next few years. It's very exciting, though.
Susan Li: And Mark, I can take the second question. So first of all, online commerce continues to be one of our strongest verticals overall. And a lot of the work that we do to improve ads performance generally really helps do things like grow conversions year-over-year, improves the performance of direct response ads. We've invested a lot in the Advantage+ set of tools, tools like Advantage+ Shopping. So I would say that our offerings for e-commerce advertisers overall are very strong, and we continue to invest in making them better and more performant. On Shops ads, specifically, this is an area where we are really, I would say, focusing on introducing improvements that continue to make it easier for businesses to onboard 2 shops. So for example, eligible Shopify businesses can now onboard to Shops on Facebook and Instagram very seamlessly. And we're making it easier for advertisers to turn their existing ads into Shops ads. And we'll continue to focus on deepening integrations with partners and leveraging AI to make Shops ads even more performant. You mentioned the Amazon ads pilot, and that's a place where we're partnering with Amazon to make Buy with Prime, to create a more seamless shopping experience on Facebook and Instagram so that it's easier for people to purchase directly from an Amazon ad. This is really early, and we're testing this experience with them. But it's another avenue for us to explore how can we make these shopping experience easier for folks on our platform.
Operator: Your next question comes from the line of Justin Post from Bank of America.
Justin Post: I was wondering if you could help us think about the messaging run rate for revenues and maybe the long-term opportunity and how you think about that going forward on a multiyear basis. And then secondly, the guidance for Q1 suggests stable growth at the midpoint despite comps getting tougher. So I'm wondering if you could help us at all think about -- the comps get increasingly tougher as we go through the year, how you're thinking about those comps and how you could grow in the second half.
Susan Li: Thanks, Justin. I can take both of those. So on your first question about messaging monetization, right now, the 2 primary avenues that we have there are click-to-messaging ads and paid messaging, which we are investing a lot in both to facilitate the full cycle of customer engagement. We saw that revenue growth from click-to-message ads remained strong in Q4. We see broadening advertiser adoption. And there, I would say that our focus in terms of where we're investing is really around enhanced optimization and reporting. So we're really trying to drive down funnel performance, enabling businesses to optimize for purchase. And we've seen strong growth in purchase optimization revenue on click-to-Messenger ads since we've rolled that out. And we're planning to bring purchase optimization to click-to-WhatsApp campaigns this year. And across the click-to-messaging ads, we're introducing more robust reporting to help advertisers kind of understand how people are engaging with them via click-to-messaging ads and what is the value of that engagement. And then, of course, in the longer term, this is a place where we're excited about the opportunities for increased automation to really help businesses scale their ability to have conversations with their consumers. On the paid messaging side, this is much earlier, of course, but we're seeing good momentum, driven by particularly strong growth from marketing messages. And we've also seen good results from our updated pricing model that we introduced in June. And here, we're really focused on making paid messaging easier to buy. So we're now testing the ability for businesses to send paid messaging directly on Meta Ads Manager. And then, again, similar to click-to-messaging, we are investing in ways to make it easier to get more done within the app. So here, we launched Flows globally in October, which enables businesses to offer richer user experiences within WhatsApp, things like selecting a seat on a flight or booking an appointment. We're seeing good early traction, and we're focused on just introducing more ways to help businesses easily create flows, and we'll plan on introducing more capabilities here. So there's a lot, I would say, going on in the portfolio of messaging monetization work that we're doing. Now your second question was around the 2024 outlook. And we obviously have not shared any guidance beyond Q1. But our revenue for the full year is going to be influenced by a number of factors, including macro conditions that are certainly harder to predict the further out you go. And over the course of 2024, as you said, we'll also be lapping periods of increasingly strong demand. So we don't provide guidance beyond Q1. There's certainly a range of outcomes, and we'll have a better read on how we will compare to future quarters as we progress through the year.
Operator: Your next question comes from the line of Doug Anmuth from JPMorgan.
Doug Anmuth: One for Mark, one for Susan. Mark, I believe you'd shifted FAIR out of Reality Labs into the Family of Apps. Can you just talk about some of the benefits there of moving that group as you pursue general intelligence? And then Susan, can you just walk us through your thought process on adding a dividend to your capital returns at this stage beyond the share repurchases?
Mark Zuckerberg: I can talk to the first one. Yes, the whole reason why we moved FAIR is basically to be closer to the GenAI group. They're both research groups. The GenAI group basically builds our Llama launch vehicles and products, but also conducts a fair amount of research, too, especially things that are going to be coming into the upcoming versions of Llama. FAIR is focused on more foundational work and longer-term work. So it's, I'd say, more things that might be a couple of years out to 10-plus years out. And as we -- I guess, here's one way to think about it. A lot of last year and the work that we're doing with Llama 3 is basically making sure that we can scale our efforts to really produce state-of-the-art models. But once we get past that, there's a lot more kind of different research that I think we're going to be doing that's going to take our foundation models in potentially different directions than other players in the industry are going to go in because we're focused on specific vision for what we're building. So it's really important as we think about what's going to be in Llama 5 or 6 or 7 and what cognitive abilities we want in there and what modalities we want to build into future multimodal versions of the models. We need to be doing that work in advance and to research those things. And it helps to -- and even though FAIR and GenAI will continue to be 2 kind of separate groups on different time horizons. I think to have some level of alignment between -- on the vision of what we're building between the 2 of them, so that way, the FAIR team can have in mind, hey, if we research this, then maybe it can intercept Llama 6 or something. Then that, I think, is just going to be more helpful for increasing the ambition and focus of all of the work that we do. It's one of the reasons that I talked about. We did open-ended research on AI for a while. But having a clear product target with these AI agents, I think, is really going to help focus the work and give us a feedback loop that's going to increase the productivity and output that we get dramatically.
Susan Li: Doug, on your second question about why now in terms of initiating a dividend, returning capital to shareholders remains an important priority for us. And we believe introducing a dividend really just serves as a nice complement to the existing share repurchase program. The dividend doesn't change how much we will be -- or it doesn't change the way we determine the total amount of capital we return. And we expect that share repurchases will continue to be the primary way that we return capital to shareholders. But introducing a dividend just gives us a more balanced capital return program and some added flexibility in how we return capital in the future.
Operator: Your next question comes from the line of Ron Josey from Citi.
Ronald Josey: Mark, I hope your knee is getting better. I wanted to ask you about Apple opening up its App Store in Europe and maybe what role that might play for Meta in further building out the App Store app install ads and things along those lines. And Susan, as a follow-up to maybe a prior question, you mentioned the potential around business messaging and the team -- what the team is doing around really testing with WhatsApp and Messenger. Just talk just how you might see this unfold maybe with AI Studio and maybe timing would be helpful.
Mark Zuckerberg: I don't think that the Apple thing is going to have any difference for us because I think that the way that they've implemented it, I would be very surprised if any developer chose to go into the alternative App Stores that they have. They've made it so onerous, and I think so at odds with the intent of what the EU regulation was that I think it's just going to be very difficult for anyone, including ourselves, to really seriously entertain what they're doing there. Susan, did you want to add anything?
Susan Li: No. I was going to take the second question, I think, which was around the rollout of some of the GenAI features from a monetization perspective. And we're -- first of all, I would say that we don't expect our GenAI products to be a meaningful 2024 driver of revenue. But we certainly expect that they will have the potential to be meaningful contributors over time. Right now, the most near-term monetization opportunity is with our ad creative tools. We've talked about some of the places that we've been rolling those features out broadly with Text Variations and Image Expansion now globally available. And we're seeing those tools receive adoption and provide real value for advertisers even at this early stage. And we're going to keep investing in making those more useful and performant, which then leads to more advertiser adoption, and that can be sort of a virtuous feedback loop. Over a longer time frame, the GenAI features that we're bringing to business messaging, which I think was where your question originated, we think really represents a compelling opportunity. We're testing AI chats on a very small scale today with a few businesses, but it will take time to continue making those AIs increasingly useful. We're hearing good feedback from the businesses testing them, and we expect to make progress this year as we expand our tests further. I'd say one other thing is just on the consumer side, again, we think GenAI can make it easier for people to produce compelling content across all of our apps, including our messaging apps. And our AI assistant certainly provides also added utilities. So in all of these areas, I would say, we're following our typical playbook of testing and tuning the experiences until they're very good, and then we'll invest in growth and eventually explore monetization.
Operator: Your last question comes from the line of Ross Sandler from Barclays.
Ross Sandler: Mark, just curious what you're seeing with Meta AI at this stage. You talked about rapid iteration of that, given your large audience. So yes, I guess, what's going on, thus far? Which of the apps in the Family of Apps have seen engagement increase from Meta AI? And do you think that there could be increased commercial activity as either your AI agent or some of the other ones out there get more usage within your apps?
Mark Zuckerberg: Yes. I think having a good assistant is going to be one of the real values that this generation of AI creates as well as giving every creator an opportunity to have an assistant or agent that people can engage with and every business and agent and also allowing people to create a bunch of quirky and fun things as well. But yes, I think Meta AI is going to be very important across the product. It currently is available in some countries in WhatsApp, Messenger and Instagram. It's at the phase where we're not really pushing it super proactively. We've sort of made it available, and as people use it, we're learning from how -- what are the basic ways that people want to engage with it. We're currently in the tuning phase on this. I mean, we started rolling this out, I think, it was in November or so, maybe October. And I would expect that, over the course of this year, we are going to start rolling this out much more prominently across our apps. And that was sort of what I was saying in my opening remarks about the analogy to Stories, where we ran a bunch of experiments, put it out there, got feedback and then eventually did a lot of integrations, even to the point where people were making jokes about us putting Stories in settings, which, for the record, never happened, but I found funny. So I think that we're going to be on that journey this year. We're basically in the learning and tuning phase now. I'm happy with how that's going. We're currently working on and planning the next set of integrations and places where this is going to be available to people across the products, and I'm really looking forward to that. And I think that's going to be one of the big themes for '24 for us.
Ken Dorell: Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again soon.
Operator: This concludes today's conference call. Thank you for your participation, and you may now disconnect. |
AAPL | 1 | 2,024 | 2024-02-01 20:17:02 | Operator: Good day, and welcome to the Apple Q1 Fiscal Year 2024 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions. I would like to turn the call over to Suhasini Chandramouli, Director of Investor Relations. Please go ahead.
Suhasini Chandramouli: Thank you for joining us. Speaking first today is Apple's CEO, Tim Cook; and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Before turning the call over to Tim, I would like to remind everyone that the quarter we're reporting today included 13 weeks, whereas the quarter we reported a year ago included 14 weeks. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed annual report on Form 10-K and the form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks.
Tim Cook: Thank you. Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $119.6 billion for the December quarter, up 2% from a year ago despite having one less week in the quarter. EPS was $2.18, up 16% from a year ago and an all-time record. We achieved revenue records across more than two dozen countries and regions including all-time records in Europe and rest of Asia-Pacific. We also continue to see strong double-digit growth in many emerging markets with all-time records in Malaysia, Mexico, The Philippines, Poland, and Turkey, as well as December quarter records in India, Indonesia, Saudi Arabia, and Chile. In Services, we set an all-time revenue record with paid subscriptions growing double-digits year-over-year. And I'm pleased to announce today that we have set a new record for our installed base, which has now surpassed 2.2 billion active devices. We are announcing these results on the eve of what is sure to be a historic day as we enter the era of spatial computing. Starting tomorrow, Apple Vision Pro, the most advanced personal electronics device ever, will be available in Apple stores for customers in the U.S. with expansion to other countries later this year. Apple Vision Pro is a revolutionary device built on decades of Apple innovation and it's years ahead of anything else. Apple Vision Pro has a groundbreaking new input system and thousands of innovations, and it will unlock incredible experiences for users and developers that are simply not possible on any other device. There is already so much excitement behind this product from reviewers, customers, and developers. They are praising everything from the incredible experience of watching a movie on a 100-foot screen to remarkable new machine learning capabilities like hand tracking and room mapping. We can't wait for people to experience the magic for themselves. Moments like these are what we live for at Apple. They're why we do what we do. They're why we're so unflinchingly dedicated to groundbreaking innovation and why we're so focused on pushing technology to its limits as we work to enrich the lives of our users. As we look ahead, we will continue to invest in these and other technologies that will shape the future. That includes artificial intelligence where we continue to spend a tremendous amount of time and effort, and we're excited to share the details of our ongoing work in that space later this year. Now, let's turn to the results for the December quarter, beginning with iPhone. We are proud to report that revenue came in at $69.7 billion, 6% higher than a year ago. The iPhone 15 lineup has earned glowing reviews and been embraced by customers. The iPhone 15 and iPhone 15 Plus feature a gorgeous new design with color-infused back glass and contoured edges, Dynamic Island, A16 Bionic, and a new 48 megapixel camera system. And the iPhone 15 Pro and iPhone 15 Pro Max set the gold standard for smartphones with a beautiful and lighter titanium design, industry-leading performance with A17 Pro and our most advanced camera system with the equivalent of seven pro lenses and the ability to record spatial video. Features like Emergency SoS and roadside assistance via satellite bring peace of mind to users when they travel, and I'm grateful for every note I've received about their lifesaving impact. Turning to Mac. Revenue came in at $7.8 billion, up 1% year-over-year, driven by the strength of our latest M3-powered MacBook Pro models in spite of having one less week of sales. Just last week, we got to wish Mac a happy 40th birthday. When it was introduced 40 years ago, Mac changed everything, and through the years, it has done so again and again. Recently, we have been on a tremendous pace of innovation. Since the introduction of Apple silicon in 2020, we've been proud to offer our users unmatched performance and power along with a remarkable Neural Engine for artificial intelligence and machine learning. This past fall, we had an amazing launch of the latest generation of Apple silicon for Mac, M3, M3 Pro, and M3 Max. These chips break new ground in power and performance empowering users to do more than they ever could before, whether they're making a musical masterpiece using the latest features in Logic Pro, or beating their high score in a graphics intensive game. A favorite amongst students, business owners, artists, and video editors, our MacBook Pro lineup is the world's best pro notebook family. And iMac, the world's most capable and best-selling all-in one, is now faster than ever, thanks to M3. In iPad, revenue for the December quarter was $7 billion, down 25% year-over-year due to a difficult compare with the launch of the M2 iPad Pro and the 10th generation iPad during the December quarter last year and one less week of sales. iPad remains the most versatile, capable, and elegant tablet on the market today. It continues to be the go-to-device for students, creators, and more with customers loving iPad's incredible combination of portability and performance. Powerful apps like Final Cut Pro and Logic Pro for iPad allow video and music creators to unleash their creativity in new ways that are only possible on iPad. iPad continues to push the boundaries of what's possible on a tablet. In Wearables, Home and Accessories, revenue came in at $12 billion, down 11% from a year ago due to a difficult compare with the launch timing of several products in this category and the impact of the 14th week last year. Across our latest Apple Watch lineup, we're enabling and encouraging our users to live a healthier day, while making Apple Watch even more intuitive to use. The new double tap gesture on Apple Watch Series 9 and Apple Watch Ultra 2 make it easier to answer calls, play and pause music or take a photo with iPhone. I've been deeply moved by the many touching stories about how features like a regular rhythm notification and fall detection helped Apple Watch users when they needed it most. And for the first time ever, users can choose a carbon-neutral option of any new Apple Watch. Meanwhile, our AirPods lineup continue to be a holiday favorite. In Services, we set an all-time revenue record of $23.1 billion and an 11% year-over-year increase. Because we had one less week this quarter, this growth represents an acceleration from the September quarter, and we achieved all-time revenue records across advertising, cloud services, payment services and video, as well as December quarter records in App Store and AppleCare. Across our services, we're constantly growing our offerings to give users even more to love. With the redesigned Apple TV app, we've made it easier for subscribers to enjoy all their favorite shows, movies and sports, including Apple TV+ hits like Masters of the Air, Monarch, and Slow Horses. We're proud to be a part of Martin Scorsese's Killers of the Flower Moon, a film that has moved audiences and earned more than 200 accolades including Best Film of the Year from the New York Film Critics Circle, nine BAFTA nominations, a Golden Globe win, and 10 Oscar nominations, including Best Picture. Across all Apple TV+ productions, we've now earned 2050 award nominations and 450 wins since we've introduced the service. We're also excited to have a new season of Major League Soccer kicking off this month. We're looking forward to seeing Lionel Messi return to the field and to following all of our favorite teams in what is sure to be an incredible season. And we're counting down to the Apple Music Super Bowl halftime show, featuring Usher. Turning to Retail. In recent months, we opened three stores, including our 100th store in Asia-Pacific. Throughout the holidays, our team members pulled out all the stops to help customers find the perfect gift. And I know our U.S. team members are especially excited to begin demoing Apple Vision Pro for our customers tomorrow. At Apple, we live and breathe innovation. We are driven to pioneer new technology that can enrich our customers' lives, and we're just as intentional about showing up with our values and being a force for good in the world. February is Black History Month, and to honor it, we've launched our new Black Unity Collection, which includes the Black Unity Sport Loop band. This year's designs reflect a lasting commitment to working toward a more equitable world. We also continue to do a central work through our Racial Equity and Justice Initiative, and we're proud to continue providing grants to organizations that are making a real impact in the world. In recent months, we've also taken significant strides in our environmental work. We're partnering with suppliers to bring more clean energy online for Apple production. We're using more recycled materials than ever before and more energy-efficient transportation than ever before. And each day, we are taking more and more steps toward becoming 100% carbon-neutral across all of our products by 2030. Apple is a company that has never shied away from big challenges. That's because we are grounded by a deep sense of purpose and guided by core belief in the transformative power of innovation. And so, we are optimistic about the future, confident in the long-term, and as excited as we've ever been to deliver for our users like only Apple can. With that, I'll turn it over to Luca.
Luca Maestri: Thank you, Tim, and good afternoon, everyone. Revenue for the December quarter was $119.6 billion, up 2% from last year. During the December quarter a year ago, two unique factors affected our results. First, we had an additional week in the quarter. And second, we had COVID-related factory shutdowns that limited iPhone supply. We estimate that the net impact of these two factors resulted in a 2 percentage point headwind to our revenue performance this quarter. We set all-time revenue records in Europe and rest of Asia-Pacific, and continue to see strong performance across our emerging markets with double-digit growth in the majority of the emerging markets we track. Products revenue was $96.5 billion, flat compared to last year, driven by strength in iPhone, offset by challenging compares for iPad and Wearables, Home and Accessories and one less week of sales this year across the entire portfolio. Thanks to our unparalleled customer loyalty and very strong levels of customer satisfaction, our total installed base of active devices set a new record across all products and all geographic segments, and is now over 2.2 billion active devices. Services revenue set an all-time record of $23.1 billion, up 11% year-over-year. When we take into account the extra week last year, this represents a sequential acceleration of growth from the September quarter. We are very pleased with our Services performance in both developed and emerging markets with all-time revenue records in the Americas, Europe, and rest of Asia-Pacific. Company gross margin was 45.9%, up 70 basis points sequentially, driven by leverage and favorable mix, partially offset by foreign exchange. Products gross margin was 39.4%, up 280 basis points sequentially, also driven by leverage and mix, partially offset by foreign exchange. Services gross margin was 72.8%, up 190 basis points from last quarter, due to a more favorable mix. Operating expenses of $14.5 billion were at the midpoint of the guidance range we provided and up 1% year-over-year. Net income was $33.9 billion, up $3.9 billion from last year. Diluted EPS was $2.18, up 16% versus last year and an all-time record. And operating cash flow was very strong at $39.9 billion. Let me now provide more detail for each of our revenue categories. iPhone revenue was $69.7 billion, up 6% year-over-year. We set all-time records in several countries and regions, including Latin America, Western Europe, the Middle East, and Korea, as well as December quarter records in India and Indonesia. Our iPhone active installed base grew to a new all-time high, and we had an all-time record number of iPhone upgraders during the quarter. Customers are loving their new iPhone 15 family, with the latest reports from 451 Research indicating customer satisfaction of 99% in the U.S. In fact, many iPhone models were among the top-selling smartphones around the world during the quarter. According to a survey from Kantar, iPhones were four out of the top five models in the U.S. and Japan, four out of the top six models in urban China and the UK, and all top five models in Australia. Mac generated revenue of $7.8 billion and return to growth, despite one less week of sales this year. This represents a significant acceleration from the September quarter when we faced a challenging compare due to the supply disruptions and subsequent demand recapture we experienced a year ago. Customer response to our latest iMac and MacBook Pro models powered by the M3 chips has been great. And our Mac installed base reached an all-time high with almost half of Mac buyers during the quarter being new to the product. Also, 451 Research recently reported customer satisfaction of 97% for Mac in the U.S. iPad was $7 billion in revenue, down 25% year-over-year. iPad faced a difficult compare because during the December quarter last year, we launched the new iPad Pro and iPad 10 generation, and we had an extra week of sales. However, the iPad installed base continues to grow and is an all-time high with over half of the customers who purchased iPads during the quarter being new to the product, and customer satisfaction for iPad was recently measured at 98% in the U.S. Wearables, Home and Accessories revenue was $12 billion, down 11% year-over-year due to a challenging launch compare and the extra week a year ago. This time last year, we had the full quarter benefit from the launches of the AirPods Pro 2nd generation, the Watch SE, and the first Watch Ultra. We continue to attract new customers to Apple Watch. Nearly two-thirds of customers purchasing an Apple Watch during the quarter were new to the product, and the latest reports from 451 Research indicate customer satisfaction of 96% in the U.S. And in Services, we were very pleased with our double-digit growth, which was driven by the strength of our ecosystem. Our installed base is now over 2.2 billion active devices and continues to grow nicely, establishing a solid foundation for the future expansion of our Services business. And we continue to see increased customer engagement with our services. Both transacting accounts and paid accounts reached a new all-time high, with paid accounts growing double-digits year-over-year. Also, our paid subscriptions showed strong double-digit growth. We have well over 1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. Finally, we continue to build on the breadth and the quality of our current services. From Oscar-nominated theatrical releases with Apple TV+ to more publications or News+ like The Atlantic and exciting new games on Arcade. Turning to Enterprise, we continue to see many business customers leverage Apple products to improve productivity and drive innovation. Target recently added the latest M3 MacBook Pro to their existing deployment of thousands of Mac’s, enabling employees across various departments to do their best work. In emerging markets, Zoho, a leading technology company headquartered in India, offers its 15,000 plus global employees a choice of devices, with 80% of their workforce using iPhone for work and nearly two-thirds of them choosing Mac as their primary computer. With the upcoming launch of Apple Vision Pro, we are seeing strong excitement in Enterprise. Leading organizations across many industries such as Walmart, Nike, Vanguard, Stryker, Bloomberg, and SAP have started leveraging and investing in Apple Vision Pro as their new platform to bring innovative spatial computing experiences to their customers and employees. From everyday productivity to collaborative product design to immersive training, we cannot wait to see the amazing things our enterprise customers will create in the months and years to come. Let me now turn to our cash position and capital return program. We ended the quarter with $173 billion in cash and marketable securities. We decreased commercial paper by $4 billion, leaving us with total debt of $108 billion. As a result, net cash was $65 billion at the end of the quarter, and our goal of becoming net cash-neutral over time remains unchanged. During the quarter, we returned nearly $27 billion to shareholders, including $3.8 billion in dividends and equivalents and $20.5 billion through open market repurchases of 112 million Apple shares. We also retired an additional 6 million shares in the final settlement of our 19th ASR. As usual, we will provide an update to our capital return program when we report results at the end of this quarter. As we move ahead into the March quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. And we expect foreign exchange to be a revenue headwind of about 2 percentage points on a year-over-year basis. As a reminder, in the December quarter a year ago, we faced significant supply constraints on the iPhone 14 Pro and 14 Pro Max due to COVID-19 factory shutdowns. And in the March quarter a year ago, we were able to replenish channel inventory and fulfill significant pent-up demand from the constraints. We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago. For our Services business, we expect a similar double-digit growth rate to what we reported in the December quarter. We expect gross margin to be between 46% and 47%. We expect OpEx to be between $14.3 billion and $14.5 billion. We expect OI&E to be around $50 million, excluding any potential impact from the mark-to-market of minority investments and our tax rate to be around 16%. Finally, today our Board of Directors has declared a cash dividend of $0.24 per share of common stock payable on February 15, 2024, to shareholders of record as of February 12, 2024. With that, let's open the call to questions.
Suhasini Chandramouli: Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question please?
Operator: Certainly. We'll go ahead and take our first question from Erik Woodring with Morgan Stanley. Please go ahead.
Erik Woodring: Hey guys, good evening. Thank you for taking my questions. I have two. And congrats on the nice quarter here. Luca, maybe if we start with you. Can you unpackage some of the Services drivers a bit for us. Obviously, really nice outperformance in the December quarter versus your expectations. A record gross margin implies your higher margin businesses were likely the sources of outperformance. But can you maybe just clarify a bit how we should think about Services growth for the March quarter? And then, speak to some of those underlying drivers in the December quarter and then in the March quarter, what the different puts and takes would be? And then, I have a follow-up please. Thank you.
Luca Maestri: Thanks, Erik, for the question. Let's start with the December quarter. As we said, up 11%, $23.1 billion is an all-time record for us, with all-time records in The Americas, in Europe, and the rest of Asia Pac. So it was pretty broad-based geographically, and very strong across all the Services categories, because we had all-time revenue records for cloud, for payments, for video, and for advertising and December quarter records for the App Store and for AppleCare. Obviously, last year, we had an extra week, so the 11% is stronger than -- the underlying performance is stronger than the 11% that we have reported. I think the entire ecosystem is doing well because we continue to see growth and new all-time highs in both transacting accounts and paid accounts, which is obviously very important. And paid subscriptions continue to grow strong double-digits. Just as a reference, we have more than a billion paid subscriptions across all the services on our platform. This is more than double the number of paid subscriptions that we had only four years ago. So, obviously, very significant growth there. What I said during the prepared remarks around the March quarter, I mentioned that we will continue to grow double-digits at a percentage that is similar to what we reported for the December quarter. We don't provide guidance around the different services categories. So, we will provide more color when we report in three months.
Erik Woodring: Okay. Thank you, Luca. And then, Tim, really nice to see your installed base reach a record high, again, against all products and geos. I'm wondering if you could share a bit more detail about the new users you were able to on-board over the last 12 months. Meaning, how might this new cohort look different from past cohorts, either in terms of geographic representation or SKU to certain products or even how their monetization trends might differ from past cohorts. And that's it from me. Thanks so much.
Tim Cook: Yes. Hi, Erik. I would say emerging markets are -- have been a very key area of strength for us. If you look at it, India grew -- in revenue terms grew strong double-digits in the December quarter and hit a quarter revenue record. The other emerging markets like Indonesia also hit a quarterly record. And we had several regions, with records from Latin America to the Middle East. And that theme has been pretty consistent across the other quarters that -- of the year as well. And so, emerging markets, very, very important. And I feel like we are doing a great job there.
Suhasini Chandramouli: Thanks, Erik. Operator, can we have the next question please?
Operator: Our next question is from Mike Ng with Goldman Sachs. Please go ahead.
Mike Ng: Hey, good afternoon. I just have two questions as well. First, on Services. Just on the outlook for the March quarter for a similar double-digit growth rate as of December quarter. I'm just wondering why not -- why won't it be potentially faster, given that the December quarter obviously had a headwind from the extra week comp, and I'd also think that some of the pricing uplifts on select Apple One services that were implemented last winter should help in the March quarter? Any additional thoughts there would be great in terms of what some of your assumptions are. And then, I have a quick follow-up.
Luca Maestri: Yes. We'll see how the quarter develops. I would point to two things. One is the fact that we mentioned that we expect a couple of points of negative foreign exchange in the March quarter, and foreign exchange was essentially flat for us in the December quarter. So, you've got a bit of a headwind there. And then, when you look at our other progression of our Services business over the last few quarters, the compares for March are slightly more difficult than the compares for December.
Mike Ng: Great. Thank you, Luca. And then, my second question. It was very interesting to hear about some of the enterprise customer investments into Vision Pro. Could you maybe just talk about some of the efforts to support Vision Pro developer ecosystem. And it was also good to hear about the potential upcoming announcements on AI. So any thoughts there would also be helpful. Thank you.
Tim Cook: Yeah. Hi. It's -- we are incredibly excited about the Enterprise opportunities with Vision Pro. I've seen several demos from different companies. Luca mentioned several in his opening remarks, but Walmart has a very cool merchandising app. There are firms that are doing collaboration -- design collaboration apps. There are field service applications. Really all over the map, there are applications that are for control center, command center kind of things. SAP has really gotten behind it and, of course, SAP is in so many of companies. I think there will be a great opportunity for us in Enterprise, and we couldn't be more excited about where things are right now. We are obviously looking forward to tomorrow. This has been multiple years of efforts from so many people across Apple. And really, it took a whole of company effort to bring it to this far. In terms of generative AI, which, I'd guess, is your focus, we have a lot of work going on internally as I've alluded to before. Our MO, if you will, has always been to do work and then talk about work and not to get out in front of ourselves. And so, we're going to hold that to this as well. But we've got some things that we are incredibly excited about that we'll be talking about later this year.
Mike Ng: Wonderful. Thank you, Tim.
Tim Cook: Yes.
Suhasini Chandramouli: Thank you, Mike. Operator, can we have the next question please?
Operator: Our next question is from Wamsi Mohan with Bank of America. Please go ahead.
Wamsi Mohan: Yes, thank you so much. I have two questions as well. First on iPhone. There have been concerns around replacement cycles lengthening, China competition intensifying, and you still beat iPhone revenues despite the weaker performance in China. Curious how you're thinking about the 15 cycle overall, given what you saw in the December quarter. And I've a follow-up.
Tim Cook: Hi, it's Tim. The -- we were up 6%, as we mentioned in the opening remarks. We are happy with that performance. Underneath there, we had really strong performance in several parts of the world with all-time records in Europe and rest of Asia-Pacific. As I mentioned earlier, we did particularly well in several emerging markets from Latin America to the Middle East. And we set December quarter records in India and Indonesia. And so, really some spectacular broad-based reactions to iPhone. We also importantly set an all-time record worldwide for iPhone upgraders. And the installed base hit a new all-time high consistent with the -- our overall devices. And so, there's lot of good things. Luca mentioned in his opening comments that iPhones were four out of the top five smartphone models in the U.S. and Japan and four out of the top six in urban China and the UK, and all top five in Australia, and the customer satisfaction level for iPhone 15 hit 99%. If you look at iPhone 15 since the announcement of it and shipment in September, so this is including some of Q4 and you compare that to iPhone 14 over the same period of time, iPhone 15 is outselling iPhone 14. And so, we feel very good about that, and the upgraders hitting a record is particularly exciting for us.
Wamsi Mohan: Great. Thank you, Tim. And as a follow-up, obviously, you're just launching the Vision Pro and it's an entirely new category. It's a price point that's a much higher starting price point relative to most of your other, probably over the last decade, product introductions, but just wondering how would you measure the success of Vision Pro over time and which Apple products adoption curve would you look at as potentially the most similar? And is there a way in which we could think Vision Pro could eclipse maybe something like the iPad in revenue over time. Thank you.
Tim Cook: You know, each product has its own journey. And so, I wouldn't want to compare it to any one in particular. I would just say we couldn't be more excited. Internally, we've got an incredible amount of excitement from developers and from customers that can't wait till tomorrow to pick up their units. And we are incredibly proud to be able to demo the unit in so many of our stores in the U.S. starting tomorrow for people that are -- that want to check it out. And so, we'll see and report the results of it in the Wearables category that you're familiar with. I think that if you look at it from a price point of view, there's an incredible amount of technology that's packed into the product. There's 5,000 patents in the product and it's, of course, built on many innovations that Apple has spent multiple years on, from silicon to displays and significant AI and machine learning. All the hand tracking, the room mapping, all of this stuff is driven by AI. And so, we're incredibly excited about it. I can't wait to be in the store for tomorrow and see the reaction myself.
Wamsi Mohan: Thank you so much, Tim.
Suhasini Chandramouli: Thanks, Wamsi. Operator, we'll take the next question please.
Operator: Our next question is from Amit Daryanani with Evercore. Please go ahead.
Amit Daryanani: Good afternoon. I have two as well. I guess, first off, I was hoping you could talk a little bit about what you're seeing in China right now. I think from a geographic basis, one of the few places that was down double-digits, while everything else was growing. So, I'm hoping you spend a bit of time discussing what are you seeing there from a competitive perspective and more importantly, from a demand perspective in China?
Tim Cook: Yeah. If you look at iPhone in China Mainland, which I think has been the focus of a lot of interest, and you look at it in constant currency, so more of an operational view, we were down mid-single digits on iPhone. And so, it was the other things that drove the larger contraction year-over-year. On the good news side, we had solid growth on upgraders year-over-year in Mainland China and we had four of the top six smartphone models in urban China. Also, IDC just put out a note, that you may have seen, that we were the top brand in -- for the full year and for the December quarter. And so, there's some good news along with – obviously, we'd prefer not to [contract] (ph).
Amit Daryanani: Fair enough. And then, as a follow-up, you folks have implemented a fair bit of changes around the App Store in Europe post the DMA implementation there. Can you just touch on what are some of the key updates? And then, Luca, as a net of it all, do you see it having any significant impact financially to your services or a broader Apple P&L statement? Thank you.
Tim Cook: Yes. You know, the -- let me try to answer a little bit of both and then Luca can add some comments to it. We announced a number of changes last week in Europe that would be in effect beginning in March. So, the last month of the first calendar quarter, the second fiscal quarter. Those are -- some of the things that we announced include alternate billing opportunities, alternate app stores, our marketplaces, if you will. We're also opening NFC for new capabilities for banking and wallet apps. And so, these are some of the things we announced. The -- if you think about what we've done over the years is, we've really majored on privacy, security, and usability. And we've tried our best to get as close to the past in terms of the things that are -- that people love about our ecosystem as we can, but we are going to fall short of providing the maximum amount that we could supply, because we need to comply with the regulation. And so, in terms of predicting the choices that developers and users will make, it's very difficult to do that with precision. And so, I will see what happens in March.
Luca Maestri: Yes, Amit. As Tim said, these are changes that we're going to be implementing in March. A lot will depend on the choices that will be made. Just to keep it in context, the changes applied to the EU market, which represents roughly 7% of our global app store revenue.
Amit Daryanani: Perfect. That's a really good perspective to have. Thank you very much.
Suhasini Chandramouli: Thank you, Amit. Operator, can we have the next question please?
Operator: Our next question is from Aaron Rakers with Wells Fargo. Please go ahead.
Aaron Rakers: Yes. Thanks for taking the question. I have two as well as you would imagine. I guess, the first question I wanted to just ask maybe unpack a little bit more, just remarkable trends that we're seeing in your product gross margin specifically. So, I'm curious as we look forward, I guess on this last quarter, where there any kind of benefits you're seeing from like just the purchase component, obligations that you've put in place, let's say, a year ago, and that flowing through. And how are you thinking about the component pricing environment as we think about that gross margin into the March quarter and looking-forward?
Luca Maestri: Yes. On the product side and then maybe I'll make a comment in total for the company. On the product side, our gross margins increased sequentially 280 basis points. So, obviously, a very significant increase. I would say the two primary components of the increase are a favorable mix. Of course, iPhone did very well. We did very well with our high-end models. And leverage, of course, it's the biggest quarter of the year for us and so we get the leverage effect. We had a partial offset, negative impact from foreign exchange. But net-net, obviously, very significant improvement. And we had very similar dynamics on the Services side where we increased sequentially 190 basis points, also, in this case, due to a more favorable mix. And so, the combined effect of the two businesses gave us the 45.9% at the total company level, which is up 70% sequentially. You've heard from my prepared remarks that we are guiding total company gross margin to 46% to 47%, which is an additional expansion of margins compared to the already very strong results of the December quarter.
Aaron Rakers: Okay. And then, the second question I was just going to ask. Tim, you alluded to kind of your excitement around generative AI and some announcements that we should think about maybe later this year. One of the things that stands out for me is that, your capital expenditures has actually come down this last year. I'm curious as you look to lean in more to generative AI, is there something we should consider about the CapEx intensity at Apple to make investments to really set the table for generative AI, kind of platform as we move forward? Just given some of the things that we've seen from some other large tech companies.
Luca Maestri: I'll take the question, Aaron. We've always said, we will never underinvest in the business. So, we are making all the investments that are necessary throughout our product development, software development, services development. And so, we will continue to invest in every area of the business and at the appropriate level. And we're very excited about what's in store for us for the rest of the year.
Aaron Rakers: Thank you.
Suhasini Chandramouli: Thanks, Aaron. Operator, can we have the next question please?
Operator: Our next question is from Krish Sankar with TD Cowen. Please go ahead.
Krish Sankar: Yes. Hi. Thanks for taking my question. I have two of them. First one for Luca, a clarification on a question. The $5 billion impact in March quarter, is that for product revenue or is that total company revenue. And along the same part, you highlighted the strong gross margins. And I understand last year, some of the commodity costs were deflationary, buy looks like it’s going to be inflationary right now. And also you've done some of the Mac conversions that -- the silicon conversions. So I'm just trying to figure out how much juice is there more to squeeze on the gross margin side? And then I'll follow up for Tim.
Luca Maestri: Yes. The -- so the first part of the question was around -- oh, the $5 billion. The $5 billion, as I mentioned, a year ago we had this disruption of supply on iPhone 14 Pro and Pro Max because of the factory shutdown due to the COVID-19 situation. And so, essentially there was pent up demand as we exited December quarter, they got fulfilled and we also did the channel fill associated with it during the March quarter. So close to $5 billion that I mentioned is entirely related to iPhone. On the gross margin side, obviously, we are at very high levels of gross margin. And I'll repeat what I said before, we've had good expansion over the last few quarters and now we are guiding to 46% to 47% and that takes into account everything that is going on, which is, the commodity environment, which is the foreign exchange situation, and obviously the product and services mix. And the outcome of this is the guidance, which obviously is very strong and we're very happy with it.
Krish Sankar: Thanks a lot, Luca. And then I have a follow-up for Tim. Tim, it was very interesting to hear your comments on enterprise. And historically, Apple has been a consumer centric company. And now with Vision Pro, Mac, it's sort of penetrating more into the enterprise. I'm kind of curious how to think about Apple of the future? Would it still be consumer centric or do you think it's going to be more enterprise focused also as we get into the future? Thank you very much.
Tim Cook: We've really concluded that we can do both. That if you look at it, what has happened over the last several years is that, employees are in a position in many companies to choose their own technology that is the best for them. And so, it sort of took some of the central command from the traditional company and decentralized the decision-making. That is a huge advantage for Apple, because there's a lot of people out there that want to use a Mac. They're using a Mac at home. They'd like to use one in the office as well. iPad has also benefited from that. Vision Pro, it's -- when you look at the ton of use cases, I mean, we're starting with a million apps and 600 plus that are -- have been designed particularly for Vision Pro. When I look at what is coming out of Enterprise, it's some of the most innovative things I've seen come out of Enterprise in a long time. And so, I think there's a like there is for the Mac and iPad, and of course, iPhone has been in enterprise since the early days of iPhone. I think there's a nice opportunity there for Vision Pro as well.
Krish Sankar: Great. Thanks a lot Tim. Very interesting to hear. Thank you.
Suhasini Chandramouli: Thank you, Krish. Operator, can we have the next question, please?
Operator: Our next question is from David Vogt with UBS. Please go ahead.
David Vogt: Great. Thanks guys. And I have two questions as well. So, Tim and Luke, I appreciate the strength in the emerging markets like India and the other names that you kind of listed on the call, but can you maybe spend some time on the Americas? Obviously, that was relatively flat, you touched on China, but what are you seeing in that market from the carriers here in the States? And is the sales cycle elongating or the replacement cycle elongating? And in your view what has to change to kind of maybe re-accelerate that business in the America's, particular in the iPhone business? And then on sort of -- I just want to make sure I understand sort of the guide. So when I think about the $5 billion pull forward last year in the March quarter from a channel fill perspective, even if I back it out last quarter or I back it up this quarter, the March quarter, this would be sort of the softest quarter since the COVID pandemic. Obviously, I know the Americas as I just touched on is a little bit softer than China, which you cleared up earlier. But how do you think about the differences in sort of the macro conditions by region? And again, do you have a sense for are we nearing a trough from a macro demand perspective or how long do you think this particular weakness persists? Thanks.
Tim Cook: Let me take the first part of your question about America. If you look at the U.S., which obviously drives the vast, vast majority of the revenue in America, we grew in the December quarter from an iPhone business point of view and the install base hit an all-time high. If you look at the replacement cycle, it's very difficult to measure the replacement cycle at any given point. And so, what we focus on internally a lot is the active install base and the -- obviously, the sales over usually a cycle and we feel better about those things. If you look at the -- who's selling what in the U.S., the iPhone is four out of the top five selling smartphones in the US. And of course, the customer satisfaction in the U.S. as we alluded to earlier is 99%. So we feel very, very good about what our position is in the U.S.
Luca Maestri: And I would add to that, keep in mind, obviously, the extra week that we had a year ago that obviously makes the compare more -- a bit distorted. On the March quarter guide, I would point to you that, obviously, the COVID years had a lot of, let's say, turmoil in it, a lot of volatility that typically you wouldn't see. If you look at our sequential progression from December to March this year versus pre-COVID versus like a more normal environment, it's actually stronger than those years.
David Vogt: Got it. Thanks, guys.
Suhasini Chandramouli: Thank you, David. Operator, can we have the last question, please?
Operator: Thank you. Our last question is from Ben Reitzes with Melius Research. Please go ahead.
Ben Reitzes: Yes. Hi. Thanks. Appreciate it. Two questions, if I can sneak them in. Just wanted to clarify on China. Tim, I think last quarter you still thought it was a growth market. Obviously, there's some concerns with the -- recently and given what we saw in the quarter, is there something that we can kind of point to where you feel that that market can resume growth in the future? And I'm wondering if you're still upbeat about that prospect. And then I just have a quick follow up.
Tim Cook: Ben, we've been in China for 30 years. And I remain very optimistic about China over the long term. And I feel good about hitting a new install base number, high watermark and very good about the growth in upgraders year-over-year during the quarter.
Ben Reitzes: Great. Thanks Tim. And just in terms of AI, I know you're not going to talk about your plans, but do you believe -- are you a believer in the edge thesis that AI and processing on smartphones and devices like yours is going to have a huge role in AI and AI apps and that it's something you guys can take advantage of.
Tim Cook: Let me just say that, I think there's a huge opportunity for Apple with GenAI and AI. And without getting into to more details and getting out in front of myself.
Ben Reitzes: Thanks Tim.
Tim Cook: Yes, Thanks, Ben.
Suhasini Chandramouli: All right. Thank you Ben. A replay of today's call will be available for two weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0106234 followed by the pound sign. These replays will be available by approximately 5 p.m. Pacific time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142 and financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123. Thanks again for joining us.
Operator: Once again, this does conclude today's conference. We do appreciate your participation. |
QCOM | 1 | 2,024 | 2024-01-31 19:29:08 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Qualcomm First Quarter Fiscal Year 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, January 31, 2024. Playback number for today's call is 877-660-6853. International callers, please dial 201-612-7415. The playback reservation number is 13743224. I would now like to turn the call over to Mauricio Lopez-Hodoyan, Vice President of Investor Relations. Mauricio Lopez-Hodoyan, please go ahead.
Mauricio Lopez-Hodoyan: Thank you, and good afternoon, everyone. Today's call will include prepared remarks by Christian Amon and Akash Palkhiwala. In addition, Alex Rogers will join the question-and-answer session. You can access our earnings release and a slide presentation that have [Technical Difficulty] on our Investor Relations website. In addition, this call is being webcast on qualcomm.com, and a replay will be available on our website later today. During the call today, we will use non-GAAP financial measures as defined in Regulation G, and you can find the related reconciliations to GAAP on our website. We will also make forward-looking statements, including projections and estimates of future events, business or industry trends or business or financial results. Actual events or results could differ materially from those projected in our forward-looking statements. Please refer to our SEC filings, including our most recent 10-K, which contain important factors that cause actual results to differ materially from the forward-looking statements. And now to comments from Qualcomm's President and Chief Executive Officer, Cristiano Amon.
Cristiano Amon: Thank you, Mauricio, and good afternoon, everyone. Thanks for joining us today. In fiscal Q1, we delivered non-GAAP revenues of $9.9 billion and non-GAAP earnings per share of $2.75 above the high end of our guidance. Revenues from our chipset business of $8.4 billion reflect healthy Android demand and continued strong momentum in automotive. Licensing business revenues were $1.5 billion. We're pleased with these results, and I will now share some key highlights from the business. In handsets, the Snapdragon 8 Gen 3 mobile platform is setting a new standard for on-device gen AI experiences for premium smartphones and powers all through flagship Android devices launched and launching this fiscal year. Notably, the Snapdragon 8 Gen 3 mobile platform for Galaxy is featured in the recently announced Samsung Galaxy S24 Ultra globally, in addition to the GalaxS24 and S24 Plus in multiple regions. The GalaxS24-Series includes on-device AI features such as live translate, interpreter, chat assist, nitography and more. This marks the beginning of how gen AI will evolve the overall smartphone experience and highlights the significant opportunity for Snapdragon platforms. We're also announcing that we extended a multiyear agreement with Samsung relating to Snapdragon platforms for flagship Galaxy smartphone launches starting in 2024. The extended agreement demonstrates the value of Snapdragon 8, our technology leadership and our successful long-term strategic partnership with Samsung. In the quarter, we also announced the Snapdragon 7 Gen 3 mobile platform, which brings leading gen AI capabilities to high-tier Android smartphones and is a category leader in both experiences and performance. In our QTL business, we're pleased to share that we recently extended several key license agreements. First, Apple exercised its unilateral option to extend its global patent license agreement for an additional two years, taking the existing agreement through to March 2027; second, we have renewed long-term agreements with two significant Chinese smartphone OEMs. In addition, we continue to negotiate new agreements or renewals with other key licensees and OEMs, including some whose current agreements are set to expire in early fiscal 2025. Automotive continues to be an important pillar of our growth and diversification strategy. Notably, 75 new models launched commercially in 2023 were for technologies, highlighting Qualcomm's grown scale in automotive and execution of our design wins. Earlier this month at CES, we announced our collaboration with Bosch to have our Snapdragon Ride Flex SoC power their new central vehicle computer. As a reminder, Snapdragon Ride Flex enables the fusion of infotainment in ADAS functionalities on a single SoC enabling automakers to realize a unified central-compute and software-defined vehicle architecture that scales across tiers. Additionally, we demonstrated digital cockpits connected services and advanced driver systems enabled by gen AI models running locally on the Snapdragon platform. This new capabilities can be enabled on a number of existing designs via a softer upgrade. This represents significant new opportunities for Qualcomm and our partners. In PCs, we're driving towards the launch of Snapdragon X Elite in mid-2024 and are pleased that our design win traction continues to increase since the platform was announced last October. We expect Snapdragon X Elite to set the industry benchmark for on-device gen AI and copilot experiences in addition to leading performance and battery life for next-generation Windows PCs. We recently expanded our mixed reality solutions with the announcement of the Snapdragon XR2+ Gen 2. Our new platform supports 4.3k per eye resolution and 90 frames per second in 12 or more concurrent cameras to deliver crisp immersive mixed reality and virtual reality experiences. We are proud to partner with Samsung and Google to provide leading XR experiences to Galaxy users by utilizing Snapdragon XR2+ Gen 2. In edge networking, we announced the Snapdragon X35 5G Modern-RF system, the world's first commercial release 17 5G RedCap solution. The Snapdragon X35 brings a new class of purpose-built 5G for Internet of Things devices. Devices powered by Snapdragon X35 are expected to launch by the first half of 2024. We continue to believe that industrial edge devices with connectivity, high-performance computing and on device AI will become one of our largest addressable opportunities fueled by the secular trends of digital transformation. As such, we're accelerating our investments in solutions, ecosystem and broad channel enablement to position ourselves for growth while we navigate the industry-wide inventory draw down. One key area of focus is to enable our customers to unlock the potential of gen AI at the enterprise using our chipset solutions. As an example, Zebra Technologies and Toshiba recently demonstrated on-device gen AI capabilities for enterprise workflows and inventory management at retail self-checkout, respectively. Additionally, Honeywell showcased a Qualcomm-powered edge AI box for warehouse applications. As we complete the first quarter of fiscal '24, ahead of our expectations, I'm very optimistic about Qualcomm's trajectory and the opportunities ahead. The fundamentals of our growth drivers remain unchanged, our diversification strategy is working, and we're making significant progress across mobile, automotive, computing, XR, edge networking, industrial IoT and more. At the upcoming Mobile World Congress in Barcelona, we will provide an update on our seller modem and connectivity leadership as well as on our overall scale of Snapdragon gen AI. I would now like to turn the call over to Akash.
Akash Palkhiwala: Thank you, Cristiano, and good afternoon, everyone. I'll start with our first fiscal quarter earnings. We are pleased to announce strong non-GAAP results above the high end of guidance with revenues of $9.9 billion and EPS of $2.75. QTL revenues of $1.5 billion and EBT margin of 74% were at the high end of guidance, reflecting slightly higher handset units. QCT delivered revenues of $8.4 billion and EBT margin of 31%, both above the high end of guidance, reflecting strength in handsets and automotive revenues. QCT EBT margin includes the benefit of revenue scale, stronger product mix and operating discipline. Handset revenues of $6.7 billion were higher than our prior expectations primarily due to the increased demand driven by the acceleration of Android flagship launches with our Snapdragon 8 Gen 3 mobile platform. Notably, our Android handset revenues from Chinese OEMs exceeded our expectations of greater than 35% sequential growth. IoT revenues of $1.1 billion reflect the industry-wide challenges we've previously outlined. We achieved record automotive revenues of $598 million which grew by 12% sequentially, reflecting the increased content in new vehicle launches with our Snapdragon digital chassis platform. Non-GAAP operating expenses decreased 5% sequentially to $2.1 billion and included the benefit of accelerated implementation of cost actions that we had previously outlined for the first half of fiscal '24. Lastly, we returned $1.7 billion to stockholders during the quarter, including $784 million in stock repurchases and $895 million in dividends. Before turning to second fiscal quarter guidance, I'll update you on global 3G, 4G, 5G handset units. We estimate that global units declined by mid-single digit percentage in calendar '23 relative to calendar '22, an improvement from our prior expectations due to the recent stabilization in demand. For calendar '24, we estimate that global handset units will be flat to slightly up on a year-over-year basis. This estimate includes expected growth of high-single digit to low double-digit percentage in 5G handsets. Turning to guidance for the second fiscal quarter. We are forecasting revenues of $8.9 billion to $9.7 billion and non-GAAP EPS of $2.20 to $2.40. The sequential decline in revenues and non-GAAP EPS relative to the first fiscal quarter will be driven by seasonality for a modem only handset customer in both QTL and QCT. In QTL, we estimate revenues of $1.2 billion to $1.4 billion and EBT margins of 69% to 73%. In QCT, we expect revenues of $7.6 billion to $8.2 billion and EBT margins of 27% to 29%. For QCT handset revenues coming off strong performance in the first fiscal quarter, we anticipate Android revenues will be approximately flat quarter-over-quarter. On a sequential basis, we expect QCT IoT revenues to grow by mid to high-single digit percentage with QCT automotive revenues slightly down, consistent with the trend in the prior year. Lastly, we expect non-GAAP operating expenses of approximately $2.2 billion. This reflects typical calendar year resets for certain employee-related costs. In closing, we're very pleased to start our fiscal year with strong execution and financial performance. In QTL, as Cristiano outlined, we are pleased to have extended several key license agreements. We do not expect any material change in QTL licensing revenue run rate as a result of these extensions. In QCT, our technology differentiation will accelerate with our on-device gen AI leadership and introduction of our custom Qualcomm Orion CPU. We also remain well positioned to execute on our diversification strategy by extending our technology portfolio to deliver industry-leading products across automotive and IoT. This concludes our prepared remarks. Back to you, Mauricio.
Mauricio Lopez-Hodoyan: Thank you, Akash. Operator, we are now ready for questions.
Operator: Thank you. [Operator Instructions] The first question is from Samik Chatterjee with JPMorgan. Please proceed with your question.
Samik Chatterjee: Hi. Thanks for taking my questions and congrats on the results here. Maybe if I can start with AI and particularly the launch of the Samsung S24. Now you have some incremental sort of experience in terms of devices launching in the market and the performance and consumer reception you're seeing to that. So I know you outlined adoption of 3G, 4G, but any way of giving us some flavor of what you're thinking in terms of adoption of these AI devices or AI on edge in terms of the smartphone market? How similar or different will that curve look like relative to 5G adoption? And any insights from the sort of pipeline you're working on will be helpful for us? Thank you and I have a follow-up.
Cristiano Amon: Hello, Samik. Thanks for the question. This is Cristiano. Look, it's early, but I think it's -- we're definitely excited about what we see in the beginning. It's not only unique to the GalasxS24, that has a number of now use cases running gen AI on the device. I mentioned a few of my prepared remarks like translation and you have a much more effective assistance in a number of different applications. We're going to see productivity coming. But we'll also see that happening with some of our other customers from China, launching a number of models. So I think we have a large number now of models being ported into our hardware for gen AI. I think we're starting to see the beginning of new use cases. Reviews have been positive, and we are happy with we've seen the results following the launch. I think we need to monitor the situation. But eventually, at a minimum, is going to have a favorable impact on mix, which is a trend that we continue to see premium and high tier with more computing power -- is the fastest-growing segment in the handset market.
Samik Chatterjee: Yeah. Okay. Got it. And maybe just as a follow-up, the -- and the Android OBX customers of the Chinese OEMs you work with, they exceeded your expectation in the fiscal first quarter -- but as you're looking to the second quarter, you're guiding to a more flattish trajectory here? I know the industry has sort of been looking at inventory refill from those customers as well, driving some of the momentum. So just wondering if you can give us an update in terms of what you’re seeing from those customers? And if at all, Huawei and their reemerges in the market is starting to have an impact in terms of volume or market share for these customers as well in the context of your flat guide for them for quarter-over-quarter? Thank you.
Akash Palkhiwala: Sure. Samik, it’s Akash. As we have said previously, as we entered fiscal ‘24, our view was that Android channel inventory had largely normalized. And so as we go through the year, we typically see normal bill bleed cycle around handset launches. So that’s kind of the phase we are in from our perspective. In the first quarter, what we saw was higher demand due to the acceleration of Android flagship launches with our new chip, Snapdragon 8 Gen 3. And we saw very strong demand across all the major Android OEMs. And so happy, of course, with that traction and that momentum carries over to the second quarter as well. And that’s what you’re seeing both in our results and our guide going forward. In terms of your comment on Huawei, really what we’ve seen since Huawei 5G launch is that the premium tier TAM in China has expanded. And so we’re continuing to see strong demand from our customers post that launch.
Operator: Our next question is from the line of Matt Ramsay with Cowen. Please proceed with your question.
Matt Ramsay: Thank you very much, guys. I guess for my first question, Cristiano, I was fit to hear, I guess, the formal announcement of an extension with your partnership with Samsung. And you mentioned, I think, in your prepared script that it started with 2024 devices, but I assume it's longer than that. So maybe you could give us a little context as to the links and any details you can share on the new agreement. You guys obviously have your new custom CPUs coming into the Snapdragon road map and some expanded MPU product as well. So we see kind of what the split is of share in the flagship at Samsung currently, but I'm just trying to understand a bit more about what this means for on a go-forward basis. Thanks.
Cristiano Amon: Thanks for the question, Matt. The agreement that we announced at this earnings call, it is a multiyear agreement. We're not disclosing the duration, but there are several years into that agreement. And I think your observation is correct. I think it starts in 2024. I think as you look at the launch of GalaxS24 is a good proxy on how we should think about the agreement between us and Samsung. But most important is the thing that you outlined. Our road map is getting stronger over time, especially with our custom CPU coming to mobile, and we're aiming to have the leadership position in the mobile performance on CPU. And our NPU continue to expand as we -- as I mentioned before, we're just at the beginning of the gen AI transition. I think in summary, we're very pleased our relationship with Samsung, and it's a very long-term relationship with this customer.
Matt Ramsay: Got it. Thank you for that. I guess my follow-up question is one for Akash, first of all, Akash, congratulations on the new COO hat. Well done. But my question is around margins. And I noticed that even with the IoT business down dramatically, there was some improvement in sequential gross margin in the quarter and back above 30% in QCT operating margins. So maybe you could discuss some of the moving parts with margins in the business because it was a -- pleasantly a bit better than I had modeled, and I kind of want to see what might be sustainable or what actions you took on a go-forward basis on both the gross and the operating side. Thanks.
Akash Palkhiwala: Thank you, Matt, and thanks for our wishes. I'm looking forward in this new role to working with Cristiano and the executive team to kind of deliver on our long-term priorities. And of course, I'll continue to remain committed to my CFO role, working closely with the team here and maintaining consistency and transparency and looking forward to seeing a lot of you at upcoming events. On the margin side, what you saw in the first quarter is really the fact that our gross margins were stronger because the mix was richer (ph). We had a higher set of premium tier launches coming through and that impacted our volume, and we benefited from that mix -- richer mix. And if you look at our second quarter guide, we are guiding largely in line with how our first quarter came in. So that was obviously great to see. From an operating margin perspective, it's -- in addition to the strength in the gross margins obviously, the revenue scale and the actions we took on the OpEx also benefited. And so we were happy to -- extremely happy to deliver 31% operating margin in QCT and really focused on delivering to the long-term target we’ve outlined to the investors.
Operator: Our next question is from the line of Mike Walkley with Canaccord Genuity. Please proceed with your question.
Mike Walkley: Great. Thanks for taking my question and congrats on extending some of the licensing deals. I guess, just want to jump a little bit into the IoT business, the three segments, I assume, consumer is still weaker. But can you update us kind of how the inventory bleed is trending for the three business within IoT? And then within that question too, just on the recovery of IoT, share with us the X Elite ramp and how material this might become for IoT, say, in the next one to two years?
Akash Palkhiwala: Maybe I'll address the first part and then Cristiano can talk through the X Elite question. From an IoT entry perspective, what we have seen is stabilization really on the consumer side. As you know, we were one of the first to call out the weakness in IoT, and now we're seeing it go through both on the industrial and the edge networking side. And consistent with our previous comments, we think the first quarter was the bottom for our IoT revenue stream. We're guiding second quarter up mid to high-single digits. Second half of the year -- fiscal year, as we see the inventory channel kind of normalizing and end markets kind of benefiting from that -- we're excited about what our product portfolio can bring and overall, lots of opportunities for us. So over -- in my mind, there's significant uncertainty, but we are cautiously optimistic, and I think we have a great product portfolio as we look forward.
Cristiano Amon: Look, your question about X Elite and in PC. It's too early. We're tracking to the launch of products with this chipset tied with the next version of Microsoft Windows that has a lot of the Windows AI capabilities. We're still maintaining the same date, which is driven by Windows, which is mid-2024, getting ready for back-to-school, what we're excited about it is since we announced that Tech Summit showing the performance of the product and the AI capabilities, design traction continue to increase. So we had increased the number of designs since last quarter. and we continue to march forward towards the launch. We like that everybody is now talking about on-device AI on PC. That's where we started this journey with X Elite. And I think that proved to be a tailwind to the opportunity for us in PCs.
Mike Walkley: Great. Thanks. And maybe Cristiano, just a quick follow-on question. Just on the auto business, how should we think about the ramp of that business over the next one to two years? You've talked about a lot of design win activity and digital chassis ramping this year, but with ADAS coming into the model, how might that business ramp towards your target in 2026.
Cristiano Amon: No, absolutely. Thank you for your question. Look, let me step back a little bit and say we're extremely pleased with our performance in auto, especially when you look at the overall market. Right now you can look at Qualcomm results with record revenues and very strong, I think, year-over-year growth. In 2023, in this year that just closed, we launched 75 models with our silicon with a significant improvement in silicon content as it relates to those immersive cockpit and in many cases, processing for safety. So we're very happy with the business. And I think the answer to your question is, we are on track to meet our target that we said on the Auto Investor Day of $4 billion and $9 billion, respectively, I think for ‘26 at the end of the decade. So we’re on track for that. And the next quarter, we’re going to give you an update on the design win pipeline that continues to grow.
Operator: Our next question comes from Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi, guys. Thanks for taking my question. So given that you've got Android, Android was pretty strong in December, and it's flat into March. How are you thinking about June seasonality given all these trends and moving pieces? I know it's usually down a bit for March, but I guess in the current what are you thinking about June seasonality.
Akash Palkhiwala: Stacy, it's Akash. No change to the shape of the year comments that we made last time. Following second quarter, we do expect third quarter to be the lowest quarter. It's one of the quarters where we do not have any significant flagship launches. And as a result, you kind of see a decline in third quarter then growth back into the fourth quarter. And it's -- when you look at second to third quarter, we expect a trend consistent with the last two years. First half, obviously benefited from this acceleration of launches for Android and pretty happy with that. And I think it sets us up as we look forward in terms of both content growth with our strong road map and just positioning overall in the handset market.
Stacy Rasgon: Got it. Thank you. And so my follow-up, I just want to ask about Huawei -- was Huawei still completely out of the model in December? And is it out of the model in the March guidance?
Akash Palkhiwala: Yeah. So as we’ve said in the past, Stacy, we do have a 4G license to ship Huawei and so we’ve continued to ship based on customer demand. But as you’re aware, they have launched a 5G device with their own chip, and that’s, I think, the priority going forward.
Operator: Our next question is from the line of Chris Caso with Wolfe Research. Please proceed with your question.
Chris Caso: Yes. Thank you. I guess just a question on QTL and coming from your comments about the global handset market, it sounds like you're a little more optimistic on the 5G market on the year, QTL revenue has been kind of stuck in this range because of where handset units have been. Do you -- I guess what's the outlook for QTL going forward in the context of what you're expecting for the handset market overall.
Akash Palkhiwala: Yeah. So as we outlined for our handset market, when you look at calendar '24, overall market, we expect it to be flat to slightly up. But within that, 5G, obviously, is our target market, especially for the chip business, we expect that to be high-single digit to low double-digit up on a year-over-year basis. Within QTL, I will stick with the guidance we have given before. We think there's a scale to the business that's aligned with the handset market and the 2 will move in line. And then on the extensions of the license, I just wanted to make sure that I said this in my prepared remarks, but just to confirm, as a result of the extension, we do not expect any material change in our QCT licensing revenue run rate. So it's consistent with the program. In the QTL licensing revenue run rate, it's consistent with the program.
Chris Caso: Okay. That's helpful. As a follow-up, Cristiano, I wonder if you could speak to sort of the decision to reengage in custom cores with Orion and what outcome you expect that? I mean, it sounds like that's been one of the reasons or one of the things behind the renewal of the Samsung agreement. What sort of change in the market because Qualcomm did custom cores in the past? And what do you expect to get out of that in terms of market share and content and such?
Cristiano Amon: Thank you, Chris, for your question. Look, it's consistent, I think, with the strategy we outlined, I think, following the acquisition of Nuvia. In the past, Qualcomm has been designing now its own custom course. And I think the first instantiation of that was for PCs. Actually, if you remember, in the past, that was the key motivation as we embark on this journey to create a leading SoC for laptops for the Windows ecosystem. We needed to have the performance leadership and we needed to design our own CPU to deliver the results that we did with X Elite. Now we're taking that across the entire road map. Your observation is correct. As we take that into mobile next, we're seeing significant interest from our partners as it truly becomes a leadership position in the marketplace now across all course, not only graphics and AI but also CPU. And we’re not stopping there, following smartphone that’s going to go into our automotive business, and we’re excited about what the team has accomplished to date. Orion is really well positioned to be the leading CPU core in the industry.
Operator: Next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. Can you talk about restocking in China? It looks like the China Android obviously, it was up a ton and it's being guided flat. Your peer was a bit cautious on this. Can you talk -- do you think you're shipping that to consumption? And do you think you're going to ship to consumption through the rest of the year? And then I had another question.
Akash Palkhiwala: Yeah. Tim, consistent with what I said earlier in the call, I think we were kind of largely at normalized inventory for Android entering the fiscal year. What you saw in the December quarter, at least for us, to a large extent was a build for the various premium tier launches that happened during the period. And so we do expect normal bill bleed cycles through the year as devices launch. But that's kind of the framework with which we are operating going forward.
Timothy Arcuri : Got it. And then now that you have the modem for longer for this one flagship customer, one can envision a scenario where maybe you can leverage that into some new RF content that you have not had in the past. Is this a scenario? I mean, it seems like it could add $1 billion maybe. I mean you were sort of running to $4 billion a year in your RFFE business prior to stopping to tell us what that is. So it seems like that is something you could potentially leverage the reliance on your modem business? Thanks.
Akash Palkhiwala: Yeah, Tim. I’d say that’s a conversation, obviously, that we will talk to the customer about. It’s a part of our portfolio, and we’ll make it available if they’re interested.
Operator: Our next question is from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi. Thanks for a couple of questions and Akash, congrats on the COO role. The first one is on the OpEx side of things. You guys did a great job in the calendar fourth quarter and you gave the guidance for the fiscal first or fiscal second quarter, how should we think about that for the remainder of the year, given your commentary on kind of doubling down on some of the opportunistic investments to diversify the company, new cores, etc.
Akash Palkhiwala: Yeah, Ross. Thank you very much. From an OpEx perspective, really, the way we think about it is any hiring that we do will be very selective and focused on really acquiring new skills that are required for diversification. But other than that, we've gone through a reduction recently. We think we're at scale to a large extent, and we're committed to operating discipline.
Ross Seymore: Great. And I guess for my follow-up, I noticed in the 10-Q, you had a new 10% customer, I think it was a 14% customer. I don't expect you to name who that is. But is that a reflection of the strong China demand that you talked about in the continuation of good future growth opportunities or was there any onetime aspect of that customer, whoever it may be popping up in the quarter?
Akash Palkhiwala: I think the you framed it in your first theory is a reasonable way of thinking about it.
Operator: Our next question is coming from the line of Tom O'Malley with Barclays. Please proceed with your question.
Tom O'Malley: Thanks for taking the question. Just passing on my congratulations to Akash as well. I just wanted to ask on the ASP side for Android. You're obviously kind of characterizing the market that's flattish into March, kind of the bottom in June and then improving from there. But you benefited from some good mix in the beginning of the fiscal year here. Could you talk about what you would expect from a mix perspective as you go to the back half? Would you see the same kind of strength on the ASP side that you've kind of seen over the past year? That would be really helpful to understand. Thank you.
Akash Palkhiwala: Yeah. So if you think about premium flagship launches for our OEMs, a lot of the launches happen in the holiday time frame just before the holidays going into Chinese New Year as well. And so you've seen a lot of those happen. We do have some significant launches through the middle of the year, but obviously, the next big launch goes into the holiday season, starting with Apple and then going into the Android launches. So that's a typical cadence. Now when -- just to confirm, just the premium tier we are talking about. Of course, there are other tiers and including the high tier, where we have very significant presence and that does drive a significant portion of our -- the launches that happened through the year and also our revenue base.
Tom O'Malley: Helpful. And then just on the auto business, you've clearly seen some weaker data points just out of the ecosystem. Can you explain why your auto business may not be levered to some of like the ADAS areas where you've seen the particular weakness of late? And like when do those ADAS and win start layering on? Is that more of like a '25 story for you guys or '26. Just can you talk about the pipeline and when you see those more advanced wins kind of layering into the to the revenue stream? Thank you.
Cristiano Amon: Hi. This is Cristiano. Look, the automotive story of Qualcomm is primarily driven by share gains as models with our silicon part of our pipeline started to materialize into revenue. And the way you should think about it, historically, a lot of the revenue was telematics, now you see the largest component been a lot of the fully immersive digital cockpits on the car. And we already have some revenue from ADAS processing. You see a lot of cars for example, in China with both ADAS and autonomy with our processor, you see some of our customers in the United States of our processor. And I think that continues to grow as we get towards our 2026 revenue target, you’re probably going to see very healthy components of all of those elements.
Tom O'Malley: Thank you.
Operator: Our final question is from the line of Tal Liani with Bank of America. Please proceed with your question.
Tal Liani: Thanks. I have two follow-ups on answers or questions you had before. The first one is Samsung. On one hand, there is a new contract. On the other hand, Samsung is going to use their own more in '24 versus '23. So net-net, are you expecting revenues of Samsung to go up or down in '24 versus '23? What are your expectations of share losses within -- can you frame it for us? And the second question is on the auto business. You had a phenomenal quarter. It's very different from the other auto companies, most of the other (ph) companies had weakness. What is the strength related to meaning is it share gain with certain customers? Is it new product or can you just put some color on the strength, the relative strength versus the others? Thanks.
Akash Palkhiwala: Yeah, Tal. Ut's Akash. So on this -- on Samsung and this is a conversation about the premium tier, I assume. In GS23, we did have global share. In the GS24 that just launched and consistent with what we said on the last quarter, we expect to have a majority share based on the model split between us and [indiscernible]. As Cristiano indicated in his prepared remarks, one of the benefits of the agreement that we did with them is it gives us predictability on our position within the premium tier going forward. And then from a content perspective, there's clearly content expansion happening. And this is really when you look at our premium tier road map, not just with gen AI coming in our custom CPU course coming in as well, but then also across other technologies. As consumers demand more capability, we see our content and our ASP both continue to grow. Switching over to your second question on automotive. You should really think -- the way to think about our automotive business is we're tied to the launch of new cars. Clearly, the industry is going through a transformation, digitization of cars, and we are right at the intersection of that transformation. We are we're benefiting our cars put in more infotainment content for experience within the car. More ADAS content comes into the car as well. And really, we get to benefit from all those intersection points in the car, and we're increasing the content as new cars launch. So that's the maybe a disconnect between some of our peers what they're seeing and what we're seeing. Stepping back, I mean, clearly, this is an industry that's going through some shorter-term dynamics, so we'll be closely monitoring it. But when you step back, our technology, our position, our products look really good, and we're excited about where we're going.
Operator: Thank you. That concludes today's question-and-answer session. Mr. Amon, do you have anything further to add before adjourning the call?
Cristiano Amon: Yes. Just in closing, I'd just like to remind everyone, look, we're as I said, we're happy with the quarter. We see the android market stabilizing after we've been to '23. That was a year of correction. We like the transition of user experience with gen AI that could create an opportunity in mobile. This is one of those times for Qualcomm. They are both our Apple and Samsung revenue on the chip side or under contract. We're very happy about that. We continue to move towards stability of the QTL revenue stream with those new agreements. As you look at the growth opportunity, I think the auto results speak for itself. We're now in the IoT segment, really focus on the launch of X Elite. In the PC, we announced a new product for XR. And if you believe that, that market is finally going to get very large scale, we're well positioned with our partnership with Meta as well as Samsung and Google. And as IoT, especially industrial goes to the correction, we expect that to resume growth. So we're focused on what we can control, busy work with the growth and diversification of the company. And I want to say a big thank you for all of our partners and employees they help us get to this quarter. Thank you very much, and I talk to you all next quarter.
Operator: Ladies and gentlemen, this concludes today's conference call. You may now disconnect. |
SBUX | 1 | 2,024 | 2024-01-30 21:50:19 | Operator: Good afternoon. My name is Diego and I will be your conference operator today. I would like to welcome everyone to Starbucks’ First Quarter Fiscal Year 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now turn the call over to Tiffany Willis, Vice President of Investor Relations. Ms. Willis, you may now begin your conference.
Tiffany Willis: Thank you, Diego, and good afternoon, everyone, and thank you for joining us today to discuss Starbucks' first quarter fiscal year 2024 results. Today's discussion will be led by Laxman Narasimhan, Chief Executive Officer, and Rachel Ruggeri, Executive Vice President and Chief Financial Officer. And for Q&A, we will be joined by Belinda Wong, Chairwoman and Co-Chief Executive Officer of Starbucks China, and Brady Brewer, Executive Vice President and Chief Marketing Officer. This call will include forward-looking statements, which are subject to various risks and uncertainties that can cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factors discussed in our filings with the SEC, including our latest annual report on Form 10-K and quarterly report on Form 10-Q. Starbucks assumes no obligation to update any of these forward-looking statements or information. GAAP results in the first quarter fiscal year 2024 and the comparative period include several items related to strategic actions, including restructuring and impairment charges, transaction and integration costs, and other items. These items are excluded from our non-GAAP results. All numbers referenced on today's call are on a non-GAAP basis unless otherwise noted or there is no non-GAAP adjustment related to the metric. As part of our non-GAAP results, revenue, operating margin, and EPS growth metrics on today's call are measured in constant currency. Current period results, however, are converted into United States dollars using the average monthly exchange rates from the comparative period rather than the actual exchange rates for the current period, excluding any related hedging activities. For non-GAAP financial measures mentioned in today's call, please refer to the earnings release and our website at investor.starbucks.com to find reconciliations of those non-GAAP measures to their corresponding GAAP measures. This conference call is being webcast and an archive of the webcast will be available on our website through Friday, March 15, 2024. Also, for your calendar planning purposes, please note that our Second Quarter Fiscal Year 2024 Earnings Conference Call has been tentatively scheduled for Tuesday, April 30, 2024. And with that, I'll now turn the call over to Laxman.
Laxman Narasimhan: Thank you, Tiffany, and thank you all for joining us this afternoon. I will start by sharing an overview of our business performance in our first quarter of fiscal 2024. I will then turn it over to Rachel Ruggeri to walk through the detailed segment results. We saw strong momentum and a highly successful holiday in the quarter with record revenue and expanded margins. We saw strong growth in our loyalty programs, sequentially increased in frequency and record spend among our loyal customers. Positive traction from new product innovations, exciting momentum in China with our focus on premium, and progress on the execution Triple Shot strategy. We also saw some unexpected headwinds which impacted the rate of growth. We feel very confident about our robust plans to address these challenges. While we are already seeing traction, there was an impact in the quarter, and it will take some time to normalize. Let me walk you through the details. Our performance in the quarter was fundamentally strong. Our Q1 total company revenue was a record $9.4 billion, up 8% year-over-year. Our global comparable store sales grew 5% year-over-year, supported by a 5% comp growth in North America, driven by 4% ticket growth, and 10% comp growth in China. Our global operating margins expanded by 130 basis points to 15.8% and our overall earnings per share grew 20% to $0.90. This speaks to the continued successful execution of our reinvention plan and the durable business we are building. We are fortunate to have built one of the strongest brands in the world and we continue to benefit from customer loyalty. Throughout the quarter, we saw our most loyal customers around the world coming into our stores more often. Specifically in the US, we set new records with our 90-day active reward members growing 13% year-over-year to a record 34.3 million, with tender reaching an all-time high of 59%, demonstrating increased engagement. Importantly, the frequency of our most loyal customers increased sequentially and spend per member reached a record in Q1, fueled by our holiday promotion which significantly exceeded our expectations. Our cold and gingerbread platforms drove a record high ticket in the US in the quarter. We also had the highest sales of Starbucks gift cards in our history, making us number two in gift cards sold. In total, we have an incredible $3.6 billion preloaded onto our cards in the US in the quarter. In short, our growing Starbucks Rewards members are visiting our stores more frequently and increasing their spend each time that they come. We also saw great momentum in China. We aim to be the best in the premium market in China. Our brand equity across Starbucks and Starbucks Reserve is second to none. Based on our latest brand tracker, Starbucks continues to be the first choice in away from home coffee, including among the Gen Z consumers. We continue to lead in brand affinity and have the highest awareness, brand familiarity, and purchase-intent scores. We have the most outstanding partners in our stores, with very strong customer connection, and the highest retention rates in our industry. We offer distinctive global and locally relevant product innovation anchored on superior coffee with food attachments and a morning daypart that now has surpassed pre-COVID levels. Our loyal customers, a major part of tender, are coming more often, and our loyalty program is growing. We're doing all of this while offering premium physical and digital experiences delivered across our distinctive store portfolio, across other physical channels and through our digital connection and doing so at a commensurate value. This ambition being best in premium in China is in line with our long-term growth ambitions for China. Let me now talk about the headwinds and our response. We entered the first quarter very strong globally, we had great momentum in August and September and that continued into October, which exceeded our expectations across every measure. Beginning in mid-November, while our business continued to grow, the growth rate was impacted by three unexpected factors. First, we saw a negative impact to our business in the Middle East. Second, events in the Middle East also had an impact in the US, driven by misperceptions about our position. Our most loyal customers remained loyal and in fact increased their frequency and spend in the quarter. But we did see a softening of US traffic. Specifically, our occasional US customers who tend to visit in the afternoon came in less frequently. I will speak in a moment as to how we quickly responded with an effective action plan. Finally, we experienced a slower than expected recovery in China, driven by a more cautious consumer. While we had a relatively very strong 11/11 holiday, the overall market weakness led to significantly increased pricing competition. We responded quickly to these headwinds. In the US, we implemented targeted offers aimed at bringing our occasional customers into our loyalty program. As we've seen over time, Starbucks Rewards members develop a routinized long-term relationship with our brand that increases both ticket and transactions. Additionally, we activated new capabilities within our proprietary deep Deep Brew data analytics and AI tool to identify and incentivize specific Rewards members cohorts. Finally, we are leaning further into our brand marketing and factual narrative and social media to engage these audiences where they are. We've already seen the positive impact of these new initiatives with our more occasional customers beginning to rebound in December. However, we continue to see further opportunity to welcome back our very occasional customers. We feel good about the trajectory over the course of the quarter, but it will take time for our plans to be fully realized. In China, we remain very confident in the long term. The market is going through a transition as we see an increase in mass market competitors, which we believe will shake out over time, and the market will emerge looking fundamentally different than what we see today. We expect a much larger and tiered market as per capita consumption continues to increase and the market matures. There are three key elements in our China strategy. First, we are offering more coffee forward, locally relevant product innovations and we're increasing engagement in social media channels through influences and partnerships, which are highly effective in China. These actions are increasing awareness and have led to greater customer frequency. Second, we have made significant investments in technology, increasing our omni-channel capability, allowing us to serve more customers through new occasions. These investments have also led to a more digitized store environment, increasing efficiency of our supply chain and stores, while enhancing the partner experience and strengthening our unit economics in both existing and new stores. Finally, we're increasing the percentage of new stores opening in lower tier markets and new county cities, where we see meaningfully stronger new store economics. As you can see, we moved quickly to respond and implement a plan to address these unexpected headwinds. It will take time for these action plans to be fully realized. That said, we remain confident in our Triple Shot strategy and our long-term growth. So let me share some of the progress in the quarter. Our first Triple Shot Reinvention priority is to elevate our brand by operating great stores and driving product innovation. The best lever for elevating our brand is our store experience. We continue to raise the bar on running great stores with a focus on enhancing both our partner and customer experience. One example is the continued rollout of our Siren System cold and food stations. We remain on track to have approximately 10% of our stores equipped with a Siren System by the end of this year. We are a coffee company, and we will continue to lead with coffee innovation. We're continuing the installation of our Clover Vertica in nearly 10% of our US company-operated stores in the quarter. We are on track to have on-demand single-cup brewers installed in nearly 60% of our US company-operated stores in fiscal year 2024. This will continue to elevate our coffee offering while also making partners more productive by reducing waste and creating efficiencies in store, allowing them to spend more time doing what they do best, connecting with our customers. Just imagine, a perfectly brewed on-demand cup of coffee at any time throughout the day, even decaf. This quality and the offering are like no other in the industry. We also continue to offer coffee blends which are distinctive and remind people of the romance of coffee. Our Verona blend is anchored in the essence of Verona, Italy. It was our tribute to the city of romance in Italy. In celebration of our five years in Italy, we will introduce a new coffee, Starbucks Milano Roast, inspired by the art and culture of Milan. Milan's miart, an international modern and contemporary art fair, is the perfect backdrop to a launch in our Milan Roastery that will then scale globally. The moment will capture our love of coffee, the passion of our partners, and the dynamism of Milano. Today, we're excited to launch the Oleato platform with Oleato customizations across the US. In the coming weeks, we will also launch Chocolate Covered Strawberry Creme Frappuccino and a Chocolate Hazelnut Cookie Cold Brew in time for Valentine's Day. Starting this week and continuing over the next few months, we will be introducing three new beverage platforms, each of which is squarely aimed at our Gen Z and millennial customers across a range of coffee and cold beverages and compelling for the afternoon. These product innovations are examples of how we continuously elevate the brand and welcome customers back with a unique Starbucks experience. We're also offering new and exciting options beyond coffee, including food that appeals to different dayparts, especially the afternoon. In January, we added new menu items, including the Potato, Cheddar & Chive Bakes and the Chicken, Maple Butter & Egg Sandwich. These are products that tide our customers over between lunch and dinner. Importantly, our digital experience makes attaching food to afternoon drink orders easy and convenient. We've seen a very positive customer response to these new items and we are expanding inventory to meet the strong demand. We're also pleased with the pace of our new store openings and strong unit economics. Our most recent age class of company operated new stores in the US is averaging unit volumes of approximately $2 million with ROIs of approximately 50%. And as we continue to open more stores, growing by approximately 4% this year in the US on a base of over 16,000, including licensed stores, we will further invest in purpose-built stores to meet our customers where they need and want us to be. This includes drive-throughs which have grown by over 500 stores since Q1 of last year. Even in the US, we see abundant greenfield opportunity ahead. Our second strategic priority is further strengthening and differentiating our leadership position in digital. We saw our mobile order and pay surpass a record high 30% of all transactions in the quarter. And we reduced downtime of mobile order and pay by half, as we continued to find ways to deliver a better customer experience. We'll continue to make the Starbucks app even better, including adding the ability to use a personal cup in ordering through the app, and the rollout of more accurate order wait times. We're also laser focused on ensuring our customers can personalize their orders in whatever way they want. One example is helping customers find products based on dietary needs. We saw record results in our US delivery business with growth of nearly 80% year-over-year, aided by our expanded partnership with DoorDash. We see significant growth for continued incremental growth as delivery represents only 2% of our transactions. Our purpose-built stores optimized for delivery and fulfillment help seize this opportunity. Additionally, we are conducting a pilot with Gopuff, targeting a fully incremental opportunity for overnight orders between 5:00 PM and 5:00 AM. In this pilot, Starbucks trained baristas prepare handcrafted Starbucks drinks and food inside Gopuff micro-fulfillment centers, delivering to the customer's door in about 30 minutes. To further expand the reach and impact of mobile ordering and rewards, we now offer Starbucks Connect in over 40% of our more than 6,700 US licensed stores with further expansion planned for this year. We're also pleased to share that Bank of America will be our next Starbucks Rewards partner, delivering even more value to our most loyal customers. This opportunity builds with the great success of our partnership at Delta Airlines that is deep in connection and engagement with our members, and is one of two new Starbucks Rewards partnerships we told you we would roll out this year. Our third strategic priority is becoming truly global. Our international business represents an important growth opportunity for us over the long term. If you look at our business excluding the headwinds, we had a strong quarter, demonstrating the momentum and resiliency across the portfolio. We opened over 420 net new stores in the quarter, a growth of 10% year-over-year, bringing total store count to over 20,600 stores with nearly 14,000 of those stores outside of China and the US. In Japan, we reached a milestone of 1,900 stores across the market with much opportunity ahead. Let me address our business in the Middle East. I am deeply distressed by the violence shaking the region. As I have shared, Starbucks condemns violence against the innocent, hate and weaponized speech. We are intensely focused on supporting our partners and the many other stakeholders affected by what is taking place. We have seen a significant impact on traffic and sales in the region, and we are working with our licensees during this time to ensure the safety and well-being of our partners and our customers. I shared earlier in my remarks how we are addressing the near-term situation in China. Overall, our business and brand in China remain strong. Our revenue in the quarter grew 20% in constant currency, underpinned by a 10% increase in comparable store sales growth as the market lapped prior year mobility restrictions. As we strengthen our position in the premium market in China, let me point to a few accomplishments of the quarter. We launched 12 new coffee forward beverages in the quarter, including Intenso, which was incredibly popular with our customers, including Gen Z, fueling the morning daypart, which is now larger than pre-COVID levels. Our digital channels accounted for a record 52% of sales, up 4 percentage points quarter-over-quarter. Our Starbucks Rewards Gold member frequency increased by nearly 10% over the prior quarter with total member engagement setting a record 73% of tender, demonstrating the stability of our most loyal customers. Our new stores continue to deliver attractive returns on both the top line and profitability, with further strength in unit economics in stores opened in new county cities. And our turnover amongst full-time store partners reached a record low in the quarter, coupled with an all-time high partner satisfaction score. Early this month we celebrated our 25th anniversary in China. With nearly 7,000 stores, we have built a durable business. We have built a terrific brand, and we are well on track to hit our 9,000 store target by 2025 and continue to have full confidence in the market opportunity. We continue to see enormous potential in China's premium market, and no one is better positioned to lead in this space. Even as we navigate a dynamic environment, we remain confident in our long-term growth in our international segment. As part of elevating our brand across the international segment, along with a second reserve store in India, we will open two additional Starbucks roasteries that celebrate coffee, art and design in markets outside the US and China. We will announce these locations and opening timings in due course. Turning to our fourth priority, we've focused on unlocking $3 billion in efficiencies, and I'm pleased to say that we're making steady progress. Our Triple Shot Reinvention efforts delivered 130 basis points of margin expansion in the first quarter of the fiscal year. As you've heard me say often, the key to our success is the experience that our partners create for our customers. We're investing in a better experience for our partners to advance our business through a more balanced growth model as we unlock efficiency. In the quarter, we have seen the effectiveness of the reinvention-driven investments we have made in in-store operational efficiencies, such as standards, equipment innovation, and scheduling improvements, leading to a more stable environment for our partners. Turnover has decreased by 5% year-over-year and is now well below pre-COVID levels. Average partner hours increased 10%, leading to a 14 percentage point increase in partner sentiment related to scheduling, specifically preferred hours, which we know is important to partners. We are listening to our partners and investing to make their experience better. Of course, we have more work to do, but we are proud of the progress we have made to date. Outside of our stores, we're working to drive efficiencies across our supply chain and expenses. I am pleased with the progress and we remain on track to unlock [few billion] (ph) dollars in efficiencies over the next three years. Our final priority is reinvigorating our partner culture. In addition to the investments in partner experience, we're focused on partner culture. Our leadership team and Board of Directors have been deeply engaged in putting the partner experience at the heart of the business. An independent assessment found that our strategic investments, greater on the ground support, a dedicated labor relations team, and more bespoke management trading are having a tangible impact on the commitments we've made to our partners. The assessment was also clear that there has been no union busting playbook at Starbucks. I want to be clear in my view on the matter of unionization at Starbucks. We believe in a direct relationship with our partners, and in the 4% of our stores in the US where our partners have chosen to be represented by a union, we are committed to finding a constructive path forward with those unions. I care deeply about our partners, their experiences and safety at Starbucks and their futures. Our partners remain core to the success of our business. And I am proud to be restitching the fabric of the green apron for all partners. Going forward, we plan to continue to focus deeply on reinvigorating our partner culture. It's a priority for me and I'll continue spending time each month working up close, shoulder to shoulder with partners in stores. I did this during my visit to India earlier this month and I will continue doing it to stay grounded in the realities of the business. Good and not so good. I'm also proud to have earned my Coffee Master black apron along with my executive leadership team. A deep connection to partners and to coffee is a top priority for me and for every leader at Starbucks. As you look ahead to what is brewing for Starbucks in 2024, I have great optimism. We have a strong strategy. Our refreshed mission, values and promises are underpinning everything we do. We have many strengths to build on and a clear plan to navigate this dynamic environment. While it will take time, we are confident we have significant headroom to further grow top line and bottom line in the long term and invest in our partners and the business while delivering strong shareholder returns. Finally, before I turn this over to Rachel, I want to remind everyone that Starbucks is focused on human connection. We stand for belonging. We stand for joy. We stand for humanity. That is what differentiates our brand and our business and has for the last 52 years. We believe this has never been more important in the world. And with that, Rachel.
Rachel Ruggeri: Thank you, Laxman, and good afternoon, everyone. Let me start by saying that I am so proud of the significant margin expansion and double-digit earnings growth we delivered in our first quarter despite the top line headwinds we experienced. Our strong focus on reinvention continued to unlock efficiencies, driving a balanced outcome where both revenue growth and margin expansion drove our earnings growth. As we have shared, we are unlocking multiple paths to support our earnings growth over the long term, creating a more durable business and this quarter proved testament to that durability. Our Q1 consolidated revenue reached a record $9.4 billion, up over 8% from the prior year, even with the confluence of factors adversely impacting our business, as Laxman discussed in detail at the top of our call. The revenue increase was driven by 5% comparable store sales growth, 8% net new company operated store growth, as well as a 6% increase in our global licensed store revenue over the prior year, underscoring the strength of our broader portfolio and our execution. Q1 consolidated operating margin expanded 130 basis points from the prior year to 15.8%, primarily driven by sales leverage and reinvention-related in-store operational efficiencies, partially offset by our continued investments in our partners. Our reinvention has successfully driven resiliency in our business, with our North America margin expanding a notable 280 basis points in the quarter, which I will discuss in further detail in a moment. Q1 EPS was $0.90, up 20% from the prior year. Our strong double-digit EPS growth in the quarter demonstrates multiple paths to drive growth and profitability. I'll now provide segment highlights for Q1. North America delivered another quarter of record revenue in Q1 with $7.1 billion, up 9% from the prior year, driven by a combination of a 5% increase in comparable store sales, inclusive of a 4% and 1% increase in average ticket and transactions respectively, as well as net new company operated growth of 4% over the prior year. Our US licensed store business also contributed to the segment's growth from increased travel and further rollout of our Starbucks Connect program. Our US company operated business delivered 5% comparable store sales growth in Q1, driven by 4% ticket growing from pricing, mix, and customization. This led us to having our highest average ticket in our 50-plus year history, as our successful holiday innovation and complementary product offerings, including our new Chai Tea Latte and Sugar Plum Cheese Danish, resonated with customers. Comparable transactions for the quarter increased 1% as traffic was pressured to negative single digits in November before it started to rebound in December. In light of the pressure traffic, and as Laxman mentioned earlier, customers showed strong loyalty through our Starbucks Rewards program with record engagement and the highest ever spend per member. North America's operating margin was 21.4% in Q1, expanding 280 basis points from the prior year, driven by 240 basis points from reinvention-related in-store operational efficiencies, as well as sales leverage and pricing, partially offset by continued investment in our partners. This substantial margin expansion in the quarter reflected the meaningful labor staffing and scheduling improvements we made as part of our reinvention. We unlocked significant stability by focusing on staffing and scheduling hours based on partners preferred shifts, which enhanced both our partners experience and subsequent store performance. We saw a store efficiency increase as items per labor hour reached its highest levels in the quarter. Outside of stores, we reaped the benefits of enhanced sourcing and waste reductions in the first quarter, as seen by improvement in the segment's product and distribution costs. When you think about the operational efficiencies that continue to manifest both in and out of stores, we expect to continue delivering progressive margin expansion. Moving to international. The segment delivered $1.8 billion in revenue in the quarter, up 12% from the prior year. The revenue growth was driven by a 12% increase in net new company-operated stores year-over-year, as well as a 7% increase in comparable store sales, driven by 11% transaction growth, partially offset by a 3% decline in average ticket. As Laxman mentioned, the pace of recovery in China was slower than expected. That, coupled with a negative impact to our business in the Middle East, pressured our international segment as a whole. However, we continue to see these headwinds as transitory and remain committed to our long-term growth ambitions in the segment. In Q1, China's revenue grew 20%, driven by 15% new store growth, as well as a 10% increase in comparable store sales growth, including 21% transaction growth, largely related to the market lapping prior year COVID impact. Comparable ticket, however, declined 9% due to mix shift, including lower sales of merchandise and increased promotional environment. The market opened 169 net new stores and entered 28 new county cities in the quarter, serving as a proof point that our commitment to expanding our premium position in the market has not wavered. Total international segment operating margin was 13.1% in Q1, contracting 110 basis points from the prior year. The contraction was primarily driven by investments in partner wages and benefits, business mix shift as a greater portion of the segment's revenue was generated in our company-operated markets versus the prior year and strategic investments, partially offset by sales leverage. Shifting to channel development. The segment's revenue of $448 million in Q1 declined 7% from the prior year, largely in line with our expectations given the sale of Seattle's Best Coffee. Our business continues to resonate with customers as Starbucks maintained the number one share position in both US At Home coffee and US Ready to Drink in the first quarter as our holiday offerings such as Peppermint Mocha and Gingerbread were among customer favorites. The segment's operating margin was 46.8% in Q1, down 60 basis points from prior year, driven by product costs in Global Coffee Alliance, partially offset by business makeshift. Although there was contraction in the first quarter, we continue to expect the segment's full-year operating margin to expand to the high 40% to low 50% range and be accretive to our total company margin. Now, moving on to our guidance for fiscal year 2024. We are confident that the business pressures we experienced in the first quarter are transitory. With that, our guidance shared at our reinvention update in November remains unchanged related to our global store growth, operating margin, and EPS. However, given the collective magnitude of headwinds on our first quarter revenue and the time it will take for our action plans to be realized, we are revising our full year outlook for revenue and comp to reflect our Q1 results, as well as account for recent trends, including a softer than planned January, which we expect will impact our Q2 performance. With that, we now expect our full year global revenue growth in the range of 7% to 10%, revised from our previous range of the low end of 10% to 12%. Full year global and US comp growth in the range of 4% to 6%, both revised from the previous range of 5% to 7%. China comp growth of low single digits for the balance of the year, revised from the previous range of 4% to 6% in Q2 through Q4 with higher comp in Q1. Just to be clear, we continue to expect to deliver full year global store growth at approximately 7%, progressive operating margin expansion on a full-year basis, full-year EPS and non-GAP EPS growth in the range of 15% to 20% as we have multiple paths to such earnings growth as we demonstrated in the first quarter. As an additional insight, here are a few clarification items related to guidance. As a reminder, our guidance does not include any impact from foreign currency translation and assumes constant currency. In terms of quarterly shape, we expect growth rates for our global revenue, comp, operating margin, as well as GAAP and non-GAAP EPS to be the lowest in Q2 and meaningfully below our full fiscal year guidance ranges due to the pressures we discussed in today's call. These metrics are then expected to rebound and stabilize in the second half of our fiscal year. While we continue to expect our effective GAAP and non-GAAP tax rates in the mid-20% range, they are expected to be meaningfully higher than our fiscal year 2023 tax rate of 23.6%, which benefited from certain discrete non-recurring tax items. Finally, our disciplined capital allocation approach continues to deliver significant results. The combination of revenue growth, margin expansion, and improved working capital underpinned by the disciplined capital allocation increased our Q1 cash from operations to a record $2.4 billion. Our strong cash generation, together with our leverage and investment grade rating, creates exceptional shareholder returns while maintaining balance sheet flexibility to fund our critical investments, creating a competitive advantage. In summary, here are key takeaways from my discussion today. First, our Triple Shot Reinvention is continuing to unlock our greatest potential, evidenced by the strong operating margin performance and balanced earnings growth in the first quarter in spite of the pressured environment. Next, our revenue and comp guidance has been revised to reflect our Q1 results and expected near-term and transitory headwinds. But importantly, despite these headwinds, we remain committed to our full-year fiscal 2024 EPS growth in the range of 15% to 20%. Further, we have robust plans to navigate through the complex and dynamic environment and recognize our plans will take time to materialize, but remain confident in our long-term growth. And finally, our focused and disciplined approach to capital allocation drives our financial fortitude and balance sheet optionality, keeping us in a position of strength. Before I close, I want to thank all the partners across the globe who consistently find ways to create joy and foster connection to and with our customers. You give me the confidence that our best days are yet to come. So, thank you, partners. With that, I'll turn it back to Tiffany.
Tiffany Willis: Thank you, Rachel. Before we open the call to Q&A, we request that your questions today be focused on the quarterly performance that we just discussed, as this call is not to address questions related to recent proxy filing. With that, Diego, let's take the first question.
Operator: Thank you. [Operator Instructions] Your first question comes from Jeffrey Bernstein, Barclays. Please go ahead.
Jeffrey Bernstein: Great. Thank you very much. Just a question on the fiscal ‘24 guidance. I appreciate that you tempered the comp growth for both the US and China. For the US, it looks like it's only a point and China, it's only a few points, but we would define that, I guess, as modestly. And, you mentioned that fiscal 2Q is expected well below the targets before accelerating the rest of the year. So with that as backdrop, I'm just wondering if you could talk a little bit about, I think you mentioned January has been softer than expected, any color you could provide there? And otherwise, your confidence in that new guidance, it does seem like it implies a rather sharp acceleration in the back half of the year. I'm just wondering how you think about the guidance relative to maybe tempering it further and not having that risk if perhaps the recovery doesn't play out as fast as you might be expecting? Thank you.
Rachel Ruggeri: Sure. Yeah. Thank you, Jeffrey. This is Rachel. As it relates to our guidance, when we look at our revised revenue guidance, it's based on the performance we saw in Q1, as well as the near-term and transitory headwinds that we've spoken about. With that, we expect Q2 will be below the full-year guidance ranges, largely due to the fact it’s going to take some time for our plans to materialize, as well as we'll continue to see impacts to our business in the Middle East. But what gives us confidence in that revenue range is the fact that we still have a very strong and growing loyal customer base. We're having increased capability as it relates to our digital programs around the world. And we've also seen that our reinvention has been very successful in helping us to meet increasing demand. Most specifically in this quarter, we saw really strong demand supported in our morning daypart, our busiest daypart in our US business. And we actually exceeded both prior year, the year before, and we're right on line with pre-COVID level. So we're encouraged by that overall just in terms of transactions. And in addition to that, as we talked about in the call, we're confident that we have multiple levers to be able to drive our earnings growth. Revenue growth is one factor, and we believe we've got growth in that guidance range. That will help drive margin expansion through -- flow through. But in addition to that, we have in-store and out-of-store efficiencies that we're seeing great success with. And so that gives us some confidence that we have a balanced path and multiple leverage to be able to drive that earnings growth of 15% to 20% on a full year basis.
Operator: Thank you. Your next question comes from Brian Harbour with Morgan Stanley.
Brian Harbour: Yeah, thank you. Good afternoon. Could you talk more about kind of the specific plans to drive sort of the occasional customer? And it sounds like you would expect some pretty solid improvement in US sales as we go through the year. It sounds like what was new was some new product platforms. Could you just elaborate on how quickly you think those will work, what might be coming on the product side that drives your confidence in US sales?
Laxman Narasimhan: Sure, let me start and I'll call on Brady a bit, to provide some more color. As we said earlier, what we saw in the US was a quarter that was actually very strong till about the middle of November. And what you see in the results, very strong performance of the loyal customers, very strong holiday performance, very strong brand equity, and very strong performance on gift card sales. And we mentioned as well that we've got about $3.6 billion loaded on our card. So manifestation of the overall brand being very strong. And so there is, of course, what we do have, the isolated impact with the occasional customers, particularly those that visit in the afternoon. So if you look at some of the actions that we have in place, first, there is actually more demand than we're currently meeting in the US. Second, our loyalty program is already performing exceptionally well as Rachel mentioned. But we have a combination of things we've been doing to address the traffic slowdown, particularly in the afternoon. The first area is innovation. We mentioned a couple of new products coming in time for Valentine's Day, but we're going to have three new beverage platforms coming in the next six months, and you will see how important that is for us over time. The second action is we're opening up our app ecosystem to bring more people into the app because we know that our members developed a routinized long-term relationship with our brand that increases both traffic and transactions. And third, we are implementing targeted offers aimed at some of these very occasional customers to bring them back into the stores. And all that of course is foundational to, we continue to execute in our stores in order to elevate partner pride, bring a great deal of passion back into the business, and ensure that we can meet more of the demand that we know exists. Brady, do you want to give a bit more flavor around some of the activations, particularly on the innovation side?
Brady Brewer: Sure. Thank you, Brian. Thank you, Lax. As Laxman said, there's a calendar of compelling product innovation. Laxman spoke about the new beverage platforms that are coming over the next few months. On food, we're seeing a lot of momentum on this health conscious all day breakfast and all day snacking that I spoke about on the investor day. As we've released new products in that space, we've seen great resonance with customers and will continue to mine that space. Then we look at digital. Laxman referenced the 30% of US transactions coming through MOP. We're seeing high demand for that service even among occasional customers. So increasing the reach of the app, number one. Increasing personalized communication in the app, both to drive tickets for those routinized customers, but also frequency for the less frequent customers is a capability that we continue to build. We talk a lot about our personalization capabilities at Starbucks, but truly that job is never done because as new technologies and capabilities come online, we are grabbing those and integrating them into our system to use that as a business accelerator. And then lastly, I'd say just making Starbucks more accessible, expanding, as you heard from Laxman, the delivery options you have with Starbucks in a very fast growing part of our business. And then looking at ways to capture more Starbucks Rewards members who are currently not members through big partnerships like the one we've just announced with Bank of America. So between compelling products, really accelerating SR member acquisition efforts and then building our brand as Laxman said to address the fact-based narrative in social media and win our customers and win every visit back, that's where we're focused.
Operator: Your next question comes from Peter Saleh with BTIG.
Peter Saleh: Great, thanks for taking the question. I did want to ask about the check dynamics going on in China. It looks like down, call it 9%, it's a pretty steep decline. Just talk about the promotional environment that you're seeing there and what exactly you guys are doing to combat that and just more specifically should we expect this check impact to really continue for the balance of the year or how do we think about that going forward? Thank you.
Laxman Narasimhan: We have Belinda online here. So maybe I'll turn this over to Belinda. Do you want to answer that question, please?
Belinda Wong: Okay. Thank you for the question. Let me just address the AT decline first, the average tech decline. First of all, our beverage and food sales were strong and contributed the majority of our comp growth in Q1 and our AT decline, the 9% decline mainly came from two areas. One is slower sales of our higher priced merchandise as our consumers now more cautious in their spending. But the per merchandise category constitutes a relatively small portion of our sales mix. Second, it's the targeted promotional investments that we're making to personalize offers and reward customers' behaviors in order to drive trial vacancy. Now, this enabled us to optimize our sales and margin. And this is powered by China Deep Brew that helps us to design the right offers to the right cohorts of customers at the right time. So that's mainly the reasons for decline. You asked about the promotional environment. Let me just say this. The coffee market is evolving, as Lax said, and going through a transition. It's still early days and it has not yet fully tiered, right? You see mass -- influx of mass market competitors focus on fast store expansion and low price tactics to drive trial. This will shake out over time and yes, we are operating under an increased promotional environment. We are not interested in entering the price war. We are focusing on capturing high quality but profitable, sustainable growth. And it is our aim to be the best and lead in the premium market, as Lax has said, which Starbucks has pioneered in China 25 years ago. We will continue to focus on premium experience that is high quality coffee and human connection. And we have clear strategies to fuel our comp and total growth. As Lax shared the three points, well the three strategies, I'll add a little bit more colors. We're going to dial up our beverage food innovation with robust marketing activations on social media and in-store. We're going to accelerate our digitalization efforts to drive innovations, sales and productivity. We're going to continue our new store expansion, infill in existing cities and accelerate new county city entry as Lax has said. We are going to dial up our omnichannel expansion, scale up our membership program and continue to invest in our partners. So we have all these strategies to drive out comp growth and total growth in traffic and ticket. So we are very confident in our ability to deliver our growth in a short and long term. Thank you.
Operator: Your next question comes from Lauren Silberman with Deutsche Bank.
Lauren Silberman: Thank you very much. I want to ask about the US business. I appreciate all the color. I guess two related questions. One, I understand you're seeing a more significant slowdown with the occasional customer. Have you also seen a slowdown in traffic with rewards customers, or are the challenges really just isolated to occasional, trying to understand some of the breadth of the social media challenges? And then second, you've ramped up the level of promotional activities for rewards. Is this effectively hitting the occasional customer? Just trying to understand how you're thinking about promotional activity ahead. Thank you.
Laxman Narasimhan: Well, let me take this on. First of all, we are seeing no slowdown in our loyal SR customers. In fact, we're seeing an increase in frequency. They're buying more. They're customizing more. That part of the business is extremely strong. We did see, as you rightfully said, a slowdown in the very occasional customers, which we're still working to get back. But the folks in the middle who are occasional, some of the tactics that we used, which of course you're seeing, essentially helped bring them back into the fray in terms of the traffic we've seen it bounce back towards December. So we're focused on ensuring that we do the right thing in terms of welcoming back our very occasional customers with the right offer, with the right innovation, and with the right experience in stores.
Operator: Your next question comes from Brian Bittner with Oppenheimer and Company.
Brian Bittner: Thanks for taking the question. Rachel, I wanted to ask about the operating margin expansion in the Americas segment. Obviously, it was very impressive. And it was driven by leverage on your store operating expense line. In fact, when we break it down on a dollar basis, on a same store basis, those operating expenses were actually flattish or even slightly down year-over-year. Can you just unpack what's going on in that line item? How sustainable is this performance on the operating expense line?
Rachel Ruggeri: Sure. As you look at the store operating expense, it's largely driven by the activities we've taken around our reinvention in in-store operational efficiencies. So that's a combination of a number of factors, including we've focused on operational execution, leveraging standards to be able to manage performance across over 9,700 stores and growing. So that's been one driver. In addition to that, we've had continued improvement in our equipment. And the investments we made in equipment a year ago, as well as the investments we're currently making, that's all annualizing and helping to support the favorability that we're seeing in the margin expansion. And then third is, more recently we focused on improving our overall scheduling. So providing more hours for our partners per store. We have a ways to go, but we know that that's a high driver of engagement. All of those efforts together have led to lower turnover and a more stable environment. And it's that stability that really allows us to create a better efficiency in serving our customers. So as an example, I already spoke about our morning daypart of this quarter in the US was the strongest that we've seen. And that's a function of all of those efforts and activities that I just spoke about being realized in supporting our demand. So creating a better experience for our partners leads to the better experience for our customers. Now, some of that was annualization from the efforts that we made last year, but we continue to see quite a bit of opportunity ahead when we think about continuing to focus on scheduling, continual focus on improvements in staffing. We have more work ahead of us there, as well as in-store, or excuse me, out-of-store efficiencies, the way we scrutinize our sourcing, the way we distribute to our stores. We've seen some benefits from that this quarter. That won't show up in store operating expense. That'll be in our product and distribution cause. But between those two lines, that's where we see potential opportunity going forward. So it gives us confidence in the progressive margin expansion, but importantly, our ability to continue to meet that 15% to 20% earnings growth.
Operator: Your next question comes from David Palmer with Evercore ISI.
David Palmer: Hi. A big picture question. I don't know if this is maybe one for Brady, but by our math, just looking back to 2016 just because you gave some percentages on what was cold and what was hot of your beverages. It looks like your US cold beverage sales have grown by roughly $750,000 per store while hot beverage sales have declined by $150,000 per store. And since pre-COVID, your rewards membership has more than doubled. But traffic is down since that time. And we don't see your customer like you do. So this is a bit of a question. But it looks like you maybe have less of that everyday hot coffee and latte consumer and more of a new type of consumer that comes less frequently and probably has ops for cold beverage. I'm envisioning them being my daughter and three of her friends coming in some afternoon. So it's more of an episodic visit, big orders, cold beverage led. So with this happening, if this is what's happening, how does that inform your strategy for growth going forward? I know you're doing some things to increase capacity on cold beverage and maybe that helps fuel the summer months a little bit more. But I'm just wondering like what are -- do you share that perspective and how does that fuel your strategy? Thank you.
Brady Brewer: Yeah, thank you, David. It's a great question. My perspective is a little different in that we don't see a tradeoff in frequency between cold beverage customers and hot beverage customers. It's really a shift in generational taste preferences where that highly frequent millennial Gen Z customer is drinking cold coffee every day, just as people of different generations were drinking hot coffee to start their day every day. So we've seen a continued increase in our cold beverage in our portfolio, as you noted. But what I found with the cold beverages is there are infinite customizations possible on the cold beverage platform. And what that means is that it's increasingly a beverage you can't get anywhere else. And so it has a staying power to it. So we don't see a trade-off in frequency from hot or cold. Cold is a great business for us, and we don't see a threat there, we see a great opportunity. You mentioned about the capacity that we can put in place with Siren Systems and other aspects of the things we're doing in reinvention, which is really about accelerating our capacity to create and craft cold beverages at pace with our customers, both in drive-through, mobile order, and delivery in particular. So that is a huge opportunity for the company. And on hot beverage, I would say we're not leaving that customer behind. We're continuing to innovate on hot beverages just as we did today with the launch of our Oleato beverages. We're launching Clover Vertica store across our portfolio. We're in 10% of stores now. And that is the best cup of brewed coffee you've ever been able to get at Starbucks rolling out on a proprietary machine. And then lastly, you mentioned, or Lax mentioned, our Milano Roast, which is really our passion for coffee coming to fruition. So whether you're a cold coffee customer or a hot coffee customer, we're increasingly creating a reason for you to visit and we see no trade-off there.
Operator: Your next question comes from Sara Senatore with Bank of America.
Sara Senatore: Thank you very much. I just wanted to ask about unit growth. I know in both the US and China, I know you mentioned new, the most recent vintage of high volumes and strong ROIs in the US, but I was curious if you are seeing anything that might suggest that the acceleration and unit growth may be translating into slower same-store transaction growth? I know this is a very kind of idiosyncratic quarter, but in the past, I think when we have seen faster growth, it has sometimes corresponded with slower same-store transactions and I wanted to see if you had any color on any variation in markets or infill versus greenfield? And then if you could just maybe address that same question in China. Thank you.
Laxman Narasimhan: Rachel, do you want to take on the US? And, Belinda, I'd love you to take on China.
Rachel Ruggeri: Sure. Thanks, Sarah, for the question. In the US, what we see is we continue to see that our unit volumes, as we shared in Laxman’s prepared remarks, are continuing to grow. And importantly, when you look at the growth in North America and in the US businesses this quarter, our revenue grew 9%. So you've got a 5% comp in there. And we've already spoken to, though we were pleased with the performance and the strength we saw, particularly our most loyal customers, we talked about some of the headwinds that related to some of the impact we saw there. But when you look broadly and you look at the combination of comp and new store growth driving to that 9%, it shows you that we still have a lot of, I'd call it, opportunity even in the US in terms of continuing to open more new stores. When we do it through purpose design, we're able to look at the market and determine how do we drive the overall trade area higher with a variety of different types of stores to meet customers where they are. So we see a lot of opportunity there. And with that, I'll turn it over to…
Laxman Narasimhan: Sara, can I just add one thing here? We've gone through a look, MSA by MSA, and what is interesting is, is you start looking at where the population has shifted, and you look at how the US is so different from what it was even five years ago. I think what you see is white space for us. And particularly as you look at purpose-defined stores and our plans to build in the US, we have a lot more headroom in the US. With that, let me call on Belinda to talk a little bit on China, both around how our business has been reset, but also the kind of growth options we see. Belinda, go ahead.
Belinda Wong: Okay, thank you. So despite the shorts-term headwinds, the long-term opportunity in China is clear. I think everyone will agree to that. So I talked extensively at the investor forum about the huge greenfield opportunities to both increase penetration in existing cities and entering new county cities. So as of end Q1, we are only in 857 cities out of nearly 3,000 in China. The opportunities are abundant. And new stores continue to deliver best-in-class store profitability and returns. And when you look at new county city stores that we have entered recently and in the past couple years, it consistently outperformed top-tier cities, new stores, and profitability too. So as Laxman has pointed to, we will accelerate our entry into new county cities. So we are on track to reach 9,000 stores, so many opportunities out there. We will -- we have a very sophisticated system visualized and to help our team to identify the right areas to open to optimize the cannibalization impact and where we should be going. So with our experience, our team, our operating muscle, and track record, I have full confidence in our store expansion plan and we're on target to achieving 13% store growth in FY ‘24.
Laxman Narasimhan: I've been to China three times in the last nine months. And one of the things that's fundamentally impressed me with the business is really how we've used COVID and the time that the business has actually taken to reset the business. If you look at the end-to-end costs from a supply chain perspective, with the digitization of what is happening end-to-end in China, it is frankly incredibly strong. I'd love to have some of that back in the US. If I look at the ability to deliver the value that we have end-to-end in China, coupled with the premium experience with the wonderful stores we design at a very low investment cost because that has also been fine-tuned. What you realize is that as we expand, the kind of economics we're seeing are very strong. And so I think that is foundational to what Belinda talked about. Big headroom in terms of cities to go to. But also what I compliment the team on is the work that has gone in to build a business end to end, that is extremely strong. This doesn't happen overnight. This happens because of 25 years of history and the muscle and the capability that the business has built in China. The team is ready, obviously, as the market [turns] (ph) and we see things come back, you're going to see the kind of economics get even better.
Operator: Your next question comes from Andrew Charles, TD Cowen.
Andrew Charles: Great, thank you. Rachel, how did you arrive at the new low single-digit China same-store sales guidance from the 4% to 6% previously? Perhaps you can help us understand the typical quarter-to-quarter changes in seasonal AWS that you typically see in China and how that factors into the new 2024 guidance? Thanks.
Rachel Ruggeri: Sure, thank you, Andrew. When we looked at the guidance for China, it's largely based around, I wouldn't say the seasonality is maybe as distinct as what we see in the US business with Q2 being so much lower than any of our other quarters and strengthening as we go through Q3, Q4, particularly because we're lapping quite a bit of compares from the prior year. If you recall last year in Q3, we were lapping the COVID impacts from the prior year. So we have a pretty big lap when you look at that comp and that compare in Q3. So it's more around the progression we expect in the business, less about the compare or about seasonality, and more about the progression in the business. And what we're looking to is Chinese New Year as an example is a good indicator of what we expect to see around the consumer environment, and that's factored into our assumptions. So a lot of it depends on mainly the recovery, the time it's going to take as Belinda and team work on the action plans, which are in some ways, I'd say adapted to what we're saying. We've already led in the premium market, but we're adapting some of our strategies as it relates to the awareness of the customer and how we go after the customer through the innovation and new channels of social media. So we expect that that's going to take some time and that's reflected in the guidance range. But I would think about it that way, is more about the recovery and the progression from where we are with the plans today, which we're expecting we'll see a rebound and closer to a stabilization in the back half of the year.
Laxman Narasimhan: I think it's fair to say that the Chinese consumer is very cautious.
Belinda Wong: Yeah.
Laxman Narasimhan: And so the recovery is going to be choppy. But as Rachel has said, we think we factored that in the guidance that we see. The long-term opportunity in China is tremendous.
Operator: Your next question comes from Sharon Zackfia with William Blair.
Sharon Zackfia: Hi, good afternoon. On the customer that lapsed in the first quarter, was there any particular demographic that you saw more of an impact with? Excuse me. And then on the conversation around the new beverage platforms, I think you said three upcoming new beverage platforms. Can you talk about the potential trade-offs there with speed as you talk about untapped demand?
Laxman Narasimhan: So I think what I heard you say was, were there any demographic, specific demographics that it impacted? And the second question was, on the three beverage platforms, is there something that is a trade-off between speed? Is that correct? I couldn't hear you properly, actually. Maybe you could repeat that question.
Sharon Zackfia: I think my sound is breaking up. When I think about you introducing new beverage platforms and introducing complexity potentially into the system, I naturally worry about throughputs. And you talk about untapped demand and the opportunity to tap into that as part of the buffer into the back half of the year and I'm just thinking about that. With the new beverage platforms and hoping you can talk about if there is a trade-off with speed or if the new beverage platforms have been designed to help facilitate throughput. Brady, do you want to take it off?
Brady Brewer: Sure. So in terms of beverage platforms specifically, I'll start there. We put every product we offer through a very rigorous set of tests and measures to make sure that it's conducive to operations, that it's easier for our partners to deliver in the stores, and make sure that it's a creative to the business. A lot of times what we'll do is we'll bring in a new product and we'll take a lower volume product out just to maintain the total complexity of the system rather than just add, add, add. We have a very disciplined approach about how we do that. And so the three beverage platforms, which we won't reveal yet, have gone through that. And so It's really about how to do these products in a way that's accretive to the business and specifically targeted. And so in these cases, this is about looking at that occasional customer and frequent customer, but particularly appealing for the afternoon where we want to continue to build our business. We've really laser targeted these products for those occasions and so we're excited to bring those to customers. And then with regards to the demographics, Starbucks attracts a very wide range of customers around the world, and particularly in the US, again, a very wide range of customers. So the way that I would characterize it is occasional, and I know we've spoken about the very occasional. That's really what we would say is the audience with whom we saw that impact in November and started rebounding in December. So that's where I would leave it and say we've got plans to bring them back.
Operator: Your next question comes from Andrew Strelzik with BMO Capital Markets.
Andrew Strelzik: Hey, thanks for taking the question. I wanted to just make sure that we understand the bridge from the revised or lowered revenue growth guidance to the maintained EPS growth guidance. Obviously the first quarter operating margin was very strong, particularly in North America. So is something changing there in your expectations for the year? The cost saves coming through faster or greater? Is there a change in how you're thinking about buyback contribution? Just any more texture on that bridge would be helpful. Thanks.
Rachel Ruggeri: Sure. Thank you for the question. As it relates to our guidance and how we're thinking about maintaining the earnings growth range of 15% to 20%. Though our revenue has been revised, I think what's important to think about that is what we're pointing to is that Q2 will be below our full year guidance ranges on all of our metrics. And then we'll expect to see a rebound and a stabilization in the back half of the year. And that rebound and stabilization will come to from the revenue growth that we're guiding to, so the 7% to 10%. And in that revenue growth range, there is an assumption, even though we've got these plans in place and we expect it will take some time to materialize, there is the impact we have from a strong and growing loyal customer base as well as what we've talked to around the strength in digital and some of the success we're seeing in reinvention. So that's factored in there to give us the confidence to be able to expect that we'll see the flow through from the revenue growth in the back half of the year. But in addition to that, what we're expecting is that we'll continue to see the strength in our in-store and out-of-store operational efficiencies. So we had good success this quarter. We'll expect some of that to continue into Q2 and it'll further into Q3 and Q4. That's how we'll be able to drive to the 15% to 20% on a full year basis.
Operator: Thank you. The last question comes from John Ivankoe with JPMorgan. You may ask your question.
John Ivankoe: Hi, thank you. It's maybe a related one to the previous, but normally operating companies, when they do reduce revenue, it's pretty customary for earnings to come down along with that. Now, you guys have communicated, I think, $3 billion of cost savings on a three-year basis. I think that's $1 billion on a gross basis on a one-year basis. Can you talk about if there were any cost savings that were pulled forward into fiscal ‘24? Were there any meaningful expenses, maybe discretionary expenses in ‘24 that were perhaps pushed out into ‘25 and ‘26. And maybe I'm getting a little bit ahead of myself at this point or getting ahead of you at this point. As we kind of think about you getting more margin on that lower revenue than maybe we would have thought earlier, does it actually lead to a more difficult comparison that you'll have to face ‘25 over ‘24 as there are just some shifts in expenses between the two years?
Rachel Ruggeri: The way I would look at it, John, is as we showed in the first quarter, we were able to demonstrate that margin expansion of 130 basis points at the total company level, given a combination of sales leverage. So we still had strong sales growth, right? That sales leverage, as well as the flow through from that sales leverage and the in-store operational efficiencies that we spoke to. And when we think about the back half of the year, we'll expect to continue to see benefit from the revenue growth and the sales leverage that comes from that. But we'll also see benefit from the in-store and out-of-store operational efficiencies, which we do have ability to increase our focus on some of those areas, which will help to ensure our 15% to 20% earnings growth commitment on a full-year basis. Outside of that, we also have investments as it relates to G&A, as it relates to our reinvention. And we'll continue to make the investments because those investments drive a meaningful impact and they're a driver of our competitive advantage. But we do have an ability to also dial up and dial down some of those investments to help support the commitments we're making. As it relates to the years ahead, I don't think it's probably best to just focus on the year we're in right now. But that's how I would expect the guidance to come together and how I'd think about Q2 relative to the balance of the year.
Laxman Narasimhan: John, if I could just add one more thing. I think we've systematized our approach to how we think about innovation, how we think about productivity, how we think about growth overall, it's a very sort of systematic approach that we have in place with pipelines around how we're looking at different things. So we have visibility clearly in terms of things that we could do, for example, about the store. And they go multiple years. And so even if we did bring something forward, because we can, it does not at all mean that we don't have more that we go after. So I feel very confident about that, that we'll continue to invest in the business. There's no impact from a buyback. I think that was a question asked earlier. None whatsoever. And we're investing in the business, but we also know that we have opportunities for us to make ourselves more efficient. At the same time, get the throughput that we think we need in order to meet the demand that exists out there.
Rachel Ruggeri: Yeah. I do think it's just worth noting is that our buybacks are expected to be nearly 1% of our earnings growth net of interest, so small in the scheme of things.
Operator: Thank you. That was our last question. I will now turn the call over to Laxman Narasimhan for closing remarks.
Laxman Narasimhan: Thank you so much, Diego. I will close by reiterating our strong momentum from the quarter and our overall confidence in our long-term growth. While we continue to navigate some headwinds, we're encouraged by the strength of our brand, particularly with our loyal customers around the world and the plans that we have in place to address the challenges we have identified. On a broader level, I've come to learn that we truly are a different kind of company here at Starbucks, but we are now operating in a different kind of world. We recognize that no one can solve the many difficult problems in the world alone. Starbucks is, however, and will continue to be the world's third place, providing people with places to come together, to connect, to find common ground, to feel they belong, and to bring a little joy in their everyday. Thank you for joining us this afternoon.
Operator: This concludes Starbucks’ first quarter fiscal year 2024 conference call. You may now disconnect. |
MSFT | 2 | 2,024 | 2024-01-30 21:32:11 | Operator: Greetings, and welcome to the Microsoft Fiscal Year 2024 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Brett Iversen, Vice President of Investor Relations. Please go ahead.
Brett Iversen: Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call, and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website, when we provide outlook commentary on today's call. Microsoft, completed the acquisition of Activision Blizzard this quarter and we are reporting its results in our More Personal Computing segment, beginning on October 13, 2023. Accordingly, our Xbox content and services revenue growth investor metric includes the net impact of Activision. Additionally, our press release and slide deck contains supplemental information regarding the net impact of the Activision acquisition on our financial results. On this call, we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's second-quarter performance in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today relate to the corresponding period of last year, unless otherwise noted. We will also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question. It will be included in our live transmission, in the transcript, and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll be making forward-looking statements which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the Risk Factors section of our Form 10-K, Forms 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.
Satya Nadella: Thank you, Brett. It was a record quarter driven by the continued strength of Microsoft Cloud, which surpassed $33 billion in revenue, up 24%. We’ve moved from talking about AI to applying AI at scale by infusing AI across every layer of our tech stack, we are winning new customers and helping drive new benefits and productivity gains. Now I'll highlight examples of our momentum and progress starting with Azure. Azure again took share this quarter with our AI advantage. Azure offers the top performance for AI training and inference in the most diverse selection of AI accelerators, including the latest from AMD and NVIDIA, as well as our own first-party silicon Azure Maia. And with Azure AI, we provide access to the best selection of foundation and open-source models, including both LLM and SLMs, all integrated deeply with infrastructure, data, and tools on Azure. We now have 53,000 Azure AI customers, over one-third are new to Azure over the past 12 months. Our new models of service offering makes it easy for developers to use LLM's from our partners like Cohere, Meta, and Mistral on Azure, without having to manage underlying infrastructure. We have also built the world's most popular SLMs, which offer performance comparable to larger models, but are small enough to run on a laptop or mobile device. Anker, Ashley, AT&T, EY, and Thomson Reuters, for example, are all already exploring how to use our SLM-5 for their applications. And we have great momentum with Azure OpenAI Service. This quarter we added support for OpenAI's latest models including GPT-4 Turbo, GPT-4 with Vision, DALL-E 3 as well as fine-tuning. We are seeing increased usage from AI-first start-ups like Moveworks, Perplexity, SymphonyAI, as well as some of the world's largest companies. Over half of the Fortune 500 use Azure OpenAI today including Ally Financial, Coca-Cola, and Rockwell Automation. For example, at CES this month, Walmart shared how it's using Azure OpenAI Service along with its own proprietary data and models to streamline how more than 50,000 associates work and transform how it's millions of customers’ shop. More broadly, customers continue to choose Azure to simplify and accelerate their cloud migrations. Overall, we are seeing larger and more strategic Azure deals with an increase in the number of $1 billion-plus Azure commitments. Vodafone, for example, will invest $1.5 billion in Cloud and AI services over the next 10 years as it works to transform the digital experience of more than 300 million customers worldwide. Now on to data. We are integrating the power of AI across the entire data stack. Our Microsoft Intelligent Data Platform brings together operational databases, analytics, governance, and AI to help organizations simplify and consolidate their data estates. Cosmos DB is the go-to database to build AI-powered apps at any scale powering workloads for companies in every industry from AXA and Kohl's to Mitsubishi and TomTom. KPMG, for example, has used Cosmos DB including its built-in native vector search capabilities along with Azure OpenAI service to power an AI assistant, which it credits with driving an up to 50% increase in productivity for its consultants. All-up, Cosmos DB data transactions increased 42% year-over-year and for those organizations who want to go beyond in-database vector search, Azure AI search offers the best hybrid search solution. OpenAI is using it for retrieval augmented generation as part of ChatGPT. And this quarter, we made Microsoft Fabric generally available, helping customers like Milliman and PwC go from data to insights to action, all within the same unified SaaS solution. Data stored in Fabric's multi-cloud data lake, OneLake increased 46% quarter-over-quarter. Now on to developers. From GitHub to Visual Studio, we have the most comprehensive and loved developer tools for the era of AI. GitHub revenue accelerated to over 40% year-over-year, driven by all-up platform growth and adoption of GitHub Copilot, the world's most widely deployed AI developer tool. We now have over 1.3 million paid GitHub copilot subscribers, up 30% quarter-over-quarter, and more than 50,000 organizations use GitHub Copilot business to supercharge the productivity of their developers from digital natives like Etsy and HelloFresh to leading enterprises like Autodesk, Dell Technologies, and Goldman Sachs. Accenture alone will rollout GitHub Copilot to 50,000 of its developers this year and we're going further making copilot ubiquitous across the entire GitHub platform and new AI-powered security features, as well as Copilot enterprise, which tailors Copilot to organization's code bases and allows developers to converse with it in natural language. We're also the leader in low-code no-code development helping everyone create apps, automate workflows, analyze data, and now build custom copilots. More than 230,000 organizations have already used AI capabilities in Power Platform, up over 80% quarter-over-quarter, and with Copilot Studio, organizations can tailor Copilot for Microsoft 365 or create their own custom copilots. It is already being used by over 10,000 organizations including An Post, Holland America, PG&E. In just weeks, for example, both PayPal and Tata Digital built copilots to answer common employee queries, increasing productivity and reducing support costs. We're also using this AI moment to redefine our role in business applications. Dynamics 365 once again took share as organizations use our AI-powered apps to transform their marketing, sales, service, finance, and supply-chain functions. And we are expanding our TAM by integrating Copilot into third-party systems too. In sales out Copilot has helped sellers at more than 30,000 organizations including Lumen Technologies and Schneider Electric to enrich their customer interactions using data from Dynamics 365 or Salesforce. And with our new Copilot for service employees at companies like Northern Trust can resolve client queries faster. It includes out-of-the-box integrations to apps like Salesforce, ServiceNow, and Zendesk. With our industry and cross-industry clouds, we're tailoring our solutions to meet the needs of specific industries. In healthcare, DAX Copilot is being used by more than 100 healthcare systems including Lifespan, UNC Health and UPMC to increase physician productivity and reduce burnout. And our Cloud for Retail was front and center at NRF with retailers from Canadian Tire Corporation, to Leatherman and Ralph Lauren sharing how they will use our solutions across the shopper journey to accelerate time to value. Now on to future of work. A growing body of evidence makes clear the role AI will play in transforming work. Our own research as well as external studies show as much as 70% improvement in productivity, using generative AI for specific work tasks. And overall early Copilot for Microsoft 365 users were 29% faster in a series of tasks like searching, writing, and summarizing. Two months in, we have seen faster adoption than either our E3 or E5 suites as enterprises like Dentsu, Honda, Pfizer, all deploy Copilot to their employees. And we are expanding availability to organizations of all sizes. We're also seeing a Copilot ecosystem begin to emerge. ISVs like Atlassian, Mural, and Trello, as well as customers like Air India, Bayer, and Siemens have all built plug-ins for specific lines of business that extend Copilot's capabilities. When it comes to Teams, we again saw record usage as organizations brought together collaboration chat, meetings, and calling on one platform and Teams has also become a new entry point for us. More than two-thirds of our enterprise Teams customers buy Phone, Rooms or Premium. All this innovation is driving growth across Microsoft 365. We now have more than 400 million paid Office 365 seats and organizations like BP, Elanco, ING Bank, Mediaset, WTW, all chose E5 this quarter to empower their employees with our best-in-class productivity apps along with advanced security compliance, voice, and analytics. Now on to Windows. In 2024, AI will become a first-class part of every PC. Windows PCs with built-in neural processing units were front and center at CES, unlocking new AI experiences to make what you do on your PC easier and faster from searching for answers and summarizing emails to optimizing performance and battery efficiency. Copilot in Windows is already available on more than 75 million Windows 10 and Windows 11 PCs and with our new Copilot key, the first significant change to the Windows keyboard in 30 years, we're providing one-click access. We also continue to transform how Windows is experienced and managed with Azure Virtual Desktop and Windows 365, introducing new features that make it simpler for employees to access and IT teams to secure their cloud PCs. Usage of cloud-delivered Windows increased over 50% year-over-year. And all-up, Windows 11 commercial deployments increased 2 times year-over-year as companies like HPE and Petrobras rolled out operating systems to employees. Now onto security. The recent security attacks, including the nation-state attack on our corporate systems, we reported a week and a half ago have highlighted the urgent need for organizations to move even faster to protect themselves from cyber threats. It's why last fall we announced a set of engineering priorities under our secure future initiative, bringing together every part of the company to advance cyber security protection across both new products and legacy infrastructure. And it's why we continue to innovate across our security portfolio as well as our operational security posture to help customers adopt a Zero Trust security architecture. Our industry-first unified security operations platform brings together our SIM Microsoft Sentinel, our XDR Microsoft Defender, and Copilot for security to help teams manage an increasingly complex security landscape. And with Copilot for security, we're now helping hundreds of early access customers including Cmax, Dow, LTI Mindtree, McAfee, Nucor Steel, significantly increase their SecOps team's productivity. This quarter, we extended copilot to Entra, Intune, and Purview. All-up, we have over 1 million customers, including more than 700,000 who use four or more of our security products like Arrow Electronics, DXC Technology, Freeport-McMoRan, Insight Enterprises, JB Hunt, and the Mosaic Company. Now on to LinkedIn. LinkedIn is now helping over 1 billion members learn, sell, and get hired. We continue to see strong global membership growth driven by member sign-ups in key markets like Germany and India. In an ever-changing job market, members are staying competitive through skill-building and knowledge-sharing. Over the last 12 months, members have added 680 million skills to their profiles, up 80% year-over-year. Our new AI-powered features are transforming the LinkedIn member experience, everything from how people learn new skills to how they search for jobs and engage with [indiscernible]. New AI features, including more personalized emails also continue to increase business ROI on the platform and our hiring business took share for the sixth consecutive quarter. And more broadly, AI is transforming our search and browser experience. We are encouraged by the momentum, earlier this month, we achieved a new milestone with 5 billion images created and 5 billion chats conducted to-date, both doubling quarter-over-quarter and both being an edge took share this quarter. We also introduced Copilot as a standalone destination across all browsers and devices, as well as a Copilot app on iOS and Android. And just two weeks ago, we introduced Copilot Pro providing access to the latest models for quick answers and high-quality image creation and access to Copilot for Microsoft 365 personal and family subscribers. Now on to gaming. This quarter we set all-time records for monthly active users in Xbox PC, as well as mobile, where we now have over 200 million monthly active users alone, inclusive of Activision Blizzard King. With our acquisition, we have added hundreds of millions of gamers to our ecosystem, as we execute on our ambition to reach more gamers on more platforms. With cloud gaming, we continue to innovate to offer players more ways to experience the games they love where and when and how they want, hours streamed increased 44% year-over-year. Great content is key to our growth and across our portfolio, I've never been more excited about our line-up of upcoming games. Earlier this month, we shared exciting new first-party titles coming this year to Xbox PC and Game Pass including Indiana Jones. And we've also announced launching significant updates this calendar year to many of our most durable franchises, which brings in millions of players each month, including Call of Duty, Elder Scrolls Online, and Starfield. In closing, we are looking forward to how AI-driven transformation will benefit people and organizations in 2024. With that, I'll hand it over to Amy.
Amy Hood: Thank you, Satya, and good afternoon, everyone. This quarter, revenue was $62 billion, up 18% and 16% in constant currency. When adjusted for the prior year's Q2 charge, operating income increased 25% and 23% in constant currency, and earnings per share was $2.93, which increased 26% and 23% in constant currency. Results exceeded expectations and we delivered another quarter of double-digit top and bottom-line growth. Strong execution by our sales teams and partners drove share gains again this quarter across many of our businesses, as Satya referenced. In our commercial business, strong demand for our Microsoft cloud offerings, including AI services drove better-than-expected growth and large long-term Azure contracts. Microsoft 365 suite strength contributed to ARPU expansion for our office commercial business, while new business growth continued to be moderated for standalone products sold outside the Microsoft 365 suite. Commercial bookings were ahead of expectations and increased 17% and 9% in constant currency on a low expiry base. The strength in long-term Azure contracts mentioned earlier, along with strong execution across our core annuity sales motions, including healthy renewals drove our results. Commercial remaining performance obligation increased 17% and 16% in constant currency to $222 billion, roughly 45% will be recognized in revenue in the next 12 months, up 15% year-over-year. The remaining portion recognized beyond the next 12 months increased 19%. And this quarter, our annuity mix was 96%. In our consumer business, the PC and advertising markets were generally in line with our expectations. PC market volumes continued to stabilize at pre-pandemic levels [Technical Difficulty] Gaming console market was a bit smaller. As a reminder, my Q2 commentary includes the net impact of Activision from the date of acquisition, inclusive of purchase accounting, integration, and transaction-related expenses. The net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first-party. At a company level, Activision contributed approximately 4 points to revenue growth, was a 2 point drag on adjusted operating income growth, and a negative $0.5 impact to earnings per share. This impact includes $1.1 billion from purchase accounting adjustments, integration and transaction-related costs, such as severance-related charges related to last week's announcement. FX was roughly in line with our expectations on total company revenue, segment-level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $33.7 billion, ahead of expectations, and grew 24% and 22% in constant currency. Microsoft Cloud gross margin percentage was 72%, relatively unchanged year-over-year. Excluding the impact of the change in accounting estimate for useful lives, gross margin percentage increased roughly 1 point, driven by improvement in Azure and Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Company gross margin dollars increased 20% and 18% in constant-currency and gross margin percentage increased year-over-year to 68%. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points, even with the impact of $581 million from purchase accounting adjustments, integration, and transaction-related costs from the Activision acquisition. Growth was driven by improvement in devices, as well as the improvement in Azure and Office 365 as just mentioned. Operating expenses increased 3% with 11 points from the Activision acquisition, partially offset by 7 points of favorable impact from the prior year Q2 charge. The Activision impact includes $550 million from purchase accounting adjustments, integration, and transaction-related cost. At a company level, headcount at the end of December was 2% lower than a year ago. Operating margins increased roughly 5 points year-over-year to 44%. Excluding the impact of the change in accounting estimate, operating margins increased roughly 6 points driven by the higher gross margin noted earlier, the favorable impact from the prior year Q2 charge, and improved operating leverage through disciplined cost control. Now, to our segment results. Revenue from Productivity and Business Processes was $19.2 billion and grew 13% and 12% in constant currency, ahead of expectations, primarily driven by better-than-expected results in LinkedIn. Office commercial revenue grew 15% and 13% in constant currency. Office 365 commercial revenue increased 17% and 16% in constant currency, in line with expectations, driven by healthy renewal execution and ARPU growth from continued E5 momentum. Paid Office 365 commercial seats grew 9% year-over-year to over $400 million with installed base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings, offset by the continued growth trends in new standalone business noted earlier. Office commercial licensing declined 17% and 18% in constant currency with continued customer shift to cloud offerings. Office Consumer revenue increased 5% and 4% in constant currency with continued momentum in Microsoft 355 subscriptions, which grew 16% to 78.4 million. LinkedIn revenue increased 9% and 8% in constant currency, ahead of expectations, driven by slightly better-than-expected performance across all businesses. In our Talent Solutions business bookings growth was again impacted by weaker hiring environment in key verticals. Dynamics revenue grew 21% and 19% in constant currency, driven by Dynamics 365, which grew 27% and 24% in constant currency with continued growth across all workloads. Bookings growth was impacted by weaker new business, primarily in Dynamics 365 ERP and CRM workloads. Segment gross margin dollars increased 14% and 12% in constant currency and gross margin percentage increased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, primarily driven by improvement in Office 365. Operating expenses decreased 5% and 6% in constant currency, with 5 points of favorable impact from the prior-year Q2 charge. Operating income increased 26% and 24% in constant currency. Next, the Intelligent Cloud segment, revenue was $25.9 billion, increasing 20% and 19% in constant currency, ahead of expectations, with better-than-expected results across all businesses. Overall server products and cloud services revenue grew 22% and 20% in constant currency. Azure and other cloud services revenue grew 30% and 28% in constant-currency, including 6 points of growth from AI services. Both AI and non-AI Azure services drove our outperformance. In our per-user business, the Enterprise Mobility and Security installed base grew 11% to over 268 million seats with continued impact from the growth trends in new standalone business noted earlier. In our on-premises server business, revenue increased 3% and 2% in constant currency, ahead of expectations, driven primarily by the better-than-expected demand related to Windows Server 2012 end of support. Enterprise and partner services revenue increased 1% and was relatively unchanged in constant currency with better-than-expected performance across enterprise support services and industry solutions. Segment gross margin dollars increased 20% and 18% in constant currency and gross margin percentage was relatively unchanged. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 1 point, driven by the improvement in Azure noted earlier, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Operating expenses decreased 8% and 9% in constant currency, with 9 points of favorable impact from the prior year Q2 charge, operating income grew 40% and 37% in constant currency. Now, to more Personal Computing. Revenue was $16.9 billion, increasing 19% and 18% in constant currency, in line with expectations overall. Growth includes 15 points of net impact from the Activision acquisition. Windows OEM revenue increased 11% year-over-year, ahead of expectations, driven by slightly better performance and higher monetizing consumer markets. Windows Commercial products and cloud services revenue increased 9% and 7% in constant-currency, below expectations primarily [Technical Difficulty] period revenue recognition from the mix of contracts. Annuity billings growth remains healthy. Devices revenue decreased 9% and 10% in constant currency, ahead of expectations due to stronger execution in the commercial segment. Search and news advertising revenue ex-TAC increased 8% and 7% in constant currency, relatively in line with expectations, driven by higher search volume, offset by negative impact from a third-party partnership. And in gaming, revenue increased 49% and 48% in constant currency, with 44 points of net impact from the Activision acquisition. Total gaming revenue was in line with expectations of stronger-than-expected performance from Activision was offset by the weaker-than-expected console market noted earlier. Xbox content and services revenue increased 61% and 60% in constant currency, driven by 55 points of net impact from the Activision acquisition. Xbox hardware revenue grew 3% and 1% in constant currency. Segment gross margin dollars increased 34% and 32% in constant currency with 17 points of net impact from the Activision acquisition. Gross margin percentage increased roughly 6 points year-over-year, driven by higher devices gross margin and sales mix shift to higher-margin businesses. Operating expenses increased 38% with 48 points of impact from the Activision acquisition, partially offset by 6 points of favorable impact from the prior year Q2 charge. Operating income increased 29% and 26% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $11.5 billion, lower-than-expected due to delivery for a third-party capacity contract shifting from Q2 to Q3. Cash paid-for PP&E was $9.7 billion. These data center investments support our cloud demand, inclusive of needs to scale our AI infrastructure. Cash flow from operations was $18.9 billion, up 69% driven by strong cloud billings and collections on a prior year comparable that was impacted by lower operating income. Free cash flow was $9.1 billion, up 86% year-over-year, reflecting the timing of cash paid-for property and equipment. This quarter, other income and expense was in line with expectations, negative $506 million, driven by interest expense and net losses on investments, partially offset by interest income. Our effective tax rate was approximately 18%. And finally, we returned $8.4 billion to shareholders through dividends and share repurchases. Now moving to our Q3 outlook, which unless specifically noted otherwise is on a US dollar basis. First FX, based on current rates, we expect FX to increase total revenue and segment-level revenue growth by less than 1 point. And we expect no impact to COGS and operating expense growth. In commercial bookings, strong execution across our core annuity sales motions, including healthy renewals along with long-term Azure commitments should drive healthy growth on a growing expiry base. Microsoft Cloud gross margin percentage should decrease roughly 1 point year-over-year, excluding the impact from the accounting estimate change, Q3 cloud gross margin percentage will be relatively flat as improvement in Office 365 and Azure will be offset by sales mix shift to Azure, as well as the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to increase materially on a sequential basis, driven by investments in our cloud and AI infrastructure and the flip of a delivery date from Q2 to Q3 from a third-party provider noted earlier. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure build-out. Next to segment guidance. In Productivity and Business Processes, we expect revenue of $19.3 billion to $19.6 billion or growth between 10% and 12%. In Office Commercial revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be approximately 15% in constant currency. While it's early days for Microsoft 365 Copilot, we're excited by the adoption we've seen to date and continue to expect revenue to grow over time. In our on-premise business, we expect revenue to decline in the low 20s. In Office Consumer, we expect revenue growth in the mid-to-high single-digits, driven by Microsoft's 365 subscriptions. For LinkedIn, we expect revenue growth in the mid-to-high single digits, driven by continued growth across all businesses. And in Dynamics, we expect revenue growth in the mid-teens, driven by Dynamics 365. For Intelligent Cloud, we expect revenue of $26 billion to $26.3 billion or growth between 18% and 19%. Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability, primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI. Our per-user business should see benefit from Microsoft 365 Suite momentum though we expect continued moderation in seat growth rates given the size of the installed base. In our on-premises server business, we expect revenue growth in the low-to-mid single-digits with continued hybrid demand, including licenses running in multi-cloud environments. And in the enterprise and partner services revenue should decline approximately 10% on a high prior year comparable for enterprise support services and more Personal Computing, we expect revenue of $14.7 billion, $15.1 billion or growth between 11% and 14%. Windows OEM revenue growth should be relatively flat as PC market unit volumes continue at pre-pandemic levels. In Windows Commercial products and cloud services, customer demand for Microsoft 365 and our Advanced Security Solutions should drive revenue growth in the mid-teens. As a reminder, our quarterly revenue growth can have variability, primarily from in-period revenue recognition, depending on the mix of contracts. In Devices, revenue should decline in the low-double-digits as we continue to focus on our higher-margin premium products. Search and news advertising ex-TAC revenue growth should be in the mid-to-high single-digits, about 8 points higher than overall search and news advertising revenue, driven by continued volume strength. And in gaming, we expect revenue growth in the low 40s, including approximately 45 points of net impact from the Activision acquisition. We expect Xbox content and services revenue growth in the low-to-mid 50s, driven by approximately 50 points of net impact from the Activision acquisition. Hardware revenue will decline year-over-year. Now back to company guidance. We expect COGS between $18.6 billion to $18.8 billion, including approximately $700 million of amortization of acquired intangible assets from the Activision acquisition. We expect operating expenses of $15.8 billion to $15.9 billion, including approximately $300 million from purchase accounting, integration, and transaction-related costs from the Activision acquisition. Other income and expenses should be roughly negative $600 million as interest income will be more than offset by interest expense and other losses. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q3 effective tax rate to be in line with our full-year rate, which we now expect to be approximately 18%. Now, some additional thoughts on the full-fiscal year. First FX, assuming current rates remain stable, we now expect FX to increase Q4 and full-year revenue growth by less than 1 point. We continue to expect no meaningful impact to full-year COGS or operating expense growth. Second Activision. For the full-year FY 2024, we expect Activision to be accretive to operating income, when excluding purchase accounting, integration and transaction-related cost. At a total company level, we delivered strong results in H1 and demand for our Microsoft Cloud continues to drive the growth in our outlook for H2. Our commitment to scaling our cloud and AI investment is guided by customer demand and a substantial market opportunity. As we scale these investments, we remain focused on driving efficiencies across every layer of our tech stack and disciplined cost management across every team. Therefore, we expect full-year operating margins to be up 1 to 2 points year-over-year, even as AI capital investments drive COGS growth. This operating margin expansion excludes the impact from the Activision acquisition and the headwind from the change in useful lives last year. In closing, we are focused on execution. So our customers can realize the benefits of AI productivity gains as we invest to lead this AI platform wave. With that, let's go to Q&A, Brett.
Brett Iversen: Thanks Amy. We'll now move over to Q&A. Out of respect for others on the call, we request the participants please only ask one question. Joe, can you please repeat your instructions?
Operator: [Operator Instructions] And our first question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.
Mark Moerdler: Thank you very much. Congratulations on the strong quarter and thanks for letting me ask the question. Amy, you've discussed Azure being stable and you deliver Azure growth stability, but if we drill in one layer, we see Azure AI [aiming] (ph) to become a bigger portion of the revenue. I understand that separating what is directly AI revenue versus other IaaS, PaaS revenue that are leveraging well driven by AI is difficult, can you help me with two related questions? Optimization has been stabilizing and at some point, it should be part of the revenue flow. How should we think about what happens then, do we see non-directly AI consumption being flattish or do we see a rebound as the cloud shift continues and the need for data of inferencing grows? Second point. On AI, where are we in the journey from training driving most of Azure AI usage to inferencing? When do you think we start to see pick-up in non-Microsoft inferencing kick in, when do you think we could hit the point where inferencing is the bigger part of the driver? Thank you.
Satya Nadella: You want me to go first and...
Amy Hood: You go first and I'll take the technical.
Satya Nadella: Yes, let me -- just on the inferencing and training, most of what you've seen for the most part is all inferencing. So, none of the large model training stuff is in any of our higher numbers at all. What small batch training, so somebody is doing fine-tuning or what have you, that will be there, but that's sort of a minor part. So, most of what you see in the Azure number is broadly inferencing. And Mark, I think it may be helpful to sort of think about, like what is the new workload in AI? The new workload in AI, obviously, in our case starts with one of the frontier -- I mean, starts with the Frontier model Azure OpenAI. But it's not just about just one model, right. So, you first -- you take that model, you do RLHF, you may do some fine-tuning, you do retrieval, which means you are sort of either heating some storage meter or you're heating some compute meters. And so to -- and by the way, you will also distil a large model to a small model and that would be a training perhaps. But that's a small batch training that uses essentially inference infrastructure. So, I think that's what's happening. So you could even say these AI workloads themselves will have a lifecycle which is they'll get rebuilt, then there'll be continuously optimized over time. So, that's sort of one-side. And I think if I understand your question, what's happening with the traditional optimization, and I think last quarter we said. One, we're going to continue to have these cycles where people will build new workloads, they will optimize the workloads and then they'll start new workloads. So I think that that's what we continue to see. But that period of massive, I'll call it, optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycles by customers, both whether it comes to AI or whether it comes to the traditional workloads.
Amy Hood: No, maybe I'll just add just a few things to that. I think whether you use the word lapping, these optimization comparables or the comparables easing, is all sort of the same thing, that we're getting to that point, in H2 that's absolutely true. We'd like to talk about the contribution of AI specifically for the reason Satya talked about, these are -- this is starting to see the application of AI at scale. And we want to be able to show people, this is how that point will work, it's inferencing workloads where people are expecting productivity gains, other benefits that grow revenue and so, I do think about those as both related. And ultimately the TAM that we go after is best sort of across both of those, both AI workload and I guess, “non-AI workload” although to Satya's point, you need all of it.
Mark Moerdler: Perfect. Thank you very much for the deep answer.
Brett Iversen: Thanks, Mark. Joe, next question, please.
Operator: Our next question comes from the line of Brent Thill with Jefferies. Please proceed.
Brent Thill: Good afternoon. Amy, the margin improvement is pretty shocking to most considering the investments that you and Satya are putting into AI. I'm curious if you could just walk through, how this is possible and what you're seeing so far in some of the costs that you're trying to manage as you scale up AI?
Amy Hood: Thanks, Brent. First of all, thanks for the question. The teams are obviously been hard at work on this topic. We do point out that, Q2 because of the impact of the charge a year ago, you're seeing larger margin improvement than I would say, sort of a run-rate margin improvement. So, let me first say that. Secondly, the absolute margin improvement has also been very good and it speaks to, I think one of the things Satya talked about and I reiterated a bit, which is that, we want really to make sure we're making investments, we're making them in consistency across the tech stack. The tech stack we're building, no matter what team is on, is inclusive of AI enablement. And so think about as building that consistency without needing to add a lot of resources to do that. It's been a real pivot of our entire investment infrastructure to be working on this work. And I think that's important, because it means you're shifting to an AI-first position, not just in the language we use, but in what people are working on day-to-day. That does obviously create a leverage opportunity. There has also been really good work put in by many teams on improving the gross margin of the products; we talked about it with Office 365, we talked about in Azure core. We even talked about it across our devices portfolio, where we've seen material improvements over the course of the year. And so, when you kind of take improvements at the gross margin level, plus this consistency of re-pivoting our workforce toward the AI-first work we're doing, without adding material number of people to the workforce, you end up with that type of leverage. And we still need to be investing. And so, the important part, invest towards the thing that's going to shape the next decade and continue to stay focused on being able to deliver your day-to-day commitments. And so it's a great question. And hopefully, that helps piece apart a few of the components.
Brent Thill: Thanks, Amy.
Brett Iversen: Thanks, Brent. Joe next question, please.
Operator: Our next question comes from the line of Kash Rangan with Goldman Sachs. Please proceed.
Kash Rangan: Hi, thank you very much. A superb quarter of great improvements. Just one question for you Satya. Cloud computing changed the tech stack in ways that we could not imagine 10 years back, the nature of the database layer, the operating system layer, every layer just changed dramatically. How do you foresee generative AI changing the tech stack as we know it? Thank you so much.
Satya Nadella: Yes, I think it's going to have a very foundational impact. In fact, you could say the core compute architecture itself changes, everything from power, power density to the data center design, to what used to be the accelerator, now is the sort of the main CPU, so to speak, or the main compute unit. And so, I think in the network, the memory architecture, all of it. So as the core computer architecture changes, I think every workload changes. And so yes, so there is a full, like, take our data layer, the most exciting thing for me in the last year has been to see how our data layer has evolved to be built for AI, right? If you think about Fabric, one of the genius of Fabric is to be able to say, let's separate out storage from the compute layer. In compute we'll have traditional SQL, we’ll have Spark. And by the way, you can have an Azure AI job on top of the same data lake, so to speak, or the lakehouse pattern. And then the business model you can combine all of those different compute. So that's the type of compute architecture. So it's sort of a -- so that's just one example. The tool stuff is changing. Office, I mean if you think about what -- if I look at Copilot; Copilots extensibility with GPT, Copilot apps to the Copilot stack, that's another sort of part of what's happening to the tech stack. So yes, I mean, definitely builds. I mean. I do believe, being in the cloud has been very helpful to build AI. But now, AI is just redefining what it means to have, what the cloud looks like, both at the infrastructure level and the app model.
Kash Rangan: Terrific. Thank you so much.
Brett Iversen: Thanks, Kash. Joe, our next question, please.
Operator: Our next question comes from the line of Karl Keirstead with UBS. Please proceed.
Karl Keirstead: Thank you. I wanted to return to AI, the six point AI lift to Azure is just extraordinary. But I wanted to ask you about your progress in standing up the infrastructure to meet that demand. If you feel like Microsoft is supply GPU-constrained. Is the success you've had maybe working through some of the scaling bottlenecks that some of the other cloud infrastructure providers have talked about, a little bit maybe on the infrastructure scaling front might be interesting. Thank you.
Amy Hood: Thanks, Karl. Maybe I'll start and Satya feel free to add on. I think we feel really good about where we have been in terms of adding capacity. You started to see the acceleration in our capital expense starting almost a year ago, and you've seen us scale through that process. And that is going toward as we talked about Servers and also new data center footprints to be able to meet what we see as this demand and really changing demand as we look forward. And so, I do feel like the team has done a very good job. I feel like, primarily obviously, this is being built by us, but we've also used third-party capacity to help when we could have that help us in terms of meeting customer demand. And I think looking forward, you'll tend to C&I guide toward it, accelerated capital expense to continue to be able to add capacity in the coming quarters, given what we see in terms of pipeline.
Brett Iversen: Thanks, Karl. Joe, next question, please.
Operator: Our next question comes from the line of Brad Zelnick with Deutsche Bank. Please proceed.
Brad Zelnick: Great, thank you so much for taking the question. The early market feedback that we're all hearing on Microsoft 365 copilot is very powerful. Can you provide more granularity on what you're seeing in terms of adoption trends versus perhaps other new product introductions in the past, what if anything is holding it back, and how much of a priority is it to get it in the hands of customers? To what lengths might you go to incentivize just getting it out in the market? Thank you.
Satya Nadella: No, thank you for the question, Brad. So, a couple of things. In my comments I said increase in relation to our previous suites like, let's say, E3 or E5. Whatever two months in, it's definitely much faster than that. And so, from that perspective. It's exciting to see, I’d say, the demand signal, the deployment signal. I was looking at by tenant, even usage, it's faster than anything else because it's easier, right. I mean, it's sort of -- it shows up in your app, if you click on it, like any ribbon thing and it becomes a daily habit. So it in fact, it reminds me a little bit of sort of the back-in-the day of PC adoption, right. It's kind of -- I think it first starts off with few people having access. There are many companies that are doing standard issue, right. So just like PCs became standard issue at some point after PCs being adopted by early adopters. I think that's the cycle that at least we expect. In terms of what we're seeing, it's actually interesting, If you look at the data we have, summarization, that's what it's like number-one, like I'm doing summarization of Teams meetings inside of Teams, during the meeting, after the meeting, word documents summarization, I get something in email on summarizing. So summarization has become a big deal. Drafts, right, you're drafting emails, drafting documents. So, anytime you want to start something, the blank page thing goes away and you start by prompting and drafting. Chat, to me, the most powerful feature is now you have the most important database in your company, which happens to be the database of your documents and communications. It is now queryable by natural language in a powerful way, right. I can go and say, what are all the things Amy said, I should be watching out for next quarter and it will come out with great detail. And so Chat, summarization, draft, also by the way, actions. One of the most used thing is, here's the Word document, go complete, I mean, create a PowerPoint for me. So, those are the stuff that is also beginning. So, I feel like these all become -- but fundamentally, what happens is, if you remember the PC adoption cycle, what it did was work artifact and work flow changed, right. You can imagine what forecasting was before excel and email and what it was after. So similarly, you'll see work and workflow change as people summarize faster, draft regulatory submissions faster. Chat to get knowledge from your business. And so, those are the things that we are seeing as overall patterns.
Amy Hood: And maybe just to add two points. One of the exciting things as I said for some companies, it's going to be standard issue like PC, for other companies, they may want to do a land with a smaller group, see the productivity gains and then expand. And so being able to lift some of the seat requirements that we did earlier this month, it's really going to allow customers to be able to use that approach too. And the other thing I would add, we always talk about in enterprise software, you sell software, then you wait and then it gets deployed, and then after deployment, you want to see usage. And in particular, what we've seen and you would expect this, in some ways with Copilot even in the early stages, obviously, deployment happens very quickly. But really what we're seeing is engagement grow. As to Satya's point on how you learn and your behavior changes you see engagement grow with time. And so I think those are just to put a pin in that, because it's an important dynamic when we think about the optimism you hear from us.
Brad Zelnick: Excellent, thank you so much.
Brett Iversen: Thanks, Brad. Joe, next question, please.
Operator: Our next question comes from the line of Mark Murphy with J.P. Morgan. Please proceed.
Mark Murphy: Yeah. Thank you very much. Is it possible to unpack the 6 point AI services tailwind, it's just to help us understand which elements ramped up by the three incremental points. For instance, is it more of the open AI inferencing, GitHub Copilot, other Copilots, the Azure OpenAI service, third party LLMs running on Azure. I'm just wondering, where did you see the strongest step-up in that activity?
Amy Hood: Mark, without getting into tons of line items, it's more simple to think of it as really, it's people adopting it for inferencing at the API generally. I mean that's the easiest way to think about it. And we also saw growth in GitHub Copilot which you talked -- which Satya talked about and we saw a growing number of third parties using it in some small ways for training. But this is primarily an inferencing workload right now in terms of what's driving that number. We used to think of it that way.
Satya Nadella: Azure OpenAI and then OpenAIs on APIs on top of Azure would be the sort of the major drivers. But there is a lot of the small batch training that goes on, whether it's let Jeff for fine-tuning. And then lot of people who are you starting to use models as a service with all the other new models, but it's predominantly Azure open AI today.
Mark Murphy: Thank you.
Brett Iversen: Thanks, Mark. Joe, next question, please.
Operator: Our next question comes from the line of Brad Reback with Stifel. Please proceed.
Brad Reback: Great, thanks very much. Amy for many, many years in Commercial Office 365 seat growth has far outpaced ARPU and over the last couple of quarters, we're getting a convergence, obviously, as the seat count gets really large. As we look-forward, should they run even for a period of time or should we expect ARPU to outpace seat growth here in the short term? Thanks.
Amy Hood: That's a great question, Brad. Let me split apart the components. And then we can come back to whether they should equalize or just go on sort of a bit, actually believe it or not, somewhat independent trajectory and I will explain why I say that. Your seat growth as we talk about is primarily from, at this point, small and medium-size businesses and really frontline workers scenarios. And to your point on occasion, those are lower ARPU seats, but there are also -- there are new seats and so you see that in the seat count number. And as we get through and we've seen that come down a little bit quarter-over-quarter and we've guided for that really to happen again next quarter, but a very separate thing is being able to add ARPU. And traditionally, and again this quarter, right, that's come over-time from E3. Then from E5. And we're continuing to see very healthy seat momentum and you heard very good renewals. So, all of that, right, completely independent in some way from seat growth. Then the next thing, that actually we just talked about, maybe in Brad's question I'm trying to recall is that, you're going to see Copilot revenue will run there as ARPU, right. That won't show a seat growth. So you'll have E3, E5 transition, Copilot, all show-up in ARPU over time, and then you’ll have the seat growth be primarily still small business and frontline worker and maybe new industry scenarios. So, I tend to not really, Brad, think about them as related lines, believe it or not. I think about them as sort of unique Independent motions we run and there is still room for seat growth and obviously with the levers we've talked about, there's room for ARPU growth as well.
Brad Reback: That's great. Thanks very much.
Brett Iversen: Thanks, Brad. Joe we have time for one last question.
Operator: Our last question will come from the line of Tyler Radke with Citi. Please proceed.
Tyler Radke: Thanks for taking my question. Satya your enthusiasm about GitHub Copilot was noticeable on the conference call and at the AI Summit in New York last week. I'm wondering how you're thinking about pricing, obviously, this is driving pretty incredible breakthroughs and productivity for developers. But how do you think about your ability to drive ARPU on the GitHub Copilot over-time and just talk us through how you're thinking about the next phase of new releases there?
Satya Nadella: Yeah. I mean -- it's -- I always go back to sort of my own conviction that this generation of AI is going to be different, started with the move from 2.5 to 3 of GPT. And then it's use inside of developer scenario with GitHub copilot and so yes. I think this is the place where it's most evolved. In terms of its economic benefits or productivity benefits and you see it. We see it inside of Microsoft, we see it in all of the key studies we put out of customers, everybody had talked to its pick-up, but it is the one place where it's becoming standard issue for any developer is like if you takeaways spell check from Word, I'll be unemployable. And similarly, it will be like -- I think GitHub Copilot becomes core to anybody who is doing software development. The thing that you brought up is a little bit of a continuation to how Amy talked about, right. So you are going to start seeing people think of these tools as productivity enhancers, right. I mean, if I look at it, our ARPUs have been great, but they're pretty low.. You know even though we've had a lot of success, it's not like we had a high-priced ARPU company. I think what you're going to start finding is, whether it's sales copilot or service copilot or GitHub Copilot of security copilot. They are going to fundamentally capture some of the value they drive in terms of the productivity of the OpEx, right. So it's like 2 points, 3 points of OpEx leverage would be goal is on software spend. I think that's a pretty straightforward value equation. And so that's the first time, I mean this is not something we've been able to make the case for before whereas now I think we have that case. Then even the horizontal copilot is what Amy was talking about, which is at the Office 365 or Microsoft 365 level, even there, you can make the same argument whatever ARPU we may even have with E5, now, you can see incrementally as a percentage of the OpEx, how much would you pay for a copilot to give you more time savings for example. And so yes, I think all up, I do see this as a new vector for us in what I'll call the next phase of knowledge work and frontline work even in their productivity and how we participate. And I think GitHub copilot, I never thought of the tools business as fundamentally participating in the operating expenses of a company's spend on, let's say, development activity and now you're seeing that transition, it is just not tools, it's about productivity of your dev team.
Brett Iversen: Thanks, Tyler. That wraps up the Q&A portion of today's earnings call. Thank you for joining us today and we look forward to speaking with all of you soon.
Amy Hood: Thank you.
Satya Nadella: Thank you.
Operator: This concludes today's conference. You may now disconnect. Enjoy the rest of your evening. |
AMD | 4 | 2,023 | 2024-01-30 20:31:03 | Operator: Greetings and welcome to the AMD Fourth Quarter and Full Year 2023 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] And as a reminder, this conference is being recorded. It is now my pleasure to introduce to you, Mitch Haws, Vice President, Investor Relations. Thank you, Mitch. You may begin.
Mitch Haws: Thank you, John, and welcome to AMD's Fourth Quarter and Full Year 2023 Financial Results Conference Call. By now you should have had the opportunity to review a copy of our earnings press release and the accompanying slides. If you've not had the chance to review these materials, they can be found on the Investor Relations page of amd.com. We will refer primarily to non-GAAP financial measures during today's call. The full non-GAAP to GAAP reconciliations are available in today's press release and the slides posted on our website. Participants on today's call are Dr. Lisa Su, our Chair and Chief Executive Officer; and Jean Hu, our Executive Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. Before we begin, I would like to note that Mark Papermaster, Executive Vice President and Chief Technology Officer will attend the Bernstein Tech, Media, Telecom & Consumer One-on-One Forum on Tuesday, February 28th; and Jean Hu, Executive Vice President, Chief Financial Officer and Treasurer will attend the Wolfe Research Semiconductor Conference on Tuesday, February 15th and the Morgan Stanley Technology, Media & Telecom Conference on March 5th. Today's discussion contains forward-looking statements based on current beliefs, assumptions and expectations, speak only as of today and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statement in our press release for more information on factors that could cause actual results to differ materially. With that, I'll hand the call over to Lisa. Lisa?
Lisa Su: Thank you, Mitch, and good afternoon to all those listening in today. We finished 2023 strong as Data Center sales accelerated significantly throughout the year, despite the mixed demand environment. As a result, we delivered record Data Center segment annual revenue and strong top-line and bottom-line growth in the fourth quarter, driven by the ramp of Instinct AI accelerators and robust demand for EPYC server CPUs across cloud, enterprise and AI customers. Looking at our financial results. Fourth quarter revenue increased 10% year-over-year to $6.2 billion, driven by a significant double-digit percentage growth in our Data Center and Client segments. On a full year basis, annual revenue declined 4% to $22.7 billion as record Data Center and Embedded segment annual revenue was offset by lower Client and Gaming segment revenue. Importantly, Data Center and Embedded segment annual revenue grew by $1.2 billion and accounted for more than 50% of revenue in 2023 as we gained server share, launched our next-generation Instinct AI accelerators and maintained our position as the industry's largest provider of adaptive computing solutions. Turning to the fourth quarter business results. Data Center segment revenue grew 38% year-over-year and 43% sequentially to a record $2.3 billion. Server CPU and Data Center GPU sales both set quarterly and annual revenue records as sales of our Data Center products accelerated throughout the year. We gained server CPU revenue share in the quarter, driven by significant double-digit percentage growth in 4th Gen EPYC Processor revenue and demand for our 3rd Gen EPYC Processor portfolio. In Cloud, while the overall demand environment remained soft, server CPU revenue increased year-over-year and sequentially as North American hyperscalers expanded 4th Gen EPYC Processor deployments to power their internal workloads and public instances. Amazon, Alibaba, Google, Microsoft and Oracle brought more than 55 AMD-powered AI, HPC and general-purpose cloud instances into preview or general availability in the fourth quarter. Exiting 2023, there were more than 800 EPYC CPU based public cloud instances available. We expect this number to grow in 2024 based on the leadership performance, efficiency and features of our EPYC CPU portfolio. In Enterprise, sales accelerated by a significant double-digit percentage in the quarter as we built momentum with Forbes 2000 customers. We closed multiple wins with large financial, energy, automotive, retail, technology and pharmaceutical companies, positioning us well for continued growth, based on expanded production deployments planned for 2024. A growing number of customers are adopting EPYC CPUs for inferencing workloads, where our leadership throughput performance deliver significant advantages on smaller models like Llama 7B, as well as the power head nodes in large training and inference clusters. Looking ahead, customer excitement for our upcoming Turin family of EPYC Processors is very strong. Turin is a drop-in replacement for existing 4th Gen EPYC platforms that extends our performance, efficiency and TCO leadership with the addition of our next-gen Zen 5 core, new memory expansion capabilities and higher core counts. Internal and end customer validation work is progressing to plan with Turin on track to deliver overall performance leadership, as well as leadership on a per core or per watt basis across a wide range of workloads when it launches later this year. Turning to our Broader Data Center portfolio. Our Data Center GPU business accelerated significantly in the quarter, with revenue exceeding our $400 million expectations, driven by a faster ramp for MI300X with AI customers. We launched our MI300 accelerator family in December with strong partner and ecosystem support from multiple large cloud providers, all the major OEMs and many leading AI developers. MI300X GPUs deliver leadership generated AI performance by combining our high-performance CDNA 3 architecture with industry-leading memory bandwidth and capacity. Customer response to MI300 has been overwhelmingly positive. And we are aggressively ramping production to support the dozens of cloud, enterprise and supercomputing customers deploying Instinct accelerators. In Cloud, we are working closely with Microsoft, Oracle, Meta and other large cloud customers on Instinct GPU deployments, powering both their internal AI workloads and external offerings. For Enterprise customers, HPE, Dell, Lenovo, Supermicro and other server vendors are on track to launch differentiated MI300 platforms later this quarter with strong demand from multiple enterprise customers. In HPC Supercomputing, we shipped the majority of AMD Instinct MI300A accelerators for the El Capitan supercomputer in the fourth quarter and expect to complete shipments this quarter for what is expected to be the world's fastest supercomputer when it comes online later this year. We also closed new Instinct GPU wins in the quarter, including the flagship system at the German High Performance Computing Center, HLRS, as well as what is expected to be one of the world's most powerful enterprise supercomputers for energy company Eni. On AI software development, we made significant progress expanding the ecosystem of AI developers working on AMD platforms with the release of our ROCm 6 software suite. The ROCm 6 stack significantly increases performance and key generative AI workloads, adds expanded support and optimizations for additional frameworks and libraries and simplifies the overall developer experience. The additional functionality and optimizations of ROCm 6 and the growing volume of contributions from the Open Source AI Software community are enabling multiple large hyperscale and enterprise customers to rapidly bring up their most advanced large language models on AMD Instinct accelerators. For example, we are very pleased to see how quickly Microsoft was able to bring up GPT-4 on MI300X in their production environment and rollout Azure private previews of new MI300 instances aligned with the MI300X launch. At the same time, our partnership with Hugging Face, the leading open platform for the AI community, now enables hundreds of thousands of AI models to run out of the box on AMD GPUs and we are extending that collaboration to our other platforms. Looking ahead, our prior guidance was for Data Center GPU revenue to be flattish from Q4 to Q1 and exceed $2 billion for 2024. Based on the strong customer pool and expanded engagements, we now expect Data Center GPU revenue to grow sequentially in the first quarter and exceed $3.5 billion in 2024. We have also made significant progress with our supply chain partners and have secured additional capacity to support upside demand. Turning to our Client segment. Revenue was $1.5 billion, an increase of 62% year-over-year and flat sequentially. We launched our latest generation Ryzen 8000 series notebooks and desktop processors in January, including our Ryzen 8040 Mobile series that combined leadership compute performance and energy efficiency with an updated MPU that delivers up to 60% more AI performance compared to our prior generation that was already industry-leading. Acer, ASUS, HP, Lenovo, MSI and other large PC OEMs will all offer notebooks powered by our Ryzen 8000 series processors with the first systems expected to go on sale in February. To further our leadership in AI PCs, we launched our Ryzen 8000 G-series processors earlier this month, which are the industry's first desktop CPUs with an integrated AI engine. Millions of AI PCs powered by Ryzen processors have shipped to date and Ryzen CPUs power more than 90% of AI-enabled PCs currently in market. Our work with Microsoft and our PC ecosystem partners to enable the next-generation of AI PCs expanded significantly in the quarter. We are aggressively driving our Ryzen AI CPU roadmap to extend our AI leadership, including our next-gen Strix processors that are expected to deliver more than three times the AI performance of our Ryzen 7040 series processors. Strix combines our next-gen, Zen 5 core with enhanced RDNA graphics and an updated Ryzen AI engine to significantly increase the performance, energy efficiency and AI capabilities of PCs. Customer momentum for Strix is strong with the first notebooks on track to launch later this year. Looking at 2024, we are planning for the PC TAM to grow modestly year-on-year, weighted towards the second half as AI PCs ramp. We continue to see strong growth opportunities for our client business as we ramp our current products, extend our AIPC leadership and launch our next wave of Zen 5 CPUs. Now turning to our Gaming segment. Revenue declined 17% year-over-year and 9% sequentially to $1.4 billion as lower semi-custom revenue was partially offset by increased sales of Radeon GPUs. Semi-custom SoC sales declined in line with our projections in the quarter. Going forward, we now expect annual revenue to decline by a significant double-digit percentage year-over-year as supply caught up with demand in 2023, and we entered the fifth year of what has been a very strong console cycle. In Gaming Graphics, revenue grew both year-over-year and sequentially, driven by strong demand in the channel for both our Radeon 6000 and Radeon 7000 series GPUs. We expanded our Radeon 7000 GPU series with the launch of new RX 7600 XT Series enthusiast desktop GPUs earlier this month that offer leadership price performance for 1080p gaming. We also launched new open source FidelityFX Super Resolution 3 software that can deliver significantly higher gaming frame rates on both GPUs and APUs. Turning to our Embedded segment. Revenue decreased 24% year-over-year and 15% sequentially to $1.1 billion as customers focused on reducing their inventory levels. We expanded our embedded portfolio in the quarter with new leadership solutions for key markets. We launched new Versal Prime adaptive SoCs for the aerospace, test and measurement, health care and communications markets that deliver industry-first support for DDR5 memory and increased DSP capability compared to our prior generation. In automotive, we launched new Versal SoC solutions that bring industry-leading AI compute capabilities and advanced safety and security features to next-generation vehicles. We also launched Ryzen embedded processors with unmatched performance and features for industrial automation, machine vision, robotics and edge server applications. Looking at 2024, we expect overall embedded demand will remain soft through the first half of the year as customers continue to focus on normalizing their inventory levels. Longer term, we're very confident in the growth trajectory of our Embedded business as our expanded product portfolio drove more than $10 billion of design wins in 2023, an increase of more than 25% compared to 2022. In summary, I'm very pleased with our fourth quarter and full year results. For 2024, we expect the demand environment to remain mixed, with strong growth in our Data Center and Client segments, offset by declines in our Embedded and Gaming segments. Against this backdrop, we believe we will deliver strong annual revenue growth and expand gross margin, driven by the strength of our Instinct EPYC and Ryzen product portfolios. Taking a step back, we believe AI is a once-in-a-generation transition that will reshape virtually every portion of the computing market, starting in the Data Center and then expanding into PCs and across multiple embedded markets. We have built excellent customer traction based on the strength of our multiyear AI hardware and software road maps, and we see clear opportunities to drive our next wave of growth as we deliver leadership AI solutions across our portfolio. In the Data Center, we see 2024 as a start of a multiyear AI adoption cycle with the market for Data Center AI accelerators growing to approximately $400 billion in 2027. Customer deployments of our Instinct GPUs continues accelerating, with MI300 now tracking to be the fastest revenue ramp of any product in our history, and positioning us well to capture significant share over the coming years based on the strength of our multi-generation Instinct GPU road map and open source ROCm software strategy. In PCs, we are focused on delivering our long-term road maps with leadership Ryzen AI NPU capabilities to enable differentiated experiences as Microsoft and our other software partners bring new AI capabilities to PC starting later this year. At the same time, we are rapidly driving leadership AI compute capabilities across the full breadth of our embedded product portfolio. This is an incredibly exciting time for the industry and even more exciting time for AMD as our leadership IP, broad product portfolio and deep customer relationships position us well to deliver significant revenue growth and earnings expansion over the next several years. Now I'd like to turn the call over to Jean to provide some additional color on our fourth quarter and full year financial results. Jean?
Jean Hu: Thank you, Lisa, and good afternoon, everyone. I'll start with a review of our financial results and then provide our current outlook for the first quarter of fiscal 2024. AMD executed well in 2023 despite of a mixed market demand environment, delivering revenue of $22.7 billion and earnings per share of $2.65. We drove year-over-year revenue growth in our Embedded and Data Center segments. In addition, we successfully launched our AMD Instinct MI300 GPUs, positioning us for a strong ramp in 2024 in the AI market. For the fourth quarter of 2023, revenue was $6.2 billion, growing 10% year-over-year as revenue growth in the Data Center and the Client segments was partially offset by the lower revenue in our Embedded and Gaming segment. Revenue was up 6% sequentially, primarily driven by the ramp of AMD Instinct GPUs across several leading customers and higher revenue from EPYC server processors, partially offset by the decline in Embedded and Gaming segment revenues. Gross margin was 51%, flat year-over-year, with higher revenue contribution from the Data Center and the Client segments offset by lower Embedded segment revenue. Operating expenses were $1.7 billion, an increase of 8% year-over-year as we invest in R&D and marketing activities to support our significant AI growth opportunities. Operating income was $1.4 billion, representing a 23% operating margin. Taxes, interest expense and other was $163 million. For the fourth quarter of 2023, diluted earnings per share was $0.77, an increase of 12% year-over-year. Now turning to our reportable segments. Starting with the Data Center segment, revenue was $2.3 billion, up 38% year-over-year and 43% sequentially driven by strong growth of both AMD Instinct GPU and the Fourth Generation AMD EPYC CPU sales. Data Center segment operating income was $666 million or 29% of revenue compared to $444 million or 27% a year ago. Higher operating income was primarily due to operating liability driven by higher revenue. Client segment revenue was $1.5 billion, up 62% year-over-year, driven by Ryzen 7000 Series CPU sales. Client segment operating income was $55 million or 4% of revenue compared to an operating loss of $152 million a year ago driven by higher revenue. Gaming segment revenue was $1.4 billion, down 17% year-over-year and 9% sequentially due to a decrease in semi customer revenue, partially offset by increase in Radeon GPU sales. Gaming segment operating income was $224 million or 16% of revenue compared to $266 million or 16% a year ago. Embedded segment revenue was $1.1 billion, down 24% year-over-year and 15% sequentially as customers continue to work down their inventory levels. Embedded segment operating income was $461 million or 44% of revenue compared to $699 million or 50% a year ago. Turning to the balance sheet and cash flow. During the quarter, we generated $381 million in cash from operations and the free cash flow was $242 million. Inventory decreased sequentially by $94 million to $4.4 billion. At the end of the quarter, cash, cash equivalents and short-term investment was strong at $5.8 billion. In the fourth quarter, we repurchased 2 million shares and returned $233 million to shareholders. For the year, we repurchased 10 million shares and returned $985 million to shareholders. We have $5.6 billion in remaining share repurchase authorization. Now turning to our first quarter of 2024 outlook. We expect revenue to be approximately $5.4 billion plus or minus $300 million. Sequentially, we expect Data Center segment revenue to be flat, with the seasonal decline in server sales offset by strong Data Center GPU ramp. Embedded revenue to decline as customers continue to work down their inventory levels. Client segment revenue to decline seasonally. And in the Gaming segment as we enter the fifth year of what has been a very strong gaming cycle and given current customer inventory levels, we expect revenue to decline by significant double-digit percentage. Year-over-year, we expect Data Center and Client segment revenues to increase by strong double-digit percentage given the strength of our product portfolio and the share gain opportunities. Embedded Segment to decline and the Gaming segment revenue to decline by significant double-digit percentage. In addition, we expect first quarter non-GAAP gross margin to be approximately 52%. Non-GAAP operating expenses to be approximately $1.73 billion. Non-GAAP effective tax rate to be 13% and the diluted share count is expected to be approximately 1.63 billion shares. While we are not providing specific full year guidance for 2024, let me provide some color. Directionally, for the year, we expect 2024 Data Center and the Client segment revenue to increase driven by the strengths of our product portfolio and the share gain opportunities. Embedded segment revenue to decline and the Gaming segment revenue to decline by significant double-digit percentage. We expect to expand gross margin in 2024 and continue to invest to address the large AI opportunities while driving operating model leverage to deliver earnings per share growth faster than top line revenue growth. In closing, we delivered solid financial results in 2023. We further strengthening our product portfolio and establishing ourselves as a leading provider of Data Center GPUs for AI. We are very well positioned to build on this momentum and deliver strong financial performance in 2024 and beyond. With that, I'll turn it back to Mitch for the Q&A session.
Mitch Haws: Thank you, Jean. John, we're happy to poll the audience for questions.
Operator: Thank you, Mitch. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Aaron Rakers from Wells Fargo. Please proceed with your question.
Aaron Rakers: Yeah. Thanks for taking the question. Just kind of framing the outlook and the guidance for this calendar first quarter. I guess the first question is, can you help us on a relative basis the $400 million of Data Center GPU revenue that you expected in Q4. What did that ultimately kind of fell off to be? And then, on the guidance into 1Q, can you help us appreciate what seasonal is defined as, as we think about the server business into the 1Q guide?
Lisa Su: Sure, Aaron. Let me start and then see if Jean has something to add. So, relative to the Data Center GPU business, we were very pleased with performance that we saw in the fourth quarter. It was always going to be a very sort of back-end quarter weighted as we were ramping the product and we saw MI300A, our HPC product actually ramped very well. And then we saw MI300X. The AI product actually exceed our expectations based on strong customer demand, the way the qualifications went and then the ramp -- manufacturing ramp. So, we were over $400 million for that business in the fourth quarter. And then, going into the first quarter, as we look at the business, server seasonality, call it, something around, let's call it, high-single-digit, low-double-digit. There are also some other pieces of the Data Center business. I think, the key piece of it is we had originally expected the ramp to be a little bit more shallow of our MI300X and what we're seeing now is the supply chain is operating really well, and the customer demand is strong. And so, we will see MI300X increase as we go into the first quarter, and things are going relatively well so.
Jean Hu: Yeah, Aaron, I'll give you some color about Client seasonality and others. So, Client is very similar to server, typically Q1 is high-single-digit to low-double-digit. That's consistent with past. On the Embedded side, it's very consistent with what we said in the past and the consistent with what you see in the industry's Embedded business is going through a bottoming process, and we think Q1, it will have a low-double-digit sequential decline. That's Embedded. On the Gaming side, Lisa mentioned during his -- her prepared remarks is we have the latest stage of product cycle in the year five of gaming console. But at the same time, we also have inventory at the customers. So, the combination of those impact, we expect the Q1 Gaming sequential declines probably more than 30%, so hopefully that help you a little bit.
Aaron Rakers: Yeah. Very helpful, Jean. And as a quick follow-up, I'm just curious. The traditional server demand that you see, I know when we looked at server CPU, shipments are down north of 20% year-over-year. Are you seeing any signals or how are you thinking about a recovery in that traditional, call it, non-AI general-purpose server market as we move through '24?
Lisa Su: Sure, Aaron. So look, I think, I agree with your characterization of the 2023 demand, although we did see some strong progress in the second half of the year, especially as customers in Cloud and Enterprise adopted our Genoa and our Zen 4 family. So going into 2024, I would say the traditional server market is probably still mixed, especially into the first half of the year. There's still some cloud optimization going on, as well as sort of enterprise being a little bit cautious. That being the case though, we also see opportunities for us to continue to grow share in the traditional server business. I think our portfolio is extremely strong. The adoption of Genoa and Bergamo, as well as our new Siena product lines are getting a lot of traction. And then, we also see Turin, our Zen 5 product coming in the second half of the year. So, even in a mixed demand environment, I think we're bullish on what traditional server CPUs can do in 2024.
Operator: And the next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. Lisa, I'm wondering if you can give us a little bit of sense in terms of the milepost that you're kind of marching toward on this $400 billion TAM that you have for 2027. For example, do you think you can gain share at a rate that's kind of similar to the rate that you gained share for server CPU or I guess maybe asked a different way, is it reasonable to kind of look at your consumer GPU share of 20 plus percent, is that a reasonable bogey, or do you have aspirations higher than that, perhaps?
Lisa Su: Yeah. Thanks, Tim, for the question. I would say a couple of things. First of all, we're really pleased with the progress that we've made in our Data Center GPU business. I think the ramp that we've seen, the customer traction that we've seen even in the last few months, I think has been great. And that gives us a lot of confidence in the ramp of this business. I think the beauty of the AI market here is, it's growing so quickly that I think we have both the market dynamic as well as our ability to gain share in that framework. The point I will make is our customer engagements right now are all quite strategic, dozens of customers with multi-generational conversations. So, as excited as we are about the ramp of MI300 and, frankly, there's a lot to do in 2024. We are also very excited about the opportunities to extend that into the next couple of years out into that '25, '26, '27 timeframe. So, I think, we see a lot of growth. I think it's a little early to make market share projections, but I would say it's a significant growth driver given the market demand, as well as our own product capabilities.
Timothy Arcuri: Thanks a lot. Jean, I guess as a follow-up. I know that you don't want to guide the full year. But I'm wondering if I can pin you down just to touch on maybe a milepost that you're kind of marching to for 2024 growth is up 20% for the whole company. Is that a reasonable target? And then I guess within Data Center, if you just add the incremental Data Center GPU revenue and you assume that the server business grows a little bit, it seems like that should maybe double year-over-year, but I'm kind of wondering if you can give us any ranges on those numbers? Thanks.
Jean Hu: Hi, Tim. Thank you for the question. Yeah, we're not guiding a year. It's very early of the year, literally, January. I think the way to think about it is, Lisa mentioned during her prepared remarks we feel pretty good about both our Data Center and the Client business to grow in 2024. Of course, the largest incremental revenue opportunities are going to come from Data Center between both the server side gaining more share, and Data Center GPU side with the significant ramp up of our MI300. I think that's how we think about it. We do have a headwind from Gaming segment. We do think year-over-year, we'll see very significant double-digit decline on the Gaming segment. And at the same time Embedded is going through the bottoming process. We do think the second-half we will see the recovery. So those are the puts and takes. I can talk about it.
Operator: And the next question comes from the line of Matt Ramsay with TD Cowen. Please proceed with your question.
Matthew Ramsay: Thank you very much. Good afternoon. Lisa, I wanted to ask, I mean there's been so much focus and scrutiny as there should be on the really exciting progression with MI300 and I mean we've progressed over the last six months from I think some doubts in the investment community on to software and your ability to ramp the product and now you've proven that you're ramping it what, I think you said dozens of customers right across different end-markets. So, it's what I'm interested in hearing a little bit more about and you guys have been open about what some of the forward programs in your traditional server business look like from a roadmap perspective. I'd be interested to hear how you're thinking about the roadmap in your MI accelerator family. Is it going to -- they're going to continue to be parts that are CPU and GPU together? Or is that a primarily a GPU only roadmap? What kind of cadence are you thinking about? I'd just be, any kind of color you can give us on some of the forward roadmap trajectory for that program would be really helpful. Thanks.
Lisa Su: Yeah, sure, Matt. So, I appreciate the comments. I think the traction that we're getting with the MI300 family is really strong. I think what's benefited us here is our use of chiplet technologies, which has given us the ability to have sort of both the APU version, as well as the GPU version and we continue to use that to differentiate ourselves and that's how we get our memory bandwidth and memory capacity advantages. As we go forward, you can imagine, like we did in the EPYC timeframe, we planned multiple generations in sequence. That's the way we're planning the roadmap. One of the things I will note about the AI accelerator market is the demand for compute is so high that we are seeing sort of an acceleration of the roadmap generations here and we are similarly planning acceleration of our roadmap. I would say that we'll talk more about the overall roadmap beyond MI300 as we get into later this year. But you can be assured that we're working very closely with our customers to have a very competitive roadmap for both training and inference that will come out over the next couple of years.
Matthew Ramsay: Thank you for that, Lisa. Just as a follow-up, I guess one of the questions that I've been getting a lot in different forms is, with respect to the $400 billion TAM that you guys have laid out for 2027. Maybe you could give us a little look under the hood as the, I guess, the -- I've got 100 versions of the same question which is, how the heck did you come up with that number. So, if you could give us a little bit more in terms of are we talking about systems and accelerator cards? Are we talking about just the silicon? Are we talking about full servers? And what kind of sort of unit assumptions? Any kind of thing that you can give us on-market sizing or what gives you the visibility so early into this generative AI trend to give a precise number of three years out? That would be really, really helpful. Thank you.
Lisa Su: Sure. Well, Matt, I don't know-how precise it is, but I think we said approximately $400 billion. But I think what we need to look at is growth rate and how do we get to those growth rates. I think we expect units to grow sort of substantial double-digit percentage. But you should also expect that content is going to grow. So, if you think about how important memory and memory capacity is as we go forward, you can imagine that we'll see acceleration there and just the overall content as we go to more advanced technology nodes. So, there's some ASP uplift in there. And then, what we also do is, we are planning longer-term roadmaps with our customers in terms of how they're thinking about sort of the size of training clusters, the number of training clusters. And then, the fact that we believe inference is actually going to exceed training as we go into the next couple of years just given as more enterprises adopt. So, I think as we look at all those pieces, I think we feel good that the growth rate is going to be significant and sustained over the next few years. In terms of what's in that TAM, it really is accelerator TAM. So, within accelerators, there are certainly GPUs and there will also be some ASICs that are other accelerators that are in that TAM. As we think about sort of the different types of models from smaller models to fine-tuning of models, to the largest large language models, I think you're going to need different silicon for those different use cases. But from our standpoint, GPUs are still going to be the sort of the compute element of choice when you're talking about training and inferencing on the largest language models.
Operator: And the next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
Joseph Moore: Great. Thank you. I think you talked about the MI300 cloud workloads being kind of split between the more customer-facing workloads versus internal. Can you talk about how you see the breakdown of that and how is your ecosystem progressing? This is a brand-new chip. It seems impressive they are able to support kind of a broad range of customer-facing workloads and cloud.
Lisa Su: Yeah, sure, Joe. So, yes, look, we are really happy with how the MI300 has come up and we've now deployed and working with a number of customers. What we have seen is certainly ROCm 6 has been a very important, as well as the direct optimization with our top cloud customers. We always said that the best way of optimizing the software is working directly on the most important workloads. And we've seen performance come up nicely, which is what we expect frankly with the GPU capabilities that we would have to do some level of optimization, but the optimization has gone well. I think to your broader question. The way I look at this is, there are lots of opportunities for us to work directly with large customers, both on the Cloud side as well as on the Enterprise side, who have specific training and inferencing workloads. Our job is to make it as easy as possible for them and so our entire tool chain all of our, sort of the overall ROCm suite has really gone through significant progress over the last six to nine months. And then, we're also getting some nice support from the open-source community. So, the work that Hugging Face is doing is tremendous. In terms of just real-time optimization on our hardware, our partnership with OpenAI on Triton and our work across a number of these open source models has helped us actually make very rapid progress.
Joseph Moore: Great. And for my follow-up, I guess a lot of the forecasting of your business that I'm hearing is coming from supply chain and we're sort of hearing AMD is building X in Asia. I guess, how would you ask us to think about that? Are you looking at being kind of sold-out for the year and so the supply chain would be close to revenue? Are you building for the best-case scenario? Just I worry about sometimes expectations when people hear the supply chain numbers. And I'm just curious how you bridge the gap.
Lisa Su: Yeah. So, I mean, Joe, I think we updated our revenue expectations this quarter from our original number of $2 billion to $3.5 billion to try to give some bounding on some of the discussion out there. The way to think about the $3.5 billion is these are customers that we're working with, who have given us firm commitments on what they need. As you know, the lead times on these products are quite long. So, it's important to have those forecasts in early and we have a strong order book. So, that gives us good confidence to exceed the $3.5 billion. From a supply chain standpoint, our goal is always to build more supply we -- and so, from that standpoint, we have also worked with our supply chain partners and secured significant capacity. Think about it as first half capacity is tight and more comes on in the second half of the year, but we've certainly made more progress there. So, we do have more supply, and we're going to continue to work with our customers on their deployments and we'll update that number as we go through the year.
Operator: And the next question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Hi. Thank you for taking the question. I had one on the MI300 as well, Lisa. I guess, first of all, how should we think about the quarterly trajectory beyond Q1? You talked about Q1 being up sequentially. Is it fair to assume kind of a straight line as we progress through the balance of the year? Or is it more second half skewed? How should we think about that? And I guess more importantly, some of the cloud potential customers that have yet to officially sign-up for or sign-off on the MI300. I guess what's the sticking point? Is it just a function of time and you just need a little bit more time to go back-and-forth and tweak things or is there a software kind of concern? I guess what's holding them back at this point?
Lisa Su: Yeah, Toshiya, thanks for the question. So, first on the MI300 trajectory. I think you would expect that revenue should increase every quarter from now through sort of the end of the year, but it will be a bit more second half weighted and part of that is just customers as they're finishing up their qualifications in their lines as well as sort of how our supply chain is ramping. So, yes, it should increase each quarter, but be a bit more second half weighted. And then, to your comment about customers, look, we are engaged with all of sort of the large customers. These are all folks that know what's really well, given our deep relationships in EPYC. I think people just have different adoption cycles as they consider what they're trying to do in their roadmap. But I view this as still very, very early innings for us in this space. And I think the question was asked earlier. I think the key is this is not just about MI300 conversation. But it really is about sort of our long-term multi-generational roadmap. And so, that's the context on which we're working with our largest customers, as well as, as you know, there's a lot of demand coming from folks that are more AI centric and not necessarily typical cloud customers, but more enterprise or let's call it AI-specific companies that we're also very well engaged with.
Toshiya Hari: Got it. That's super helpful. And then as my follow-up, maybe one for Jean on the gross margin side. You're guiding Q1 to 52%. I'm curious, again, I'm sure you're not going to give quantitative guidance beyond Q1, but how to think about the trajectory for Q2 and beyond? I'm pretty sure you're working through some kinks as it pertains to the Instinct ramp. Hopefully, that improves over time. So that should be a tailwind. FPGAs perhaps the second half turns for the better. And you've got server CPU volume growth throughout the year. So, it feels like you've got multiple tailwinds as we think about gross margin progression on a sequential basis. But what are the potential headwinds as we move throughout 2024? Thank you.
Jean Hu: Yeah, Toshiya, thank you for the question. Yeah, you're absolutely right. We have some puts and takes that impact our gross margin. We guided the Q1, 120 basis points higher than Q4 sequentially, primarily because the higher Data Center contribution actually more than offset the decline of Embedded business in Q1. Going forward, the way to think about it is as you said is the major driver is going to be Data Center business is going to grow much faster than other segment. That mix change will help us to expand the gross margin nicely. I think you also are spot on, the Embedded coming back in second half, which will be a tailwind. With the Data Center GPU, we are at the very early stage of ramp. We are improving testing time yield and continue to expand gross margin and we expect to be accretive to corporate average. So, those are all the tailwinds coming in the second half. I would say the headwinds side continue to be in the first half where we see Embedded business not only Q1 we see sequential decline, Q2 probably are going to be sequentially flattish versus Q1. That is a headwind for us. Because it does have a very nice gross margin. But overall, we feel pretty good about the trajectory of the gross margin improvement, especially second half.
Operator: And the next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Thanks for letting me ask the question. I wanted to get into the competitive environment. First on the Instinct side of things. How that's going? It doesn't seem to be slowing down your ramp whatsoever, but then also on the straight server CPU side of things. Lisa, you said you're gaining share in that area. But as we think about future road maps, pricing incentives, those sorts of things, any meaningful change in the competitive environment that you're seeing throughout 2024?
Lisa Su: Sure, Ross. So look, I think the environment for us is always competitive. So, I think that has not changed. If I look at the Instinct side, I think we have -- I think we've shown that MI300 and our roadmap are actually very competitive. There are some places where let's call it, it's more even like in the training environment. But as we look at the inferencing environment, we think we have significant advantages. And that's showing through in some of our customer work. So we think for both training and inference, we will continue to be very competitive. And then, as you go into the CPU side again, from our view, with each generation of EPYC, we've continued to gain share. I think, we exited the fourth quarter at record share for AMD. And we're still quite underrepresented in Enterprise. So I think there is an opportunity for us to continue to gain share as we go through 2024. From a competitive standpoint, what we see is Zen 4 is extremely competitive right now with Genoa, Bergamo, Siena. And as we go into Turin, we're deep in the design in-cycle for Zen 5 and Turin and we feel very good about how we're positioned.
Ross Seymore: Thanks for that. I guess as my follow up. On the Data Center side, another theme that's been pervasive throughout 2023 at least was the GPU side driving out the CPU side. You mentioned that there is still a little bit of cloud digestion going on within your EPYC business. But where do you see that standing? I know you're going to gain share, et cetera, but you guys fully benefit from the Instinct side for the Data Center GPU side, but what about on the CPU side of things? Is that headwind now behind us or is it still an issue?
Lisa Su: I think we expect the CPU business from a market standpoint to grow, Ross. As we go into 2024, I think the rate and pace of growth will depend a little bit on the macro and just overall CapEx trends. But from our standpoint, we are starting to see some of our larger customers plan their refresh cycles. There's a lot of let's call it older equipment that has yet to be refreshed and the value proposition for refresh is so strong because the energy efficiency and sort of the footprint of the newer generations are so much better than sort of the four or five year old infrastructure that we do see that refresh cycle happening as we get into 2024. I think the exact timing, we will have to understand more as it, as the market evolves as we go through the year.
Operator: And the next question comes from the line of Vivek Arya with Bank of America Securities. Please proceed with your question.
Vivek Arya: Thanks for taking my questions. So first one, Lisa, from you gave us the $2 billion plus number for MI before, now you've have raised it to over $3.5 billion. And I'm curious what drove the change, was it incremental demand signals, was it supply? And can you supply more of, let's say, demand is $4 billion or $5 billion or $6 billion, right, what is the limitation? And sort of related to that, on the competition side, your competitor will launch their B100 later in the year, do you think that will change the competitive landscape in anyway?
Lisa Su: Yes. Sure, Vivek. So, I think what we said is as we went from $2 billion to $3.5 billion, it really is mostly customer demand signals. So as orders have come on books and as we've seen programs moved from, let's call it, pilot programs into full manufacturing programs, we have updated the revenue forecast. As I said earlier, from a supply standpoint, we are planning for success. And so, we worked closely with our supply chain partners to ensure that we can ship more than $3.5 billion, substantially more depending on what customer demand is as we go into the second half of the year. And then, in terms of again roadmaps, as I said, we are very focused on a competitive roadmap this -- that sort of what the next generations are beyond MI300. So, I do believe that we have a strong roadmap in-place and continue to work with our customers to sort of adopt our roadmap as quickly as possible.
Vivek Arya: Got it. And a longer-term question, Lisa. If I look at the success that AMD has enjoyed, its many factors, but a few of them included your early adoption of chiplets and the strong partnerships you have had with TSMC. But now we are seeing your x86 competitor Intel also adopt chiplet or tile technology as they call it. And then I think recently the manufacturing update they gave, they said, they are two years ahead in terms of incorporating gate all-around and backside our delivery. So, let's assume they are right and they have either caught up to TSMC or maybe they are ahead. What impact does that have on AMD in kind of the medium to longer term?
Lisa Su: Yeah. Sure, Vivek. Look, we're always looking at what's next, right? So, on the chiplet technology, I mean, we're sort of on the fourth generation of the chiplet technologies. I think we've learned a lot about how to optimize performance there. We are very aggressive with our adoption of leading-edge technology as it's needed. But I think those are only a few of the pieces. We're also focused on continuing to innovate on architecture and design. So, I think the longer-term question that you ask is I think we're expecting that the competition is going to be on a similar process technology and even in that case, I think we feel like we have a very strong roadmap going forward and will continue to drive both the CPU and the GPU roadmap very aggressively.
Operator: And the next question comes from the line of Harsh Kumar with Piper Sandler. Please proceed with your question.
Harsh Kumar: Yes, hey, thanks for letting me ask the question, guys. I have two questions. Let me start-off with the accelerator side. The question we get a lot from our customers is they want to understand the value proposition of the MI300. So, Lisa, I was hoping you could give us some understanding of price versus power comparison or compute power? And then today, are you seeing your customers that are buying the MI300 are they primarily buying it for inferencing today or are they using it primarily for tooling? And maybe for Jean. Jean, do you think is it possible for MI300 to finish the year at a run-rate of about $1.5 billion?
Lisa Su: Okay, Harsh. So, let me start, to your question about the value proposition for MI300. Again, customers are using it for different reasons, but presume that there is a performance per dollar benefit to using AMD. So that's one piece of it. The other piece of it though is we intrinsically have more bandwidth and memory capacity on MI300X compared to the competition. And what that means is for large language models that are many tens of billions of parameters you make -- you could potentially do the workload in fewer GPUs. So, it's a substantial system savings and allows you to do much more work within the same system. In terms of what customers are using MI300 for today, I would say there are a number of customers using it for large language model inferencing and there are also customers that are using it for training. So I think the whole point is being a strong partner. When you put these AI systems in-place, they are sometimes mixed-use systems. So they would be used for both training and inference.
Mitch Haws: John, we have time for two more questions.
Jean Hu: Yeah, Harsh. Let me answer your question about the MI300. Exiting Q4 2024, is it possible to get to $1.5 billion? It is possible, right, because Lisa mentioned earlier, we'll see sequential increase in each quarter and more back-end loaded in second-half and we do have a supplies more than $3.5 billion. And of course we will continue to make progress with our customers. So the math, yeah, it's possible, but right now we are really looking at focus on the execution of the current $3.5 billion plus.
Operator: And the next question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi, guys. Thanks for taking my questions. For the first one, you talked about the -- you expected a more shallow ramp of the MI300 and it's clearly doing better than that. So, some of the upside I guess in the near-term is that being pulled forward from the second-half or is this like a step-up or is it more of a step-up in-demand both in the first half and the second-half relative to what you were seeing before? Like how do I interpret that by shallow comment that you made?
Lisa Su: Sure, Stacy. I don't think it's a pull-forward of demand. I think what it is we wanted to see how long it would take for customers to fully qualify and get their workloads performance. So, yeah, that depends a lot on the actual engineering work that's done and now that we're, let's call it a quarter later, we've seen that it's gone really well. So, it's actually gone a bit better, then our original forecast. And as a result, we've seen stronger demand signals and customers are gaining confidence in their ability to deploy a significant number of MI300 this year.
Stacy Rasgon: Got it. Thank you. For my follow-up I wanted to ask Matt's question a little more directly, you didn't quite answer it. That the $400 billion number that you've got out there, is that just silicon in chips or is there hardware and servers and stuff like that in that number as well, like what's in that number?
Lisa Su: Yeah, I thought I had answered it, but yes, I'll answer it again. It is accelerator chips. It is not systems. So, think of it as GPUs, ASICs that will be there. Those types of things, but it includes, obviously, it includes memory and other things that are packaged together with the GPUs.
Jean Hu: Yeah, memory will be quite significant, right? So, memory is a big portion of the two.
Operator: And the final question comes from the line of Chris Danely with Citi. Please proceed with your question.
Christopher Danely: Hey, thanks for squeezing me and team. I guess, question for Lisa as MI300 revenue ramps how do you see the customer concentration, let's say a year or two from now? Do you think you'll have one or two customers that are in double-digits or one or two that are half the revenue or do you think it will be totally fragmented?
Lisa Su: I don't think it will be one or two that are half the revenue, Chris. I think we are building this as a -- really, we're happy to see sort of the broad adoption as always with sort of the large cloud partners. We might see sort of one or two that are higher than others, but I don't think you see the type of concentration that you mentioned.
Christopher Danely: Great. And then just a follow-up on somebody else's question on sort of Intel's roadmap versus TSMC. So, I'm sure you're intimately familiar with TSMC's manufacturing roadmap and we've all seen the Intel open up the kimono on what they expect to happen over the next couple of years. I mean, do you think Intel is going to close the gap somewhat with what you've found here over the next couple of years? Do you think they'll be able to maintain the lead?
Lisa Su: Look, I feel very good about our partnership with TSMC, they continue to execute extremely well. We'll see what happens over the next few years. But I'd like to kind of reemphasize what I said earlier, even in the case of process parity, we feel very good about our architectural roadmap and all the other things that we add, as we look at our entire portfolio of CPUs, GPUs, DPUs, adaptive SoCs and kind of put them together to solve problems. I think we feel really good about what we can do with our customers. So, we're always going to be paying attention to sort of the process race, but I think we feel very good about sort of our strategy and how do we continue to sort of push the envelope on the computing roadmaps.
Operator: And that is the end of the question-and-answer session. I would like to turn the floor back over to the AMD team for any closing comments.
Mitch Haws: Great, John. That concludes today's call. Thank you to everyone for joining us today.
Operator: And this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
GOOG | 4 | 2,023 | 2024-01-30 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2023 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors discussed in our upcoming Form 10-K filing for the year ended December 31, 2023. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now I'll turn the call over to Sundar.
Sundar Pichai: Hello, everyone. Our results reflect strong momentum and product innovation continuing into 2024. Today, I'm going to talk about four main topics. One, our investments in AI, including how it's helping Search; two, subscriptions, which reached $15 billion in annual revenue, up 5x since 2019. Subscriptions is growing strongly powered by YouTube Premium and Music, YouTube TV and Google One. Three, Cloud, which crossed $9 billion in revenues this quarter and saw accelerated growth driven by our GenAI and product leadership; and four, our investments and focus to meet the growth opportunities ahead.
First, AI and Search. As you know, we have long led the way in using AI to improve many of our products from Search to Ads to most of our consumer and enterprise products, helping billions of people already. Last year brought new excitement around GenAI, and I'm proud of how we responded responsibly with deep advances in foundation models and a number of great launches.
We closed the year by launching the Gemini era, a new industry-leading series of models that will fuel the next generation of advances. Gemini is the first realization of the vision we had when we formed Google DeepMind, bringing together our 2 world-class research teams. It's engineered to understand and combine text, images, audio, video and code in a natively multimodal way, and it can run on everything from mobile devices to data centers.
Gemini gives us a great foundation. It's already demonstrating state-of-the-art capabilities, and it's only going to get better. Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products.
That starts with Search. We are already experimenting with Gemini in Search, where it's making our Search Generative Experience, or SGE, faster for users. We have seen a 40% reduction in latency in English in the U.S. I'm happy with what we are seeing in the earliest days of SGE. It's available through Search Labs in 7 languages.
By applying generative AI to Search, we are able to serve a wider range of information needs and answer new types of questions, including those that benefit from multiple perspectives. People are finding it particularly useful for more complex questions like comparisons or longer queries. It's also helpful in areas where people are looking for deeper understanding, such as education or even gift ideas.
We are improving satisfaction, including answers for more conversational and intricate queries. As I mentioned earlier, we are surfacing more links with SGE and linking to a wider range of sources on the results page, and we'll continue to prioritize approaches that add value for our users and send valuable traffic to publishers.
Beyond SGE, we are continuing to use AI to make searching more accessible and intuitive. Circle to Search lets you search what you see on Android phones with a simple gesture without switching apps. It's available starting this week on Pixel 8 and Pixel 8 Pro and the new Samsung Galaxy S24 Series.
And Lens now offers generative AI overviews. You can add text to a visual search to ask questions about anything you see and get AI-powered insights in the moment. In addition to Search, we are also seeing a lot of interest in our AI-powered solutions for advertisers. That includes our new conversational experience that uses Gemini to accelerate the creation of Search campaigns.
Then there is Bard, our conversational AI tool that complements Search. It's now powered by Gemini Pro and is much more capable at things like understanding, summarizing, reasoning, coding and planning. It's now in over 40 languages and over 230 countries around the world. Looking ahead, we'll be rolling out an even more advanced version for subscribers powered by Gemini Ultra.
That's a good segue to subscriptions. As I said earlier, it's now a $15 billion business annually. YouTube is the key driver of our subscription revenues. Available in over 100 countries and regions, YouTube Music and Premium have real momentum. They're engaging passionate users and driving great returns for the music industry and creators.
YouTube TV is also doing well. We've had great consumer feedback on the viewing experience. People love the navigation, multiview and unlimited DVR. NFL Sunday Ticket has found its perfect home on YouTube, and Philipp will talk about that more.
Let me also talk about our subscription service, Google One. It's doing incredibly well with strong user growth. It provides expanded storage, unlocks exclusive features in Google products and allows us to build a strong relationship with our most engaged users. Google One is growing very well, and we are just about to cross 100 million subscribers. From here, we are going to bring in more AI features and look forward to more strong growth to come.
Next, Google Cloud. Throughout 2023, we introduced thousands of product advances, including broad GenAI capabilities across our AI infrastructure, our Vertex AI platform and our new Duet AI agents. In Q4, our product and GenAI leadership enabled us to win and expand relationships with many leading brands, including Hugging Face, McDonald's, Motorola Mobility and Verizon.
Google Cloud offers our AI Hypercomputer, a groundbreaking supercomputing architecture that combines our powerful TPUs and GPUs, AI software and multi-slice and multi-host technology to provide performance and cost advantages for training and serving models. Customers like Anthropic, Character.AI, Essential AI and Mistral AI are building and serving models on it.
For developers building GenAI applications, we offer Vertex AI, a comprehensive enterprise AI platform. It helps customers like Deutsche Telekom and Moody's discover, customize, augment and deploy over 130 GenAI models, including PaLM, MedPaLM, Sec-PaLM and Gemini as well as popular open source and partner models. Vertex AI has seen strong adoption with the API request increasing nearly 6x from H1 to H2 last year.
Using Vertex AI, Samsung recently announced its Galaxy S24 Series smartphone with Gemini and Imagen 2, our advanced text-to-image model. Shutterstock has added Imagen 2 to their AI image generator, enabling users to turn simple text prompts into unique visuals. And Victoria's Secret & Co. will look to personalize and improve the customer experience with Gemini, Vertex AI, Search and Conversations.
Customers are increasingly choosing Duet AI, our packaged AI agents for Google Workspace and Google Cloud Platform, to boost productivity and improve their operations. Since its launch, thousands of companies and more than 1 million trusted testers have used Duet AI. It will incorporate Gemini soon.
In Workspace, Duet AI is helping employees benefit from improved productivity and creativity at thousands of paying customers around the world, including Singapore Post, Uber and Woolworths. In Google Cloud Platform, Duet AI assists software developers and cybersecurity analysts. Duet AI for Developers is the only GenAI offering to support the complete development and operations life cycle, fine-tuned with the customer's own core purpose and policies. It's helping Wayfair, GE Appliances and Commerzbank write better software, faster with AI code completion, code generation and chat support. With Duet AI and Security Operations, we are helping cybersecurity teams at Fiserv, Spotify and Pfizer.
Our robust growth has been driven by strong direct and indirect channels. With ISVs, we have nearly tripled the number of co-sell deals from 2022 to 2023. In our ecosystem, there are nearly 90,000 Google Cloud GenAI-enabled consultants. And Accenture has teamed up with Google Cloud to create a joint generative AI center of excellence.
Next, let me turn to our focus and discipline as we pursue the opportunities ahead. Search, YouTube and Cloud are supported by our state-of-the-art compute infrastructure. This infrastructure is also key to realizing our big AI ambitions. It's a major differentiator for us. We continue to invest responsibly in our data centers and compute to support this new wave of growth in AI-powered services for us and for our customers. Through this, we are being disciplined in how we run the company.
You've heard me talk about our efforts to durably reengineer our cost base and to improve our velocity and efficiency. That work continues. Teams are working to focus on key priorities and execute fast, removing layers and simplifying their organizational structures. As just one example, our devices team has brought together different teams from across Nest, Fitbit and other teams into a new functional structure. This will help us pull resources and drive progress across our Pixel portfolio. Across different teams, we have wound down some nonpriority projects, which will help us invest and operate well in our growth areas.
We are also improving our machine utilization, building on our years of experience in driving cost efficiencies in our computing infrastructure and operations. And through our supplier efficiency efforts and automation of certain processes, we have made major improvements in areas like procurement, achieving significant savings.
That's a snapshot of the quarter. Before I close, a couple of other highlights. Pixel 8, our AI-first phone, was awarded Phone of the Year by numerous outlets. It now uses Gemini Nano with features like Magic Compose for Google Messages and more to come.
In our Other Bets portfolio of companies, Waymo, which is deeply focused on safety, reached over 1 million fully autonomous ride-hailing trips. And Isomorphic Labs entered into strategic partnerships with Eli Lilly and Novartis to apply AI to treat diseases, which has great potential.
2023 was a year of profound innovation and product momentum. Thank you to our many partners. We succeed when our partners do, and we are grateful for the work we do together. From our partners across the Android ecosystem who are on display at CES to our deep relationships with retailers, small businesses and advertising partners, to the next generation of AI start-ups and developers and many more. I also want to thank all of our employees for their hard work throughout 2023 and the start of the new year. I'm excited for what's ahead in 2024. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone. Google Services revenues of $76 billion were up 12% year-on-year. In Google advertising, Search and other revenues grew 13% year-on-year, led again by solid growth in the retail vertical. We had particular strength in retail in APAC, a trend that began in the second quarter of 2023 and continued through the end of the year.
YouTube ads revenue were up 16% year-on-year driven by growth in both direct response and brand. And network revenues declined 2% year-on-year. In subscriptions, platforms and devices, which was previously named Google Other, year-on-year revenues increased 23% driven by strong growth in subscriptions.
Now for some color on the quarter and where we see continued upside for long-term advertising growth. Over the last few calls, I have consistently highlighted how we're putting Google AI to work for our customers to deliver profitability and help them achieve their goals in a do-more-with-less environment.
From a product perspective, in Q4, Performance Max remained a bright spot. We're also excited about demand gen momentum. This is our big bet to help social advertisers find and convert consumers via immersive, relevant visual creatives across YouTube, including YouTube Shorts, Gmail and Discover. In a single campaign, you get access to over 3 billion users as they stream, scroll, connect and decide what to buy. Tens of thousands of advertisers are testing and on average seeing 6% more conversions per dollar versus image-only ads and discovery campaigns.
As we look ahead, we're also starting to put generative AI in the hands of more and more businesses to help them build better campaigns and even better performing ads. Automatically created assets help advertisers show more relevant search ads by creating tailored headlines and descriptions based on each ad's context. Adoption was up with strong feedback in Q4. In addition to now being available in 8 languages, more advanced GenAI-powered capabilities are coming to ACA.
And then last week's big news was that Gemini will power new conversational experience in Google Ads. This is open and beta to U.S. and U.K. advertisers. Early tests show advertisers are building higher-quality search campaigns with less effort, especially SMBs who are 42% more likely to publish a campaign with good or excellent ad strength. We can't wait to see how this continues to drive performance and level the playing field for advertisers of all sizes.
As we shared last quarter, Ads will continue to play an important role in the new search experience, and we'll continue to experiment with new formats native to SGE. SGE is creating new opportunities for us to improve commercial journeys for people by showing relevant ads alongside search results. We've also found that people are finding ads either above or below the AI-powered overview helpful as they provide useful options for people to take action and connect with businesses.
Looking at our strong Search performance for the fourth quarter. Retail was a highlight. We continue to see a stronger start to the season up to and including Cyber Five. In Q3, we indicated that we were seeing early trends of consumers being very price-conscious, and we saw this play out in Q4. With promotional demand at an all-time high, deal seekers using Google had access to 2x the deals in the U.S. versus last season as well as a better shopping experience. Launches included a one-stop shop deals destination, new filters like [ Get it Fast ] and AI-generated gifting recommendations in SGE. These new features drove incremental query growth during key shopping moments like Cyber Five.
Our proven AI-powered ad solutions were also a win for retailers looking to accelerate omni growth and capture holiday demand. Quick examples include a large U.S. big-box retailer who drove a 60%-plus increase in omni ROAS and a 22%-plus increase in store traffic using Performance Max during Cyber Five; and a well-known global fashion brand, who drove a 15%-plus higher omnichannel conversion rate versus regular shopping traffic by showcasing its store pickup offering across top markets through pickup later on shopping ads.
Moving on to YouTube. We're obviously pleased with YouTube's advertising revenue growth in Q4 and also significant growth in our subscription revenue. I'll reiterate what I have said before: YouTube's success starts with creator success. We give millions of creators more ways to create content and connect with fans and more ways to make money and build their own businesses than any other platform. More creators means more content, which leads to more viewers. And via ads and subscriptions, these viewers fund our creators and drive the eyeballs and engagement our advertisers want.
To keep this momentum going, we're focused on delivering value across 4 pillars: creation, viewers, monetization and responsibility. First, creation, which increasingly takes place on mobile devices. We've invested in a full suite of tools, including our new YouTube Create app for Shorts, to help people make everything from 15-second Shorts to 15-minute videos to 15-hour live streams with a production studio in the palm of their hands.
GenAI is supercharging these capabilities. Anyone with a phone can swap in a new backdrop, remove background extras, translate their video into dozens of languages, all without a big studio budget. We're excited about our first products in this area from Dream Screen for AI-generated backgrounds to Aloud for AI-powered dubbing. There is more to come.
Number two, viewers. We continue to grow watch time across YouTube with strong growth in Shorts and connected TV. Shorts remains a top priority. We have 2 billion-plus logged-in users every month, and we are averaging 70 billion in daily views. Connected TVs, or what we refer to as the living room, is where viewership is growing the fastest. We're investing to make this experience even better with interactive features tailored to TVs, plus the content people love: our creators, NFL Sunday Ticket and the range of live sports and studio content via YouTube TV and Primetime Channels. Put this all together and YouTube is the must-have app on every connected TV.
Monetization is pillar #3 and realized through a combination of ad-supported and subscription offerings. Advertising generates the bulk of our revenue, and we continue to invest heavily here. We've rolled out CTV-first formats like 30-second nonskippable ads and pause experiences as well as an industry-first send-to-phone experience that lets people use a second screen to engage with ads.
For Shorts, we've developed new formats that are less interruptive to viewers. It's early. We're learning but excited by the opportunities for ads this can unlock. Shorts monetization continues to progress nicely.
Our AI-powered video formats from video reach and video view campaigns to demand gen and video action continue to make advertiser dollars go further and drive results across the funnel. We're also introducing new and existing advertisers to YouTube via sports content. 90-plus upfront and scatter advertisers, including Unilever, are partnering with YouTube in our first year across NFL Sunday Ticket in-game advertising opportunities.
Our subscription offerings are also growing at a healthy clip. YouTube Music and Premium performed well. Premium users are delivering more value to our partners and YouTube than even ad-supported users do. On average, each additional Premium sign-up boost earnings for creators, music and media partners and YouTube itself. And we've made Premium even more attractive with new features, bundles and other enhancements.
We're also pleased with our first season of NFL Sunday Ticket. It gave creators new opportunities to create content and feed user engagement across traditional user content and professional sports content. Feedback on the user experience, including multiview, has been great. We're excited to continue to innovate here.
Responsibility is our fourth pillar, and it underlines everything we do across YouTube. We continue to focus relentlessly on this. As always, deepening our relationships with key partners to bring them the best of Google is a key priority for us, and we continue to do this across industries in Q4.
We just talked about the NFL. Sundar mentioned Samsung, among others earlier. Another highlight was our expanded partnership with Porsche to enhance customers' digital experiences with a deeper in-vehicle integration of Google built-in services, including Google Maps and Play. Whether it's continued collaboration with our partners and key ecosystems, we're putting Google AI to work for more customers. I'm excited about the opportunities for continued impact in 2024.
I'll wrap with a huge note of gratitude to our customers and partners. Our success is only possible because of their success and then to our Googlers for their outstanding work and focus this year.
Ruth, over to you.
Ruth Porat: Thank you, Philipp. We are very pleased with our full year results with 2023 Alphabet revenues of $307 billion, up 9% versus 2022, which added $25 billion to revenues for the year. We ended with a strong fourth quarter with consolidated revenues of $86.3 billion, up 13% versus last year in both reported and constant currency.
Search remained the largest contributor to revenue growth. My comments will be on year-over-year comparisons for the fourth quarter, unless I state otherwise.
Total cost of revenues was $37.6 billion, up 6%. Other cost of revenues was $23.6 billion, up 5%, with the increase driven primarily by content acquisition costs associated with YouTube subscription offerings. The growth rate also reflects the offsetting benefit of lapping $1.2 billion in inventory-related charges that we called out in the fourth quarter last year as well as a reduction in depreciation expense due to changes in estimated useful lives we made starting in the first quarter of 2023.
In terms of total expenses, the year-on-year comparisons reflect an additional $1.2 billion in exit charges that we took in the fourth quarter of 2023 in connection with actions to optimize our global office space. As you can see in our earnings release, these charges were allocated across the expense lines in other cost of revenues and OpEx based on associated head count.
Operating expenses were $25 billion, up 11%, primarily reflecting an increase in R&D expenses, which were driven by the real estate charges, followed by compensation. Operating income was $23.7 billion, up 30%, and our operating margin was 27%. Net income was $20.7 billion, and EPS was $1.64. We delivered free cash flow of $7.9 billion, which was affected by the timing of the $10.5 billion tax payment we made on October 16 that we called out previously related to the deferral of certain tax payments to the fourth quarter.
For the full year 2023, free cash flow was $69 billion. We repurchased a total of $62 billion of our Class A and Class C shares in 2023 and ended the year with $111 billion in cash and marketable securities.
Turning to segment results. Within Google Services, revenues were $76.3 billion, up 12%. Google Search and other advertising revenues of $48 billion in the quarter were up 13%, led again by growth in retail. YouTube advertising revenues of $9.2 billion were up 16% driven by both direct response and brand advertising. Network advertising revenues of $8.3 billion were down 2%.
Subscriptions, platforms and devices revenues, which we previously referred to as other revenues, were $10.8 billion, up 23%, primarily reflecting growth in YouTube subscription revenues. TAC was $14 billion, up 8%. Google Services' operating income was $26.7 billion, up 32%, and the operating margin was 35%.
Turning to the Google Cloud segment. Revenues were $9.2 billion for the quarter, up 26%. We're very pleased with the momentum of GCP with an increasing contribution from AI. Google Workspace also delivered strong revenue growth primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $864 million and an operating margin of 9%.
As to our Other Bets, for the full year 2023, revenues were $1.5 billion and the operating loss was $4.1 billion. Results in the fourth quarter benefited from a milestone payment in one of the Other Bets.
Turning to our outlook for the business. With respect to Google Services, first, within advertising. We were pleased with the sequential revenue growth of Search and YouTube advertising throughout 2023, which reflects the extraordinary work across our teams to drive improved experiences for users and attractive ROI for advertisers. As we enter 2024 with advertising revenues of more than $100 billion higher than 2019, we remain focused on sustaining healthy growth on this larger base.
Second, within subscriptions, platforms and devices, our total revenues from subscription products reached $15 billion for the full year 2023 driven primarily by substantial growth in subscribers for our YouTube subscription offerings. The substantial increase in our subscription revenues over the past few years demonstrates the ability of our teams to deliver high value-add offerings and provides a strong base on which to build, including through YouTube and newer services like Google One.
Play had solid growth again in the fourth quarter driven primarily by an increase in the number of buyers. In devices, we continue to make sizable investments with increased emphasis on our Pixel family, particularly with AI-powered innovation while driving further efficiencies across the portfolio.
Turning to Google Cloud. We are pleased with operating performance in the year. Full year revenues of $33 billion were up 26% versus prior year, ending with strong Q4 performance. The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.
In terms of profitability, the improvement in 2023 reflects sustained focus across the team with the intent to maintain healthy profitability while we continue to invest to support long-term growth.
Turning to margins and expenses. As we have repeatedly stressed, we remain committed to our framework to durably reengineer our cost base as we invest to support our growth priorities. Key contributors to moderating our expense growth include: first, product and process prioritization to ensure we have the right resources behind our most important opportunities and to reallocate resources where we can; second, organizational efficiency and structure. We're focused on removing layers to simplify execution and drive velocity.
Both product prioritization and the organization design efforts result in a slower pace of hiring, as you can see with our head count down year-on-year, reflecting the reductions we announced in the first quarter of 2023 and a much slower pace of hiring. We will continue to invest in top technical and engineering talent.
Finally, we continue to execute the other work streams to slow expense growth, including improving efficiency in our technical infrastructure, streamlining operations across Alphabet through the use of AI, increasing efficiency of our spend with suppliers and vendors through our central procurement organization and optimizing our real estate portfolio.
With respect to CapEx, our reported CapEx in the fourth quarter was $11 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.
With regard to Other Bets, we've been working to sharpen our investment focus while capturing the upside given compelling technology breakthroughs across the portfolio. For example, last week, Alphabet's X announced that it would be moving to spin out more projects as independent companies through external capital, giving X the opportunity to bring more focus to the breakthrough technologies it is working on to address some of the world's most pressing challenges.
Thank you. Sundar, Philipp and I will now take your questions.
Operator: [Operator Instructions] And our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two for Philipp. Philipp, the first one is about sort of a lot of the new generative AI advertising tools. You obviously have a lot of irons in the fire here. You've been talking about some of the early momentum with tens of thousands of advertisers.
The question is, can you sort of walk us through some of the hurdles and gating factors that we should be thinking through that dictate the pace at which these tools can really be rolled out broadly just so we and advertisers can kind of get an understanding for when they could have a bigger impact on the whole business? And then secondly, how do you think about the long-term sales force intensity of the advertising business as you roll more AI-based tools like PMax impacting the overall ad allocation?
Philipp Schindler: Yes. Thank you so much. So I've covered this a little bit on previous quarters. AI has been at the core of our advertising products for a very, very long time. And the recent advances are really allowing us to drive more value for advertisers across a large range of different areas: bidding, targeting, creative as well as our core advertiser and publisher experiences.
We are seeing in core search ads, for example, the bidding side, the value-based bidding as a very significant one; on the targeting side, the broad match; on creative, responsive search ads automatically created ads assets. And we are very happy with the progress we're seeing in those areas.
I think I mentioned in one of the previous calls that one, you asked about hurdles and gating factors. The AI essentials play neutral in this, trying to get everybody ready to really take full advantage of those tools. We talked about the progress on PMax as well that we're very happy with in Q4. So overall, I think we are on track with what we're expecting here.
On the sales force intensity side, we have done a few reallocations or let me call it portfolio adjustments. As you know, we have 2 large different teams. One is our LCS, large customer solutions team that's really focused on transformational growth for our largest and most sophisticated customers. And we have our -- we call them GCS, Global Customer Solutions team, which is the channel where really every customer starts from some of our largest customers now to also the millions of smaller ones and SMBs.
The GCS is really then scaling growth by dynamically delivering really the right treatment for every customer. And important to note, it's also our fastest-growing channel, and it delivered particularly strong growth in Q4. So we have done adjustments here to focus more resources on the GCS side.
But I also want to be clear, when we restructure, there's always an opportunity to be more efficient and smarter in how we service and grow our customers. We're not restructuring because AI is taking away roles that's important here. But we see significant opportunities here with our AI-powered solution to actually deliver incredible ROI at scale, and that's why we're doing some of those adjustments. So I look at sales force intensity as a stronger focus going forward on the channels I mentioned here.
Operator: Our next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: One for Ruth and one for Philipp. Ruth, you're now into year 2 of durably reengineering your cost structure. Can you just help us assess your progress so far? And are there any guideposts that we should be thinking about going forward?
And then Philipp, can you talk more about NFL Sunday Ticket and just what your key learnings were in year 1? How are you thinking about the returns on the investment on both from an advertising perspective and then also subscribers to both Sunday Ticket and YouTube TV?
Ruth Porat: Thanks for the question. So we are very pleased with the progress we're continuing to make, and we are very committed to the framework to durably reengineer our cost base really as we're investing to support the growth priorities. I tried to call out a number of them in opening comments, but really, as you're looking at the work being done across Google, across Alphabet, it does start with product and process prioritization to make sure we've got the right resources behind the most important opportunities, and then that creates the opportunity for reallocating resources where we can.
Then we talked a lot about this quarter about organizational efficiency and structure, and we're focused on removing layers to simplify execution and drive velocity. The combination of those 2, product prioritization and organizational design work, has resulted in the slower pace of hiring. You can see that in our head count numbers down year-on-year. You can see it in some of the -- in the results that we delivered in the fourth quarter.
You can -- and it also goes to the announcements around first quarter and much lower pace of hiring. At this point in the quarter, we do estimate that severance-related expense will be roughly $700 million in the first quarter as we've continued these efforts. But as I said in opening comments, we will continue to invest in top engineering.
So that's sort of the big one, if you start with product prioritization and organizational design, which is why also I made the note about the severance-related expense, which helps pave the way as we're continuing to do the work that we're doing. But then we have a host of other work streams, which I talked about, everything with improving efficiency in our technical infrastructure, which is a very large ongoing effort; streamlining operations across Alphabet through use of AI; all the work we're doing with our suppliers and vendors; the work we're doing optimizing our real estate portfolio. So when we've described durably reengineering, it's about continuing to build on work that started, and that is ongoing.
Philipp Schindler: So on the NFL Sunday Ticket side, look, as I said earlier, NFL Sunday Ticket supports our long-term strategy and really help solidify YouTube's position as a must-have app on everyone's TV set.
You asked about some of the learnings. Maybe I'll start with the viewing experience. We've received great feedback so far. People like the navigation, multiview, the chat, the lack of latency, really, really positive feedback on this one. You asked about the ads and the subs. Maybe I'll start with the subscribers.
We're pleased with the NFL Sunday Ticket sign-ups in our first season both as part of the YouTube TV bundle and as a stand-alone offering on YouTube Primetime Channels. Remember, you can access them via both. Nothing more to share on the sub side today on this one.
On the ad side, as you know, advertisers can buy from an NFL lineup as part of our YouTube Select portfolio. And this actually allows advertisers to reach football fans across YouTube's pretty unique breadth of NFL content, independently of whether you're viewing live NFL games or on YouTube TV or Primetime Channels or watching NFL highlights, post-game commentary on YouTube channels.
And we saw solid demand across the ad market around our YouTube Sunday Ticket offering here. We're excited about the partnership ahead or the partnerships ahead. This is our first season. And I mentioned over 90 upfront and scatter advertisers partnered with YouTube in our first year across NFL Sunday Ticket in-game opportunities, which we really appreciate.
Operator: Our next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Two, if I could. Sundar, a bigger-picture question, coming back to your comments earlier in the call on Search Generative Experience. When you think about the evolution of product over the next couple of years, how do you envision more traditional search and things like the Google Assistant continuing to evolve in a world of Search Generative Experience and Bard? And what that might mean for elements of commercial and noncommercial search and how use cases might change in the years ahead?
And then Ruth, I just want to make sure we understood some of the messaging from the release and the public comments around one-timers in the quarter itself. It seems as if they were not allocated to the segments but are more elements of Other Bets and Alphabet-level activities. I just want to confirm whether elements of those one-timers were captured in the P&L statement and whether there were also any elements of legal one-timers that would be called out this quarter as well.
Sundar Pichai: Thanks, Eric. Great question. Look, it is an exciting time. Clearly, as I said, as we are incorporating SGE in the product, the early feedback is positive. And we've been iterating on it, and it clearly works for certain type of queries very well. We are expanding the set of queries where it works very well. It definitely is answering a certain category of queries for the first time in a better way. So that gives us direction to proceed as well.
Overall, one of the things I think people underestimate about Search is the breadth of Search, the amount of queries we see constantly on a new day, which we haven't seen before. And so the trick here is to deliver that high-quality experience across the breadth of what we see in Search.
And over time, we think Assistant will be very complementary. And we will again use generative AI there, particularly with our most advanced models in Bard and allows us to act more like an agent over time, if I were to think about the future and maybe go beyond answers and follow through for users even more. So that is the -- directionally, what the opportunity set is. Obviously, a lot of execution ahead. But it's an area where I think we have a deep sense of what to do. And all the work we have taken so far, the feedback has been super positive.
Ruth Porat: And then in terms of your other question, so on the real estate charge of $1.2 billion in exit charges related to real estate, that is in Alphabet-level activities. But the other comment I was making in opening comments is when you go through the various line items, R&D, et cetera, you see it spread there. And we have a table and IR can walk anybody through the technicals on that just to understand how it then gets arrayed across the various lines in the P&L.
Operator: Our next question comes from Michael Nathanson with MoffettNathanson.
Michael Nathanson: I have two for Philipp, I think. Given the importance of connected TV engagement in YouTube, can you talk about the opportunity outside the U.S. for connected TV? And what the company is doing at large to drive more adoption of YouTube or connected TVs given the Google operating system? And can you talk about outside the U.S.?
And then you've been consistent about the strength of Shorts over the past year. Can you talk a bit about the modernization challenges? Do you still see the headwinds that you saw at the beginning? Anything you could share about the density of the auction or advertising interest on Shorts. So help us with whether or not that's still a headwind to growth.
Philipp Schindler: Yes. Thank you so much for your question. On the connected TV side, I mentioned it actually continues to perform really well. I said before, YouTube is the leader in U.S. streaming watch time and it's not just one audience group diving deep it's really all audiences. On the international side, it's something we are closely looking at. There's nothing specific I have to add at this moment in time on this one.
On the Shorts monetization side, look, we built Shorts to respond to the huge demand from both creators and viewers for short-form video. And we're very pleased with the growth we've seen. I mentioned 2 billion-plus logged-in users every month, 70 billion in daily views. Specifically to the monetization question, Shorts monetization continues to progress nicely. In fact, actually, since we introduced revenue sharing for Shorts, the total creator earnings generated from Shorts have increased every month, and we expect this to continue. And similar, obviously, to our long-form videos, we're really committed here to a long-term partnership. And you heard me say this before, right, when creators succeed, we succeed.
Operator: Our next question comes from Stephen Ju with UBS.
Stephen Ju: So Philipp, this is not a new question, but it's also been about 2 years since PMax was launched. But it seems like there's been this long lineage of product development and rollout of things like smart bidding in your history, which I believe at the time was designed to help smaller advertisers more easily run search advertising.
And today, you're helping me to generate creative as well as manage my spend and maximize ROI across multiple Google Services. So how are you feeling about enabling SMBs who otherwise could not advertise with you before? And what kind of TAM expansion tailwind does that create for your revenue growth over the longer term?
Philipp Schindler: Look, as you know, SMBs are a huge focus for us. We mentioned this several times before. They're part of our GCS channel, not only there's more in this. But they've been under a ton of change over the last few years. And our focus has always been here on investing in solutions that really help level the playing field, and you mentioned several of those. So actually, SMBs can compete with bigger brands and more sophisticated advertisers.
And so the feedback we're always getting is they need easy solutions that could drive value quickly, and several of the AI-powered solutions that you're mentioning are actually making the workflow and the whole on-ramp and the bidded targeting creative and so on, you mentioned that is so much easier for SMBs. So we're very satisfied with what we're seeing here. We will continue to invest. And I feel AI is really a helpful, very interesting future path to make life not only easier but also much more productive and better ROIs over time, more level playing field for SMBs.
Operator: Our next question comes from Justin Post with BAML.
Justin Post: Maybe one for Sundar and one for Ruth. Just on Search growth, I think there are some concerns on use of competitive AI tools as an alternative to Search. Just wondering if you're seeing any changes in query volumes, positive or negative, since you've seen the year evolve and more Search Generative Experiences. And what can really make Google stand out versus other AI tools?
And then Ruth, CapEx was $11 billion, a step-up, obviously. Any onetime items in there? Or is that how we should think about the new run rate into '24.
Sundar Pichai: Thanks, Justin. First of all, look, we think about effects on Search, obviously, more broadly. People have a lot of information choices. So -- and user expectations are constantly evolving. And so we've been doing this for a long time. And I think what ends up mattering is a strong continuous track record of innovation.
Obviously, generative AI is a new tool in the arsenal. But there's a lot more that goes into Search: the breadth, the depth, the diversity across verticals, stability to follow through, getting actually access to rich, diverse sources of content on the web and putting it all together in a compelling way.
And I think, through the year 2, when we test, we test Search Generative Experience, particularly against everything that's out there. And we can see the progress we are making and how much users are liking the experience better. And so I think I feel very good about the progress. And our road map for '24 is strong both on the Search and the underlying AI progress, including the model. So I'm pretty excited about what's ahead of us in '24.
Ruth Porat: And with respect to CapEx, the CapEx of $11 billion in the fourth quarter, as I indicated, was overwhelmingly investment in our technical infrastructure. To your question, there was no onetime item in there. It really reflects is our outlook for everything Sundar and Philipp and I have been talking about, the extraordinary applications of AI within Google DeepMind, Google Services, Google Cloud, it's across the board for users, for advertisers, developers, cloud enterprise customers, governments. And it's really the long-term opportunity that offers.
So last quarter, we did note that CapEx would continue to grow in 2024. We do expect 2024 full year CapEx to be notably larger than 2023. As a note, I think you all know this, but timing of cash payments can affect the quarterly CapEx number. But the main point is we're continuing to invest.
Operator: Our next question comes from Ross Sandler with Barclays.
Ross Sandler: So I guess a question for, I don't know if it's Sundar or Philipp. But if we go back to the DOJ trial that happened in the fall, there was a document that was disclosed from Google that said something along the lines of why being on ad quality team to deliver 20% RPM growth in Search is a fragile strategy. So dating back to 2019, your business has, I think, more than doubled since then.
So I guess, as we sit here today in early 2024, how do you feel about Google's ability to drive Search RPM going forward? And I guess in the context of what Ruth said tonight about the large revenue base, just how do you feel about the monetization?
Sundar Pichai: Look, I think I have tremendous confidence in the quality driven both our work, be it search quality, ads quality, our improvements on search, our improvements on ads RPM, all -- 2 foundational pillars are extraordinary focus on ads quality so that we deliver the actual ROI to advertisers and improve the experience for users and all underpinned by rigor and technical excellence and go-to-market excellence, right?
So the fundamental attributes don't change. I think AI gives us opportunity both on the organic side as well as on the monetization side. And I think we are in the early days of it. I think we'll be able to, taking a long-term view, serve information needs in a deeper way. And so I think about it in that -- with that long-term context, and I'm pretty excited about what's ahead.
Operator: And our last question will be from Mark Mahaney with Evercore.
Mark Stephen Mahaney: One question on YouTube AI and one on cloud. On cloud first, there's just this volatility, this material deceleration last quarter and the nice reacceleration this quarter. Is that explained by where we are in the optimization cycle, and it may be generative AI workloads starting to trickle in now and cause that growth curve to bend back up? Any commentary just on the sort of the volatility, the deceleration and the reacceleration that we've seen?
And then Philipp, I wanted to ask on the creative side, and particularly on YouTube and ads and the creative, using AI to improve the creative and really to offer SMBs who have been with Google forever but offer them now performance-based video ad campaigns created by AI. Is that kind of a new growth area? How far along are you in terms of offering this out into the market? And do you think that this opens up a new area of spend that wasn't there before?
Sundar Pichai: Thanks, Mark. On cloud, let me take that. First of all, a combination of factors. I think definitely excitement around the AI solutions on top of our foundational pillar, be it data and analytics, infrastructure, security, et cetera. But AI is definitely something which is driving interest and early adoption. And as you saw that greater than 70% of GenAI unicorns are using Google Cloud. And so I think it's an area where our strengths will continue to play out as we go through '24, especially when I look at innovation ahead from us on the AI front. And second, I think there are regional variations, but the cost optimizations in many parts are something we have mostly worked through. And I think that was a contributing factor as well.
Philipp Schindler: So on your YouTube question, maybe let me start with a general view. YouTube's mission, you know, has enabled millions of creators around the world to share their voice and connect with audiences and obviously build thriving businesses here. And AI has been a very critical piece of this already.
You are obviously aware of the made YouTube announcement where we introduced a whole lot of new complementary creativity features on YouTube, including Dream Screen, for example, and a lot of other really interesting tools and thoughts. You can obviously imagine that we can take this more actively to the advertising world already. As you know, it continues already to power AI, a lot of our video ad solutions and measurement capabilities. It's part of video-rich campaigns. Multi-format ads are -- actually, there is a generative creator music that actually makes it easier for creators to design the perfect soundtrack already.
And as I said earlier, AI will unlock a new world of creativity. And you can see how this will -- if you just look at where models are heading, where multimodal models are heading, where the generation capabilities of those models are heading, you can absolutely see how this will impact and positively impact and simplify the flow for creators, similar to what you see already emerging in some of our core products like ACA on the Search side.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2024 call. Thank you and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
GOOGL | 4 | 2,023 | 2024-01-30 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2023 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Forms 10-K and 10-Q, including the risk factors discussed in our upcoming Form 10-K filing for the year ended December 31, 2023. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now I'll turn the call over to Sundar.
Sundar Pichai: Hello, everyone. Our results reflect strong momentum and product innovation continuing into 2024. Today, I'm going to talk about four main topics. One, our investments in AI, including how it's helping Search; two, subscriptions, which reached $15 billion in annual revenue, up 5x since 2019. Subscriptions is growing strongly powered by YouTube Premium and Music, YouTube TV and Google One. Three, Cloud, which crossed $9 billion in revenues this quarter and saw accelerated growth driven by our GenAI and product leadership; and four, our investments and focus to meet the growth opportunities ahead.
First, AI and Search. As you know, we have long led the way in using AI to improve many of our products from Search to Ads to most of our consumer and enterprise products, helping billions of people already. Last year brought new excitement around GenAI, and I'm proud of how we responded responsibly with deep advances in foundation models and a number of great launches.
We closed the year by launching the Gemini era, a new industry-leading series of models that will fuel the next generation of advances. Gemini is the first realization of the vision we had when we formed Google DeepMind, bringing together our 2 world-class research teams. It's engineered to understand and combine text, images, audio, video and code in a natively multimodal way, and it can run on everything from mobile devices to data centers.
Gemini gives us a great foundation. It's already demonstrating state-of-the-art capabilities, and it's only going to get better. Gemini Ultra is coming soon. The team is already working on the next versions and bringing it to our products.
That starts with Search. We are already experimenting with Gemini in Search, where it's making our Search Generative Experience, or SGE, faster for users. We have seen a 40% reduction in latency in English in the U.S. I'm happy with what we are seeing in the earliest days of SGE. It's available through Search Labs in 7 languages.
By applying generative AI to Search, we are able to serve a wider range of information needs and answer new types of questions, including those that benefit from multiple perspectives. People are finding it particularly useful for more complex questions like comparisons or longer queries. It's also helpful in areas where people are looking for deeper understanding, such as education or even gift ideas.
We are improving satisfaction, including answers for more conversational and intricate queries. As I mentioned earlier, we are surfacing more links with SGE and linking to a wider range of sources on the results page, and we'll continue to prioritize approaches that add value for our users and send valuable traffic to publishers.
Beyond SGE, we are continuing to use AI to make searching more accessible and intuitive. Circle to Search lets you search what you see on Android phones with a simple gesture without switching apps. It's available starting this week on Pixel 8 and Pixel 8 Pro and the new Samsung Galaxy S24 Series.
And Lens now offers generative AI overviews. You can add text to a visual search to ask questions about anything you see and get AI-powered insights in the moment. In addition to Search, we are also seeing a lot of interest in our AI-powered solutions for advertisers. That includes our new conversational experience that uses Gemini to accelerate the creation of Search campaigns.
Then there is Bard, our conversational AI tool that complements Search. It's now powered by Gemini Pro and is much more capable at things like understanding, summarizing, reasoning, coding and planning. It's now in over 40 languages and over 230 countries around the world. Looking ahead, we'll be rolling out an even more advanced version for subscribers powered by Gemini Ultra.
That's a good segue to subscriptions. As I said earlier, it's now a $15 billion business annually. YouTube is the key driver of our subscription revenues. Available in over 100 countries and regions, YouTube Music and Premium have real momentum. They're engaging passionate users and driving great returns for the music industry and creators.
YouTube TV is also doing well. We've had great consumer feedback on the viewing experience. People love the navigation, multiview and unlimited DVR. NFL Sunday Ticket has found its perfect home on YouTube, and Philipp will talk about that more.
Let me also talk about our subscription service, Google One. It's doing incredibly well with strong user growth. It provides expanded storage, unlocks exclusive features in Google products and allows us to build a strong relationship with our most engaged users. Google One is growing very well, and we are just about to cross 100 million subscribers. From here, we are going to bring in more AI features and look forward to more strong growth to come.
Next, Google Cloud. Throughout 2023, we introduced thousands of product advances, including broad GenAI capabilities across our AI infrastructure, our Vertex AI platform and our new Duet AI agents. In Q4, our product and GenAI leadership enabled us to win and expand relationships with many leading brands, including Hugging Face, McDonald's, Motorola Mobility and Verizon.
Google Cloud offers our AI Hypercomputer, a groundbreaking supercomputing architecture that combines our powerful TPUs and GPUs, AI software and multi-slice and multi-host technology to provide performance and cost advantages for training and serving models. Customers like Anthropic, Character.AI, Essential AI and Mistral AI are building and serving models on it.
For developers building GenAI applications, we offer Vertex AI, a comprehensive enterprise AI platform. It helps customers like Deutsche Telekom and Moody's discover, customize, augment and deploy over 130 GenAI models, including PaLM, MedPaLM, Sec-PaLM and Gemini as well as popular open source and partner models. Vertex AI has seen strong adoption with the API request increasing nearly 6x from H1 to H2 last year.
Using Vertex AI, Samsung recently announced its Galaxy S24 Series smartphone with Gemini and Imagen 2, our advanced text-to-image model. Shutterstock has added Imagen 2 to their AI image generator, enabling users to turn simple text prompts into unique visuals. And Victoria's Secret & Co. will look to personalize and improve the customer experience with Gemini, Vertex AI, Search and Conversations.
Customers are increasingly choosing Duet AI, our packaged AI agents for Google Workspace and Google Cloud Platform, to boost productivity and improve their operations. Since its launch, thousands of companies and more than 1 million trusted testers have used Duet AI. It will incorporate Gemini soon.
In Workspace, Duet AI is helping employees benefit from improved productivity and creativity at thousands of paying customers around the world, including Singapore Post, Uber and Woolworths. In Google Cloud Platform, Duet AI assists software developers and cybersecurity analysts. Duet AI for Developers is the only GenAI offering to support the complete development and operations life cycle, fine-tuned with the customer's own core purpose and policies. It's helping Wayfair, GE Appliances and Commerzbank write better software, faster with AI code completion, code generation and chat support. With Duet AI and Security Operations, we are helping cybersecurity teams at Fiserv, Spotify and Pfizer.
Our robust growth has been driven by strong direct and indirect channels. With ISVs, we have nearly tripled the number of co-sell deals from 2022 to 2023. In our ecosystem, there are nearly 90,000 Google Cloud GenAI-enabled consultants. And Accenture has teamed up with Google Cloud to create a joint generative AI center of excellence.
Next, let me turn to our focus and discipline as we pursue the opportunities ahead. Search, YouTube and Cloud are supported by our state-of-the-art compute infrastructure. This infrastructure is also key to realizing our big AI ambitions. It's a major differentiator for us. We continue to invest responsibly in our data centers and compute to support this new wave of growth in AI-powered services for us and for our customers. Through this, we are being disciplined in how we run the company.
You've heard me talk about our efforts to durably reengineer our cost base and to improve our velocity and efficiency. That work continues. Teams are working to focus on key priorities and execute fast, removing layers and simplifying their organizational structures. As just one example, our devices team has brought together different teams from across Nest, Fitbit and other teams into a new functional structure. This will help us pull resources and drive progress across our Pixel portfolio. Across different teams, we have wound down some nonpriority projects, which will help us invest and operate well in our growth areas.
We are also improving our machine utilization, building on our years of experience in driving cost efficiencies in our computing infrastructure and operations. And through our supplier efficiency efforts and automation of certain processes, we have made major improvements in areas like procurement, achieving significant savings.
That's a snapshot of the quarter. Before I close, a couple of other highlights. Pixel 8, our AI-first phone, was awarded Phone of the Year by numerous outlets. It now uses Gemini Nano with features like Magic Compose for Google Messages and more to come.
In our Other Bets portfolio of companies, Waymo, which is deeply focused on safety, reached over 1 million fully autonomous ride-hailing trips. And Isomorphic Labs entered into strategic partnerships with Eli Lilly and Novartis to apply AI to treat diseases, which has great potential.
2023 was a year of profound innovation and product momentum. Thank you to our many partners. We succeed when our partners do, and we are grateful for the work we do together. From our partners across the Android ecosystem who are on display at CES to our deep relationships with retailers, small businesses and advertising partners, to the next generation of AI start-ups and developers and many more. I also want to thank all of our employees for their hard work throughout 2023 and the start of the new year. I'm excited for what's ahead in 2024. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone. Google Services revenues of $76 billion were up 12% year-on-year. In Google advertising, Search and other revenues grew 13% year-on-year, led again by solid growth in the retail vertical. We had particular strength in retail in APAC, a trend that began in the second quarter of 2023 and continued through the end of the year.
YouTube ads revenue were up 16% year-on-year driven by growth in both direct response and brand. And network revenues declined 2% year-on-year. In subscriptions, platforms and devices, which was previously named Google Other, year-on-year revenues increased 23% driven by strong growth in subscriptions.
Now for some color on the quarter and where we see continued upside for long-term advertising growth. Over the last few calls, I have consistently highlighted how we're putting Google AI to work for our customers to deliver profitability and help them achieve their goals in a do-more-with-less environment.
From a product perspective, in Q4, Performance Max remained a bright spot. We're also excited about demand gen momentum. This is our big bet to help social advertisers find and convert consumers via immersive, relevant visual creatives across YouTube, including YouTube Shorts, Gmail and Discover. In a single campaign, you get access to over 3 billion users as they stream, scroll, connect and decide what to buy. Tens of thousands of advertisers are testing and on average seeing 6% more conversions per dollar versus image-only ads and discovery campaigns.
As we look ahead, we're also starting to put generative AI in the hands of more and more businesses to help them build better campaigns and even better performing ads. Automatically created assets help advertisers show more relevant search ads by creating tailored headlines and descriptions based on each ad's context. Adoption was up with strong feedback in Q4. In addition to now being available in 8 languages, more advanced GenAI-powered capabilities are coming to ACA.
And then last week's big news was that Gemini will power new conversational experience in Google Ads. This is open and beta to U.S. and U.K. advertisers. Early tests show advertisers are building higher-quality search campaigns with less effort, especially SMBs who are 42% more likely to publish a campaign with good or excellent ad strength. We can't wait to see how this continues to drive performance and level the playing field for advertisers of all sizes.
As we shared last quarter, Ads will continue to play an important role in the new search experience, and we'll continue to experiment with new formats native to SGE. SGE is creating new opportunities for us to improve commercial journeys for people by showing relevant ads alongside search results. We've also found that people are finding ads either above or below the AI-powered overview helpful as they provide useful options for people to take action and connect with businesses.
Looking at our strong Search performance for the fourth quarter. Retail was a highlight. We continue to see a stronger start to the season up to and including Cyber Five. In Q3, we indicated that we were seeing early trends of consumers being very price-conscious, and we saw this play out in Q4. With promotional demand at an all-time high, deal seekers using Google had access to 2x the deals in the U.S. versus last season as well as a better shopping experience. Launches included a one-stop shop deals destination, new filters like [ Get it Fast ] and AI-generated gifting recommendations in SGE. These new features drove incremental query growth during key shopping moments like Cyber Five.
Our proven AI-powered ad solutions were also a win for retailers looking to accelerate omni growth and capture holiday demand. Quick examples include a large U.S. big-box retailer who drove a 60%-plus increase in omni ROAS and a 22%-plus increase in store traffic using Performance Max during Cyber Five; and a well-known global fashion brand, who drove a 15%-plus higher omnichannel conversion rate versus regular shopping traffic by showcasing its store pickup offering across top markets through pickup later on shopping ads.
Moving on to YouTube. We're obviously pleased with YouTube's advertising revenue growth in Q4 and also significant growth in our subscription revenue. I'll reiterate what I have said before: YouTube's success starts with creator success. We give millions of creators more ways to create content and connect with fans and more ways to make money and build their own businesses than any other platform. More creators means more content, which leads to more viewers. And via ads and subscriptions, these viewers fund our creators and drive the eyeballs and engagement our advertisers want.
To keep this momentum going, we're focused on delivering value across 4 pillars: creation, viewers, monetization and responsibility. First, creation, which increasingly takes place on mobile devices. We've invested in a full suite of tools, including our new YouTube Create app for Shorts, to help people make everything from 15-second Shorts to 15-minute videos to 15-hour live streams with a production studio in the palm of their hands.
GenAI is supercharging these capabilities. Anyone with a phone can swap in a new backdrop, remove background extras, translate their video into dozens of languages, all without a big studio budget. We're excited about our first products in this area from Dream Screen for AI-generated backgrounds to Aloud for AI-powered dubbing. There is more to come.
Number two, viewers. We continue to grow watch time across YouTube with strong growth in Shorts and connected TV. Shorts remains a top priority. We have 2 billion-plus logged-in users every month, and we are averaging 70 billion in daily views. Connected TVs, or what we refer to as the living room, is where viewership is growing the fastest. We're investing to make this experience even better with interactive features tailored to TVs, plus the content people love: our creators, NFL Sunday Ticket and the range of live sports and studio content via YouTube TV and Primetime Channels. Put this all together and YouTube is the must-have app on every connected TV.
Monetization is pillar #3 and realized through a combination of ad-supported and subscription offerings. Advertising generates the bulk of our revenue, and we continue to invest heavily here. We've rolled out CTV-first formats like 30-second nonskippable ads and pause experiences as well as an industry-first send-to-phone experience that lets people use a second screen to engage with ads.
For Shorts, we've developed new formats that are less interruptive to viewers. It's early. We're learning but excited by the opportunities for ads this can unlock. Shorts monetization continues to progress nicely.
Our AI-powered video formats from video reach and video view campaigns to demand gen and video action continue to make advertiser dollars go further and drive results across the funnel. We're also introducing new and existing advertisers to YouTube via sports content. 90-plus upfront and scatter advertisers, including Unilever, are partnering with YouTube in our first year across NFL Sunday Ticket in-game advertising opportunities.
Our subscription offerings are also growing at a healthy clip. YouTube Music and Premium performed well. Premium users are delivering more value to our partners and YouTube than even ad-supported users do. On average, each additional Premium sign-up boost earnings for creators, music and media partners and YouTube itself. And we've made Premium even more attractive with new features, bundles and other enhancements.
We're also pleased with our first season of NFL Sunday Ticket. It gave creators new opportunities to create content and feed user engagement across traditional user content and professional sports content. Feedback on the user experience, including multiview, has been great. We're excited to continue to innovate here.
Responsibility is our fourth pillar, and it underlines everything we do across YouTube. We continue to focus relentlessly on this. As always, deepening our relationships with key partners to bring them the best of Google is a key priority for us, and we continue to do this across industries in Q4.
We just talked about the NFL. Sundar mentioned Samsung, among others earlier. Another highlight was our expanded partnership with Porsche to enhance customers' digital experiences with a deeper in-vehicle integration of Google built-in services, including Google Maps and Play. Whether it's continued collaboration with our partners and key ecosystems, we're putting Google AI to work for more customers. I'm excited about the opportunities for continued impact in 2024.
I'll wrap with a huge note of gratitude to our customers and partners. Our success is only possible because of their success and then to our Googlers for their outstanding work and focus this year.
Ruth, over to you.
Ruth Porat: Thank you, Philipp. We are very pleased with our full year results with 2023 Alphabet revenues of $307 billion, up 9% versus 2022, which added $25 billion to revenues for the year. We ended with a strong fourth quarter with consolidated revenues of $86.3 billion, up 13% versus last year in both reported and constant currency.
Search remained the largest contributor to revenue growth. My comments will be on year-over-year comparisons for the fourth quarter, unless I state otherwise.
Total cost of revenues was $37.6 billion, up 6%. Other cost of revenues was $23.6 billion, up 5%, with the increase driven primarily by content acquisition costs associated with YouTube subscription offerings. The growth rate also reflects the offsetting benefit of lapping $1.2 billion in inventory-related charges that we called out in the fourth quarter last year as well as a reduction in depreciation expense due to changes in estimated useful lives we made starting in the first quarter of 2023.
In terms of total expenses, the year-on-year comparisons reflect an additional $1.2 billion in exit charges that we took in the fourth quarter of 2023 in connection with actions to optimize our global office space. As you can see in our earnings release, these charges were allocated across the expense lines in other cost of revenues and OpEx based on associated head count.
Operating expenses were $25 billion, up 11%, primarily reflecting an increase in R&D expenses, which were driven by the real estate charges, followed by compensation. Operating income was $23.7 billion, up 30%, and our operating margin was 27%. Net income was $20.7 billion, and EPS was $1.64. We delivered free cash flow of $7.9 billion, which was affected by the timing of the $10.5 billion tax payment we made on October 16 that we called out previously related to the deferral of certain tax payments to the fourth quarter.
For the full year 2023, free cash flow was $69 billion. We repurchased a total of $62 billion of our Class A and Class C shares in 2023 and ended the year with $111 billion in cash and marketable securities.
Turning to segment results. Within Google Services, revenues were $76.3 billion, up 12%. Google Search and other advertising revenues of $48 billion in the quarter were up 13%, led again by growth in retail. YouTube advertising revenues of $9.2 billion were up 16% driven by both direct response and brand advertising. Network advertising revenues of $8.3 billion were down 2%.
Subscriptions, platforms and devices revenues, which we previously referred to as other revenues, were $10.8 billion, up 23%, primarily reflecting growth in YouTube subscription revenues. TAC was $14 billion, up 8%. Google Services' operating income was $26.7 billion, up 32%, and the operating margin was 35%.
Turning to the Google Cloud segment. Revenues were $9.2 billion for the quarter, up 26%. We're very pleased with the momentum of GCP with an increasing contribution from AI. Google Workspace also delivered strong revenue growth primarily driven by increases in average revenue per seat. Google Cloud delivered operating income of $864 million and an operating margin of 9%.
As to our Other Bets, for the full year 2023, revenues were $1.5 billion and the operating loss was $4.1 billion. Results in the fourth quarter benefited from a milestone payment in one of the Other Bets.
Turning to our outlook for the business. With respect to Google Services, first, within advertising. We were pleased with the sequential revenue growth of Search and YouTube advertising throughout 2023, which reflects the extraordinary work across our teams to drive improved experiences for users and attractive ROI for advertisers. As we enter 2024 with advertising revenues of more than $100 billion higher than 2019, we remain focused on sustaining healthy growth on this larger base.
Second, within subscriptions, platforms and devices, our total revenues from subscription products reached $15 billion for the full year 2023 driven primarily by substantial growth in subscribers for our YouTube subscription offerings. The substantial increase in our subscription revenues over the past few years demonstrates the ability of our teams to deliver high value-add offerings and provides a strong base on which to build, including through YouTube and newer services like Google One.
Play had solid growth again in the fourth quarter driven primarily by an increase in the number of buyers. In devices, we continue to make sizable investments with increased emphasis on our Pixel family, particularly with AI-powered innovation while driving further efficiencies across the portfolio.
Turning to Google Cloud. We are pleased with operating performance in the year. Full year revenues of $33 billion were up 26% versus prior year, ending with strong Q4 performance. The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.
In terms of profitability, the improvement in 2023 reflects sustained focus across the team with the intent to maintain healthy profitability while we continue to invest to support long-term growth.
Turning to margins and expenses. As we have repeatedly stressed, we remain committed to our framework to durably reengineer our cost base as we invest to support our growth priorities. Key contributors to moderating our expense growth include: first, product and process prioritization to ensure we have the right resources behind our most important opportunities and to reallocate resources where we can; second, organizational efficiency and structure. We're focused on removing layers to simplify execution and drive velocity.
Both product prioritization and the organization design efforts result in a slower pace of hiring, as you can see with our head count down year-on-year, reflecting the reductions we announced in the first quarter of 2023 and a much slower pace of hiring. We will continue to invest in top technical and engineering talent.
Finally, we continue to execute the other work streams to slow expense growth, including improving efficiency in our technical infrastructure, streamlining operations across Alphabet through the use of AI, increasing efficiency of our spend with suppliers and vendors through our central procurement organization and optimizing our real estate portfolio.
With respect to CapEx, our reported CapEx in the fourth quarter was $11 billion, driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers. The step-up in CapEx in Q4 reflects our outlook for the extraordinary applications of AI to deliver for users, advertisers, developers, cloud enterprise customers and governments globally and the long-term growth opportunities that offers. In 2024, we expect investment in CapEx will be notably larger than in 2023.
With regard to Other Bets, we've been working to sharpen our investment focus while capturing the upside given compelling technology breakthroughs across the portfolio. For example, last week, Alphabet's X announced that it would be moving to spin out more projects as independent companies through external capital, giving X the opportunity to bring more focus to the breakthrough technologies it is working on to address some of the world's most pressing challenges.
Thank you. Sundar, Philipp and I will now take your questions.
Operator: [Operator Instructions] And our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two for Philipp. Philipp, the first one is about sort of a lot of the new generative AI advertising tools. You obviously have a lot of irons in the fire here. You've been talking about some of the early momentum with tens of thousands of advertisers.
The question is, can you sort of walk us through some of the hurdles and gating factors that we should be thinking through that dictate the pace at which these tools can really be rolled out broadly just so we and advertisers can kind of get an understanding for when they could have a bigger impact on the whole business? And then secondly, how do you think about the long-term sales force intensity of the advertising business as you roll more AI-based tools like PMax impacting the overall ad allocation?
Philipp Schindler: Yes. Thank you so much. So I've covered this a little bit on previous quarters. AI has been at the core of our advertising products for a very, very long time. And the recent advances are really allowing us to drive more value for advertisers across a large range of different areas: bidding, targeting, creative as well as our core advertiser and publisher experiences.
We are seeing in core search ads, for example, the bidding side, the value-based bidding as a very significant one; on the targeting side, the broad match; on creative, responsive search ads automatically created ads assets. And we are very happy with the progress we're seeing in those areas.
I think I mentioned in one of the previous calls that one, you asked about hurdles and gating factors. The AI essentials play neutral in this, trying to get everybody ready to really take full advantage of those tools. We talked about the progress on PMax as well that we're very happy with in Q4. So overall, I think we are on track with what we're expecting here.
On the sales force intensity side, we have done a few reallocations or let me call it portfolio adjustments. As you know, we have 2 large different teams. One is our LCS, large customer solutions team that's really focused on transformational growth for our largest and most sophisticated customers. And we have our -- we call them GCS, Global Customer Solutions team, which is the channel where really every customer starts from some of our largest customers now to also the millions of smaller ones and SMBs.
The GCS is really then scaling growth by dynamically delivering really the right treatment for every customer. And important to note, it's also our fastest-growing channel, and it delivered particularly strong growth in Q4. So we have done adjustments here to focus more resources on the GCS side.
But I also want to be clear, when we restructure, there's always an opportunity to be more efficient and smarter in how we service and grow our customers. We're not restructuring because AI is taking away roles that's important here. But we see significant opportunities here with our AI-powered solution to actually deliver incredible ROI at scale, and that's why we're doing some of those adjustments. So I look at sales force intensity as a stronger focus going forward on the channels I mentioned here.
Operator: Our next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: One for Ruth and one for Philipp. Ruth, you're now into year 2 of durably reengineering your cost structure. Can you just help us assess your progress so far? And are there any guideposts that we should be thinking about going forward?
And then Philipp, can you talk more about NFL Sunday Ticket and just what your key learnings were in year 1? How are you thinking about the returns on the investment on both from an advertising perspective and then also subscribers to both Sunday Ticket and YouTube TV?
Ruth Porat: Thanks for the question. So we are very pleased with the progress we're continuing to make, and we are very committed to the framework to durably reengineer our cost base really as we're investing to support the growth priorities. I tried to call out a number of them in opening comments, but really, as you're looking at the work being done across Google, across Alphabet, it does start with product and process prioritization to make sure we've got the right resources behind the most important opportunities, and then that creates the opportunity for reallocating resources where we can.
Then we talked a lot about this quarter about organizational efficiency and structure, and we're focused on removing layers to simplify execution and drive velocity. The combination of those 2, product prioritization and organizational design work, has resulted in the slower pace of hiring. You can see that in our head count numbers down year-on-year. You can see it in some of the -- in the results that we delivered in the fourth quarter.
You can -- and it also goes to the announcements around first quarter and much lower pace of hiring. At this point in the quarter, we do estimate that severance-related expense will be roughly $700 million in the first quarter as we've continued these efforts. But as I said in opening comments, we will continue to invest in top engineering.
So that's sort of the big one, if you start with product prioritization and organizational design, which is why also I made the note about the severance-related expense, which helps pave the way as we're continuing to do the work that we're doing. But then we have a host of other work streams, which I talked about, everything with improving efficiency in our technical infrastructure, which is a very large ongoing effort; streamlining operations across Alphabet through use of AI; all the work we're doing with our suppliers and vendors; the work we're doing optimizing our real estate portfolio. So when we've described durably reengineering, it's about continuing to build on work that started, and that is ongoing.
Philipp Schindler: So on the NFL Sunday Ticket side, look, as I said earlier, NFL Sunday Ticket supports our long-term strategy and really help solidify YouTube's position as a must-have app on everyone's TV set.
You asked about some of the learnings. Maybe I'll start with the viewing experience. We've received great feedback so far. People like the navigation, multiview, the chat, the lack of latency, really, really positive feedback on this one. You asked about the ads and the subs. Maybe I'll start with the subscribers.
We're pleased with the NFL Sunday Ticket sign-ups in our first season both as part of the YouTube TV bundle and as a stand-alone offering on YouTube Primetime Channels. Remember, you can access them via both. Nothing more to share on the sub side today on this one.
On the ad side, as you know, advertisers can buy from an NFL lineup as part of our YouTube Select portfolio. And this actually allows advertisers to reach football fans across YouTube's pretty unique breadth of NFL content, independently of whether you're viewing live NFL games or on YouTube TV or Primetime Channels or watching NFL highlights, post-game commentary on YouTube channels.
And we saw solid demand across the ad market around our YouTube Sunday Ticket offering here. We're excited about the partnership ahead or the partnerships ahead. This is our first season. And I mentioned over 90 upfront and scatter advertisers partnered with YouTube in our first year across NFL Sunday Ticket in-game opportunities, which we really appreciate.
Operator: Our next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Two, if I could. Sundar, a bigger-picture question, coming back to your comments earlier in the call on Search Generative Experience. When you think about the evolution of product over the next couple of years, how do you envision more traditional search and things like the Google Assistant continuing to evolve in a world of Search Generative Experience and Bard? And what that might mean for elements of commercial and noncommercial search and how use cases might change in the years ahead?
And then Ruth, I just want to make sure we understood some of the messaging from the release and the public comments around one-timers in the quarter itself. It seems as if they were not allocated to the segments but are more elements of Other Bets and Alphabet-level activities. I just want to confirm whether elements of those one-timers were captured in the P&L statement and whether there were also any elements of legal one-timers that would be called out this quarter as well.
Sundar Pichai: Thanks, Eric. Great question. Look, it is an exciting time. Clearly, as I said, as we are incorporating SGE in the product, the early feedback is positive. And we've been iterating on it, and it clearly works for certain type of queries very well. We are expanding the set of queries where it works very well. It definitely is answering a certain category of queries for the first time in a better way. So that gives us direction to proceed as well.
Overall, one of the things I think people underestimate about Search is the breadth of Search, the amount of queries we see constantly on a new day, which we haven't seen before. And so the trick here is to deliver that high-quality experience across the breadth of what we see in Search.
And over time, we think Assistant will be very complementary. And we will again use generative AI there, particularly with our most advanced models in Bard and allows us to act more like an agent over time, if I were to think about the future and maybe go beyond answers and follow through for users even more. So that is the -- directionally, what the opportunity set is. Obviously, a lot of execution ahead. But it's an area where I think we have a deep sense of what to do. And all the work we have taken so far, the feedback has been super positive.
Ruth Porat: And then in terms of your other question, so on the real estate charge of $1.2 billion in exit charges related to real estate, that is in Alphabet-level activities. But the other comment I was making in opening comments is when you go through the various line items, R&D, et cetera, you see it spread there. And we have a table and IR can walk anybody through the technicals on that just to understand how it then gets arrayed across the various lines in the P&L.
Operator: Our next question comes from Michael Nathanson with MoffettNathanson.
Michael Nathanson: I have two for Philipp, I think. Given the importance of connected TV engagement in YouTube, can you talk about the opportunity outside the U.S. for connected TV? And what the company is doing at large to drive more adoption of YouTube or connected TVs given the Google operating system? And can you talk about outside the U.S.?
And then you've been consistent about the strength of Shorts over the past year. Can you talk a bit about the modernization challenges? Do you still see the headwinds that you saw at the beginning? Anything you could share about the density of the auction or advertising interest on Shorts. So help us with whether or not that's still a headwind to growth.
Philipp Schindler: Yes. Thank you so much for your question. On the connected TV side, I mentioned it actually continues to perform really well. I said before, YouTube is the leader in U.S. streaming watch time and it's not just one audience group diving deep it's really all audiences. On the international side, it's something we are closely looking at. There's nothing specific I have to add at this moment in time on this one.
On the Shorts monetization side, look, we built Shorts to respond to the huge demand from both creators and viewers for short-form video. And we're very pleased with the growth we've seen. I mentioned 2 billion-plus logged-in users every month, 70 billion in daily views. Specifically to the monetization question, Shorts monetization continues to progress nicely. In fact, actually, since we introduced revenue sharing for Shorts, the total creator earnings generated from Shorts have increased every month, and we expect this to continue. And similar, obviously, to our long-form videos, we're really committed here to a long-term partnership. And you heard me say this before, right, when creators succeed, we succeed.
Operator: Our next question comes from Stephen Ju with UBS.
Stephen Ju: So Philipp, this is not a new question, but it's also been about 2 years since PMax was launched. But it seems like there's been this long lineage of product development and rollout of things like smart bidding in your history, which I believe at the time was designed to help smaller advertisers more easily run search advertising.
And today, you're helping me to generate creative as well as manage my spend and maximize ROI across multiple Google Services. So how are you feeling about enabling SMBs who otherwise could not advertise with you before? And what kind of TAM expansion tailwind does that create for your revenue growth over the longer term?
Philipp Schindler: Look, as you know, SMBs are a huge focus for us. We mentioned this several times before. They're part of our GCS channel, not only there's more in this. But they've been under a ton of change over the last few years. And our focus has always been here on investing in solutions that really help level the playing field, and you mentioned several of those. So actually, SMBs can compete with bigger brands and more sophisticated advertisers.
And so the feedback we're always getting is they need easy solutions that could drive value quickly, and several of the AI-powered solutions that you're mentioning are actually making the workflow and the whole on-ramp and the bidded targeting creative and so on, you mentioned that is so much easier for SMBs. So we're very satisfied with what we're seeing here. We will continue to invest. And I feel AI is really a helpful, very interesting future path to make life not only easier but also much more productive and better ROIs over time, more level playing field for SMBs.
Operator: Our next question comes from Justin Post with BAML.
Justin Post: Maybe one for Sundar and one for Ruth. Just on Search growth, I think there are some concerns on use of competitive AI tools as an alternative to Search. Just wondering if you're seeing any changes in query volumes, positive or negative, since you've seen the year evolve and more Search Generative Experiences. And what can really make Google stand out versus other AI tools?
And then Ruth, CapEx was $11 billion, a step-up, obviously. Any onetime items in there? Or is that how we should think about the new run rate into '24.
Sundar Pichai: Thanks, Justin. First of all, look, we think about effects on Search, obviously, more broadly. People have a lot of information choices. So -- and user expectations are constantly evolving. And so we've been doing this for a long time. And I think what ends up mattering is a strong continuous track record of innovation.
Obviously, generative AI is a new tool in the arsenal. But there's a lot more that goes into Search: the breadth, the depth, the diversity across verticals, stability to follow through, getting actually access to rich, diverse sources of content on the web and putting it all together in a compelling way.
And I think, through the year 2, when we test, we test Search Generative Experience, particularly against everything that's out there. And we can see the progress we are making and how much users are liking the experience better. And so I think I feel very good about the progress. And our road map for '24 is strong both on the Search and the underlying AI progress, including the model. So I'm pretty excited about what's ahead of us in '24.
Ruth Porat: And with respect to CapEx, the CapEx of $11 billion in the fourth quarter, as I indicated, was overwhelmingly investment in our technical infrastructure. To your question, there was no onetime item in there. It really reflects is our outlook for everything Sundar and Philipp and I have been talking about, the extraordinary applications of AI within Google DeepMind, Google Services, Google Cloud, it's across the board for users, for advertisers, developers, cloud enterprise customers, governments. And it's really the long-term opportunity that offers.
So last quarter, we did note that CapEx would continue to grow in 2024. We do expect 2024 full year CapEx to be notably larger than 2023. As a note, I think you all know this, but timing of cash payments can affect the quarterly CapEx number. But the main point is we're continuing to invest.
Operator: Our next question comes from Ross Sandler with Barclays.
Ross Sandler: So I guess a question for, I don't know if it's Sundar or Philipp. But if we go back to the DOJ trial that happened in the fall, there was a document that was disclosed from Google that said something along the lines of why being on ad quality team to deliver 20% RPM growth in Search is a fragile strategy. So dating back to 2019, your business has, I think, more than doubled since then.
So I guess, as we sit here today in early 2024, how do you feel about Google's ability to drive Search RPM going forward? And I guess in the context of what Ruth said tonight about the large revenue base, just how do you feel about the monetization?
Sundar Pichai: Look, I think I have tremendous confidence in the quality driven both our work, be it search quality, ads quality, our improvements on search, our improvements on ads RPM, all -- 2 foundational pillars are extraordinary focus on ads quality so that we deliver the actual ROI to advertisers and improve the experience for users and all underpinned by rigor and technical excellence and go-to-market excellence, right?
So the fundamental attributes don't change. I think AI gives us opportunity both on the organic side as well as on the monetization side. And I think we are in the early days of it. I think we'll be able to, taking a long-term view, serve information needs in a deeper way. And so I think about it in that -- with that long-term context, and I'm pretty excited about what's ahead.
Operator: And our last question will be from Mark Mahaney with Evercore.
Mark Stephen Mahaney: One question on YouTube AI and one on cloud. On cloud first, there's just this volatility, this material deceleration last quarter and the nice reacceleration this quarter. Is that explained by where we are in the optimization cycle, and it may be generative AI workloads starting to trickle in now and cause that growth curve to bend back up? Any commentary just on the sort of the volatility, the deceleration and the reacceleration that we've seen?
And then Philipp, I wanted to ask on the creative side, and particularly on YouTube and ads and the creative, using AI to improve the creative and really to offer SMBs who have been with Google forever but offer them now performance-based video ad campaigns created by AI. Is that kind of a new growth area? How far along are you in terms of offering this out into the market? And do you think that this opens up a new area of spend that wasn't there before?
Sundar Pichai: Thanks, Mark. On cloud, let me take that. First of all, a combination of factors. I think definitely excitement around the AI solutions on top of our foundational pillar, be it data and analytics, infrastructure, security, et cetera. But AI is definitely something which is driving interest and early adoption. And as you saw that greater than 70% of GenAI unicorns are using Google Cloud. And so I think it's an area where our strengths will continue to play out as we go through '24, especially when I look at innovation ahead from us on the AI front. And second, I think there are regional variations, but the cost optimizations in many parts are something we have mostly worked through. And I think that was a contributing factor as well.
Philipp Schindler: So on your YouTube question, maybe let me start with a general view. YouTube's mission, you know, has enabled millions of creators around the world to share their voice and connect with audiences and obviously build thriving businesses here. And AI has been a very critical piece of this already.
You are obviously aware of the made YouTube announcement where we introduced a whole lot of new complementary creativity features on YouTube, including Dream Screen, for example, and a lot of other really interesting tools and thoughts. You can obviously imagine that we can take this more actively to the advertising world already. As you know, it continues already to power AI, a lot of our video ad solutions and measurement capabilities. It's part of video-rich campaigns. Multi-format ads are -- actually, there is a generative creator music that actually makes it easier for creators to design the perfect soundtrack already.
And as I said earlier, AI will unlock a new world of creativity. And you can see how this will -- if you just look at where models are heading, where multimodal models are heading, where the generation capabilities of those models are heading, you can absolutely see how this will impact and positively impact and simplify the flow for creators, similar to what you see already emerging in some of our core products like ACA on the Search side.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2024 call. Thank you and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
CMCSA | 4 | 2,023 | 2024-01-25 11:51:04 | Operator: Good morning ladies and gentlemen, and welcome to the Comcast fourth quarter and full year 2023 earnings conference call. At this time, all participants are in a listen-only mode. Please note that this conference call is being recorded. I will now turn the call over to Executive Vice President, Investor Relations, Ms. Marci Ryvicker. Please go ahead, Ms. Ryvicker.
Marci Ryvicker: Thank you Operator, and welcome everyone. Joining us on today’s call are Brian Roberts, Mike Cavanagh, Jason Armstrong, and Dave Watson. I will now refer you to Slide 2 of the presentation accompanying this call, which can also be found on our Investor Relations website and which contains our Safe Harbor disclaimer. This conference call may include forward-looking statements subject to certain risks and uncertainties. In addition, during this call, we will refer to certain non-GAAP financial measures. Please see our 8-K and trending schedule issued earlier this morning for the reconciliations of these non-GAAP financial measures to GAAP. With that, I’ll turn the call over to Mike.
Mike Cavanagh: Thanks Marci, and good morning everyone. We’re less than a month into the new year and 2024 is already off to a great start. Two weeks ago, our entire company came together to make history, shattering records with the first exclusively streamed NFL Wildcard Game on Peacock. Nearly 23 million viewers watched the Kansas City Chiefs take on the Miami Dolphins, consuming 30% of all internet traffic in the U.S. and setting a new record in total U.S. internet traffic for any night. Our investment in the network and our technology platforms built over decades enabled us to shine, delivering a seamless experience on the internet and Peacock, demonstrating that our company is in an excellent position to win in this era of high bandwidth consumption. Also, Universal Pictures’ Oppenheimer picked up five Golden Globe awards, including Best Picture, Best Director, Best Actor, Best Supporting Actor, and Best Original Score. With 2024 off to a terrific start, let’s look back at 2023, where we produced consistently strong financial results and continued to execute against our long term strategy. We’ve positioned our company to benefit from a significant number of scaled and diversified growth opportunities that are margin accretive, namely residential broadband, mobile, business services, theme parks, studios, and Peacock. In aggregate, our revenue in these businesses grew 8% in 2023 and comprised 55% of our total revenue for the year. Our healthy cash flow generation and strong balance sheet have enabled the organic investment that fuels these businesses and at the same time fund substantial capital return, including significant share repurchases. All of this has translated into excellent financial performance. For the third consecutive year, we generated the highest revenue, adjusted EBITDA and adjusted EPS in our company’s history. Now let’s go deeper on some of the important achievements during the year. I’m really proud of the progress we’ve made in our connectivity businesses. We maintained a strong trajectory in Xfinity Mobile, increasing our subscriber lines by 24% and total domestic wireless revenue by nearly 20%. We also performed well in our business services segment, which grew full year revenue and EBITDA by nearly 5% with margins approaching 60%, and we exceeded our goal of adding over 1 million new homes and businesses passed and expect to do at or above this level in 2024. Our domestic broadband business remains strong. We kept our very large and healthy base of subscribers flat while growing residential ARPU 3.9%, the high end of our historical range, driving solid EBITDA growth in connectivity and platforms and expanding margins to around 40% on an underlying basis. We achieved all of this despite an intensely competitive environment, and as I look back on 2023, I am confident that our strategy combined with excellent execution sets us up extremely well to navigate the road ahead. While the competitive environment is likely to remain at these levels for a period of time, broadband is still a very large, healthy and profitable market, and the consumption trends that we’re seeing are encouraging for the future. Customers are connecting more devices in their homes and are using them for applications that require more capacity, faster speeds and lower latency. Our fiber-deep and capital efficient network is more than ready to meet this demand with 100,000 miles of fiber and a clear path to offering multi-gigabit symmetrical speeds ubiquitously across our entire footprint with DOCSIS 4.0. I’d like to spend a minute briefly addressing the government’s affordable connectivity program. First, it’s important to note that we’ve built on our decade-long history in digital equity to effectively participate in ACP and have successfully leveraged the national verifier program in the process. While we hope that the White House and Congress renew this funding and keep these important resources available to the many people and households who have relied upon this program to stay digitally connected, we have already begun to communicate with ACP participants and will provide a range of options, including our highly successful internet essentials program, in the event that funding is discontinued. Shifting to content and experiences, we have positioned ourselves to drive long term profitable growth. Over the span of decades, we’ve built a remarkable portfolio of iconic content and strong franchises in both film and television, including live sports, news and entertainment. Our market-leading businesses have tremendous reach and continue to perform and execute collaboratively, playing to our strengths by leveraging our IP and our incredible partners. Let’s start with our studio group, where we hit a major milestone ranking as the number one studio in film by worldwide box office with hits such as Super Mario Bros., Oppenheimer, Fast 10, and Five Nights at Freddy’s. We are proud to work alongside our creative partners like Christopher Nolan, Chris Meledandri, and Jason Blum, who are innovative industry leaders to develop content that continues to delight audiences. And I’m really excited about another fantastic film slate in 2024 with the latest installment of Kung Fu Panda in March, along with Despicable Me and Twisters in July, and Wicked slated for November, which will also benefit Peacock as these films and many others enter the Pay-1 window. At the same time, our media segment continues to deliver, reaching over 100 million households every quarter with leading sports, news and entertainment. We have the number one most watched news organization in the U.S. and Sunday Night Football is pacing to be the most watched prime time show for an unprecedented 13th consecutive year. Peacock continued to be the fastest growing streamer in the U.S., a result of our holistic business model which leverages all of our brands to serve a broad range of viewers by providing them with options to match their evolving habits. In the short period of time since we launched in 2020, we’ve seen strong momentum, ending the year at 31 million paid subscribers at a $10 ARPU, supported by healthy trends in both engagement and churn, and I’m excited for 2024. We started with the successful Wild Card Game, which will soon be followed by Oppenheimer coming exclusively to Peacock and a full slate of both new and returning originals such as Ted, Peacock’s most watched original title, additional Pay-1 movies, and the Summer Olympics later this year. These next Olympic Games promise to be nothing short of spectacular with the return of fans, this time to Paris, one of the most beautiful cities in the world. With the NBC Broadcast Network airing more content than ever before and Peacock as the streaming home for all games, NBC Universal will be the most comprehensive Olympic destination in U.S. media history with Xfinity once again playing a huge role in delivering each game on our entertainment OS platform, which is now also available to charter customers through Xumo. At parks, we achieved record-high revenue and EBITDA in 2023 and have exciting new attractions and experiences in the years ahead. We’ll open Donkey Kong, another Nintendo-themed land next year in Osaka, which will expand Super Nintendo World by another 70%. We expect continuation of the strong trends in Hollywood also driven by Super Nintendo World, and we’ll see the completion of Epic Universe, our fourth gate in Orlando, prior to its grand opening in 2025. In summary, we are very pleased with all that we have achieved in 2023. We have incredible teams in each of our businesses and have executed against our plan exceptionally well, delivering very strong EBITDA, EPS and free cash flow. Going forward, our highest priority is to continue our strong operational performance enabled by the investments we are making in our six key growth areas, fueling their growth and further improving the profile of our business mix. The strength and stability of our company, including our balance sheet, enables us to make these investments while also providing our shareholders with substantial capital returns. Since we started buying back stock in late May of 2021, we have repurchased approximately 15% of our total shares outstanding, and with today’s announcement we have now increased our annualized dividend by 150% since I joined the company in 2015. Putting it all together, our strategy is working and we see many years ahead that this formula will continue to deliver for our company and shareholders. Jason, over to you.
Jason Armstrong: Thanks Mike, and good morning everyone. I’ll begin on Slides 4 and 5 with our consolidated results. Total revenue increased 2% to $31.3 billion for the fourth quarter and was consistent at $121.6 billion for the full year. On a reported basis, EBITDA was consistent at $8 billion for the fourth quarter and up 3% to $37.6 billion for the full year. Our EBITDA results include severance and other in this quarter, as well as in last year’s fourth quarter. Excluding these items totaling $527 million this quarter and $638 million in last year’s quarter, adjusted EBITDA decreased 1% in the fourth quarter and remained at 3% growth for the full year. Adjusted EPS was up 2% to $0.84 a share for the fourth quarter and increased 9% to $3.98 for the full year. We generated $1.7 billion of free cash flow for the quarter and $13 billion for the full year, which translates into $3.13 in free cash flow per share, which was up 10% year-over-year, and we returned over 100% of this to shareholders, with $4.7 billion of capital returned to shareholders in the quarter and $15.8 billion for the full year. Our strong level of free cash flow includes the significant investments we’re making to support and grow our business in six broad and diversified growth categories, including residential broadband, wireless, and business services connectivity, along with theme parks, streaming and premium content at our studios. Taken together, these growth areas generated more than half of our total company revenue and grew at a high single digit rate during the quarter and for the full year. Now let’s turn to our business results, starting on Slide 6 with connectivity and platforms. As a reminder, our largest foreign exchange exposure is to the British pound, which was up nearly 6% year-over-year. As usual, in order to highlight the underlying performance of the connectivity and platforms business, I will refer to year-over-year growth on a constant currency basis. Revenue for total connectivity and platforms was flat at $20.4 billion. Unpacking that, revenue in our core connectivity business - domestic broadband, domestic wireless, international connectivity, and business services connectivity, increased 7% to $11 billion, while video, advertising and other revenue declined 8% to $9 billion. Our strategy is to invest to drive growth in our core connectivity businesses while at the same time carefully managing businesses that are important, but face secular headwinds. On balance, this is a favorable mix shift for the profitability of our overall connectivity and platform segment, as reflected in our results. EBITDA for total connectivity and platforms increased 3% with EBITDA margins improving 130 basis points year-over-year. This includes severance and other of $422 million in the quarter and $456 million of charges in last year’s fourth quarter. Excluding these items in both periods, EBITDA increased 2% to $8 billion and EBITDA margins improved by 110 basis points. Margins for our domestic legacy cable business improved 70 basis points to 46.2%. In terms of how our underlying performance in connectivity and platforms breaks out between residential and business, on the same basis excluding severance and other from both periods, residential EBITDA grew 2% with margins improving 120 basis points, and business services EBITDA increased 5% with margins nearly unchanged at an impressive 57%. Now let’s get further into the details, starting with our connectivity growth drivers. Residential connectivity revenue grew 7% driven by 4% growth in domestic broadband, 15% growth in domestic wireless and 19% growth in international connectivity, while business services connectivity revenue grew 6%. Domestic broadband was once again driven by very strong ARPU growth of 3.9% for the quarter and for the year, landing at the high end of our historical 3% to 4% range while our base of 32 million broadband subscribers remained stable over the past year, including the 34,000 subscriber loss this quarter. We remain focused on competing aggressively but in a financially balanced way, as evidenced by this quarter and past years’ results. With the broadband marketplace remaining extremely competitive, we will continue to manage this balance and expect ARPU growth will remain strong within our historical range and continue to be the driver of our residential broadband revenue growth in 2024. While we do not expect subscriber trends to improve in the coming quarters, we do expect them to improve over time. At the macro level, customers are consuming more, connecting more devices in their homes, and are using them for applications that collectively require either faster speeds, lower latency, and higher reliability over time. These secular trends are all moving in our favor, and we believe our marginal cost to add capacity to our network is unrivalled. This is why we are investing in our fiber-fed network to further increase capacity and offer multi-gig symmetrical speeds ubiquitously across our footprint and ensure that we stay way ahead of consumer demand with the best broadband offering and experience. We have deployed mid-splits to about 35% of our footprint and expect that to reach around 50% by the end of 2024. On the back of this, we launched our first DOCSIS 4.0 market during the fourth quarter and will continue to launch additional markets this year. We are focused on what we can control - that means segmenting our customer base by offering our customers the right price, including value options at different speed tiers and driving ARPU ahead in an environment where broadband subscriber growth remains challenged, and we’re doing this in the context of aggressive network upgrades and expansion, putting us in a great position to eventually return to subscriber growth. Speaking of network expansion, we exceeded our goal of passing 1 million new homes and businesses in 2023, landing at nearly 1.1 million, and we plan to replicate this in 2024 with this level, or potentially even greater footprint expansion. Switching to wireless, we hit a great milestone, eclipsing $1 billion in quarterly revenue for the first time this quarter. With the year-over-year increase due to higher service revenue driven by continued strong momentum in customer lines, which were up 1.3 million or 24% year-over-year to 6.5 million in total. This includes 310,000 lines we just added in the quarter. We’ve had a healthy run rate generating around 300,000 net additional lines per quarter for the last two years, and we’re consistently in the market testing new offers and will continue to do that throughout the coming year, with the goal that some of these offers will translate into accelerated line additions as the year progresses. With only 11% penetration of our domestic residential broadband customer accounts, we still have a big opportunity and a long runway ahead for growth in wireless. International connectivity revenue increased 19% driven by steady mid-teens growth in broadband along with strong growth in wireless, which had healthy growth in both device sales and service revenue. Finally, business services connectivity revenue increased 6% driven by consistent growth in our small business category as we grew ARPU through rate and higher penetration of additional products like Security Edge, and from strong growth in midmarket and enterprise. The revenue growth in our connectivity businesses was offset by declines in video, advertising, and other revenue. The video revenue decline was driven by continued customer losses. The lower other revenue reflects similar dynamics in wire line voice, and advertising was impacted by a tough comparison to last year, which benefited from higher political revenue in our domestic markets. As I mentioned earlier, excluding severance and other, connectivity and platforms’ total EBITDA increased 2% with adjusted margin of 110 basis points. To unpack this improvement, the main driver is the mix shift to our high margin connectivity businesses, a transition you’ve seen for the last few years and that we expect to continue. In addition to the mix shift, we are benefiting from ongoing cost discipline. For every quarter this year, including the fourth quarter, five out of six categories of expenses we report have decreased. The only category that grew is direct product costs, which are success-based and directly associated with the significant growth in our connectivity businesses. In addition, we continue to get more efficient with better tools and technology. Compared to 2017, we reduced our domestic truck rolls by nearly 50% and customer interactions are down nearly 40%, even while we increased our domestic relationships by nearly 5 million over this same time period. The investment we are making in our network, including virtualization and using technology to enhance the customer experience, not only makes us more competitive, it makes us more cost efficient. Together, the mix shift, the cost discipline and the technology advances we’ve made in customer service are all structural, and we expect them to continue, positioning us to drive higher profitability and further margin expansion in 2024 and for the foreseeable future. Now let’s turn to content and experiences on Slide 7. Revenue increased 6% to $11.5 billion and EBITDA increased 2% to $923 million. Excluding severance at $101 million this quarter and $186 million in last year’s fourth quarter, adjusted EBITDA decreased 6%, reflecting a decrease in media partially offset by strong growth at studios and record results at parks. Now let’s take a closer look at content and experiences, starting with media. Media revenue increased 3% driven by strong growth at Peacock, which was up 57% and, similar to wireless, crossed the $1 billion in quarterly revenue mark for the first time. Domestic distribution increased 9% driven by Peacock subscription revenue growth of 88% fueled by the continuation of solid growth in our paid subscriber base. We ended the quarter with 31 million Peacock paid subscribers, up 10 million over the past year, including 3 million net additions in the quarter driven by sports, including the NFL and the Big 10, and movies, notably the day and date movie, Five Nights at Freddy’s, and a variety of originals and other entertainment programming. International networks revenue, which is mainly distribution revenue for Sky Sports, increased 17% primarily due to the increase in sports content this year as well as the positive impact of foreign currency translation. Finally, domestic advertising declined 7% due to a tough comparison to last year, which included a significant incremental contribution in advertising from Telemundo’s broadcast of the FIFA World Cup. Excluding the World Cup, advertising increased nearly 3% driven by strong Peacock advertising and from our strong sports line-up. Peacock advertising increased 50%, again excluding the World Cup, and hit an all-time high. Media EBITDA decreased 50% mainly due to higher sports costs, reflecting a full quarter of a contractual rate increase in our NFL programming, the addition of Big 10 to our sports programming line-up this year, and higher Premier League costs compared to last year when games were paused for four weeks to accommodate the timing of the World Cup. At Peacock, EBITDA losses continued to moderate in the fourth quarter with nice year-over-year improvement resulting in full year losses for Peacock of $2.7 billion, which was slightly better than the expectation we had previously communicated. 2023 marked the peak in annual losses at Peacock, and for 2024 we expect to show meaningful improvement in losses versus 2023. Turning to studios, revenue increased 4% driven by theatrical revenue growth of 59% due to our performance at the box office this quarter with Five Nights at Freddy’s, Trolls Band Together, The Exorcist, and Migration. In fact, Five Nights at Freddy’s was the highest grossing horror film of 2023 and also set a record on Peacock as the most watched title of all time in the first five days of its release. In addition to the films this quarter, we benefited from prior period titles moving through profitable licensing windows, driving EBITDA growth of 83% to $308 million. At theme parks, revenue increased 12% and EBITDA also increased 12% to $872 million for the quarter. These strong results were again driven by growth at our international parks, especially as Osaka continues to benefit from strong demand from Super Nintendo World driving higher attendance and per-cap spending relative to both last year and pre-pandemic levels. In Hollywood, we also continued to benefit from the positive consumer reaction to Super Nintendo World, which opened earlier in 2023, driving strong attendance and growth in per-caps and resulting in Hollywood’s best fourth quarter EBITDA in its history. In Orlando, our results were also strong with attendance in line with 2019 pre-pandemic levels and revenue substantially ahead. Now I’ll wrap up with free cash flow and capital allocation on Slide 8. As I mentioned previously, we generated $1.7 billion in free cash flow this quarter and $13 billion for the year, and we achieved this while absorbing meaningful capital investments to expand our footprint and further strengthen our domestic broadband network, scale our streaming business, and support the continued build of our Epic Universe park ahead of its 2025 opening. As a result, total capital spending increased 13% for the year driven by higher capex. At connectivity and platforms, capex increased 1.5% for the full year, with capex intensity coming in at 10.1% primarily driven by investments to further strengthen and extend our network. In 2024, we expect capex intensity to be in the same range as we continue to transition our U.S. network to DOCSIS 4.0 and accelerate our growth in homes passed. I’ll just note that while our capex intensity at connectivity and platforms has been around 10% for the past few years, this is not a specific internal target for us, rather it’s an output. Our teams are going as fast as possible; however, if for example we have an opportunity to accelerate further our growth in homes passed at accretive economics, then we’d welcome that opportunity. But right now, the envelope has been right around 10% and we’re very happy with the pace that we are on and the progress we’re making. Content and experiences capex increased by $1.2 billion for the full year, driven by parks with Epic accounting for the majority of the increase in spend. In 2024, we expect parks capex to remain elevated and then decrease in 2025 when we open Epic. Working capital was $2 billion for the year, which was better than we expected, improving a billion over last year’s level. Our 2023 results included benefits from the pause in production during the work stoppages associated with the writers and actors strikes during the year. Turning to return of capital on our balance sheet, for the full year we returned a total of $15.8 billion to shareholders - this includes share repurchases of $11 billion, including $3.5 billion in the fourth quarter. In addition, dividend payments totaled $4.8 billion. As we announced this morning, we are raising our dividend by $0.08 a share to $1.24 per share - that’s our 16th consecutive annual increase. We ended the year with net leverage of 2.3 times, in line with our target leverage of around 2.4 times, and we expect to remain at this target level in 2024. Wrapping up, we had a very solid quarter and a great year, and we’re focused on continuing to execute our long term growth strategy supported by our balanced and disciplined approach to capital allocation. I’m proud of the steady and consistent framework which guides our decision-making. We’re going to invest aggressively for organic growth across our six key areas. We’ll protect our balance sheet and cash flow position and return capital to shareholders. Now I’ll turn it over to Brian for a few remarks before we turn to Q&A.
Brian Roberts: Thanks Jason, and good morning everyone. I’d like to just emphasize a couple of points. As I think about the year, it’s hard not to be really proud of what we’ve accomplished. 2023 was the best financial year in our 60-year history, and we already have nice momentum in 2024. As Mike and Jason just outlined, we have a unique company that is incredibly well positioned. We always try to think about and invest for the long term, particularly across the six key growth drivers. What’s also important is that in 2023 alone, we returned $16 billion in capital to our shareholders. As you just heard, it’s the 16th straight year that we just raised our dividend - that’s consistency. When you put this all together, we have a great team - that’s always most important to me, and we’re making the right adjustments to our businesses to position us to win, grow, and continue to return capital to shareholders. While there may be speculation on what we could do next, I’d like you to hear it directly from me: I love the company we have, so the bar continues to be even higher for us to do anything other than the plan you heard today. I want to thank all our employees for a great 2023 as they continue to execute at the highest level. With that, let me hand it over to Marci to take all your questions.
Marci Ryvicker: Thanks Brian. Operator, let’s open the call for Q&A please.
Operator: Thank you. We will now begin the question and answer session. [Operator instructions] Our first question is coming from Ben Swinburne from Morgan Stanley. Your line is now live.
Ben Swinburne: Thanks, good morning. Brian, thanks for those clear comments. I wanted to ask you guys about broadband and separately about Peacock. I guess Jason, you talked about and Mike talked about sort of the consumer trends that you think play to your strengths, but you guys are doing a lot at the network level, including in ’24 you talked about your converged offers that you’re testing maybe getting more aggressive. I know you’re not going to put a timeline on it, but can you talk a little bit about the opportunity to re-accelerate broadband customer trends, because the product you are bringing to the marketplace is seemingly getting better even this year, and I realize you’re talking long term, but I just wanted to hear more from you on the things you’re doing and the business and product today, and how that may or may not translate into better trends on the customer front over the course of the next 12 to 24 months. Then on Peacock, I guess maybe for Mike, how much more investment does this business need? I think you guys had talked a while ago about getting to $5 billion of programming investment. If you look at the fourth quarter anyway, you’re basically there now, you’ve got good revenue momentum. I’m trying to think about the path to getting this business to breakeven, so I’d love to hear what you think the business needs in terms of incremental investment from here. Thanks a lot.
Dave Watson: Hey Ben, this is Dave. Let me start with broadband and then hand it over to Mike and Jason. On broadband, as Mike and Jason said, the environment pretty much remains the same - you know, there is still the macro activity, moves are down, but to your point, it is intensely competitive, especially the difference that has been there in this particular competitive cycle, it’s especially in the lower income segment, so the result of it is the main driver, customer activity, continues to be lower connects as churn remains near record lows, and despite this, we’re striking, I think, the right balance between customer growth and ARPU. We kept our sub base relatively flat, grew ARPU 3.9% for the quarter and the year, and so we’re also growing C&P but expanding margins. Competitive cycles like this one, we’ve been through many, and what makes--you know, what happens during some of these cycles, there is new footprint, the competitive footprint, some unique discounting occurs. I think fiber is a pretty good example of one that we went through years ago and continue to have. There is pressure on net adds as you go through the initial phase of the cycle, but we evolved our approach and we have and continue to compete very well against fiber. I think this cycle is headlined by fixed wireless and really the emphasis on more of the lower income segment. They added new footprint, there’s some ARPU pressure, but we have and continue to adapt. The key for us through this cycle is continue to build better products, from the network to the Wi-Fi experience, and the network investments that we’re making are very consistent and we’ve laid it out - mid-splits, we’re pleased with our progress, we’re finishing ’23 33% upgraded, we’ll be around 50% by year-end ’24, and we’ve started to deploy 4.0 and our path towards symmetrical service offerings, so this is all due to where we believe strongly the market is going. The market is going to have more devices that will be used and be hung on the network, and there will be more usage and engagement, so for the long run, we want to be in position to compete as things shift. We’re going to compete in a segmented way for every segment, and we’ll be aggressive in each one; but we don’t expect subscriber trends to improve over the coming quarters but we do expect to grow over time. We will compete aggressively and be in position when the macro environment shifts, and as we see with fixed wireless, there’s an opportunity and will be an opportunity to get more win backs. We want to be in position for that as well. Throughout it all, we’re going to protect the healthy base of 32 million broadband customers, managing rate and volume throughout.
Mike Cavanagh: Hey, it’s Mike, Ben. Thanks for the question on Peacock. I’ll expand a little bit on the question but get to it in terms of where we see programming going in the end. I’ve got to say, we couldn’t be prouder of what we accomplished with Peacock in 2023. To end the year with paying subs at 31 million, up 50% year-over-year, and that’s only three years in, we’re achieving a level of scale with paying subs that’s about 60% of the level of the streamers that have been out there for many years domestically, ex-Netflix. We’re holding a very strong ARPU at $10 per sub, so while it’s not the scale we ultimately plan to get to, I’ve got to say the team has done a fantastic job when lots questioned, could we even get this far. From here, it’s really a matter of continuing to execute against the strategy that’s gotten us here, and that is expected, as we said earlier, to drive improvement in Peacock’s bottom line from the peak losses that we saw in 2023. When you really think about what that strategy is, it’s to manage Peacock and our linear TV businesses as one. The strategy really is to leverage the great relevant content properties we have, both at NBC which is news and sports and entertainment, obviously Bravo and some of the other assets we have in the cable business, and Universal with the Pay-1 window, so when you put it all together, continuing to execute against that. We’re going to look to get more scale, and the things we’re doing are both to drive more scale, more subs, but also get more engagement with the subs we have and drive improvements in churn, which we’ve been pretty pleased with. To ultimately your question, where are we relative to--you know, leveling off a little bit of the growth rate of programming spend as we get to this level is clearly part of the improvement in Peacock losses standalone, that will be a factor as we see continued strong growth on the revenue side, given the higher level of subs and the expectation for continuing to add. But again, I would just say I’m less focused on what standalone Peacock losses are doing than I am on doing what’s right for the long term, for the totality of the media business, which is linear and streaming. I think we’ve navigated a very good path for us, so really pleased with what we’ve done.
Ben Swinburne: Thank you very much.
Marci Ryvicker: Thanks Ben. Operator, next question, please.
Operator: Thank you. The next question is coming from Craig Moffet from Moffet Nathanson. You line is now live.
Craig Moffett: Hi, thank you. I wonder if you could do an early post mortem on the Chiefs-Dolphins playoff game, what kind of subscription growth it drove at Peacock and what kind of early churn impact you’ve had on that. I know there was some chatter that you guys tried to play down about whether that amount of traffic load on the internet would have some impact on fixed wireless, but I’m wondering if you just have any observations about how other platforms handled the kind of the volume that that game drove in terms of traffic.
Mike Cavanagh: Sure Craig, it’s Mike. I’ll start, and Dave can chime in, if he likes. As we said earlier, we couldn’t be more pleased with the way we performed in the Wild Card Game. It was the biggest live stream event in U.S. history, which is no small feat to have performed so seamlessly, which really highlights what we’ve done in Dave’s business on the broadband side and the technology platforms that we have built and have talked about repeatedly, that are supporting Peacock, Sky and our Xfinity products, and now Xumo, so I think we’ve built tremendous advantage and are always looking for ways to--we’re very happy to see the impact on our broadband usage, regardless of what it means for other ways of getting the platform across. We couldn’t be happier that it worked well and performed really well with that many concurrent streams. But in terms of adding subs, we would expect to see--we’re not going to comment on it today, but we would expect to see an increase in paid subs. We’re focused now on retention of the subs that came in right around the game. What’s important is both the subs that came in during the game and the engagement of the people that were already don the platform, so engagement and retention is really going to be focused on what’s coming next, and we teased a lot of that, including Oppenheimer coming to the platform on February 16. We have the Summer Olympics coming, and now that we’re post strikes, you’ll see a number of Peacock originals and additional movies from the Pay-1 window that we’ve got with Universal. But really, when I think about it, at the scale we’ve gotten to, what’s important is to keep people engaged with the platform and all the content that’s there, not the Wild Card Game unto itself, so the job always is to get more people in the door and get everybody that’s already in the door re-engaged with the platform around that game, and then try to continue to drive engagement afterwards. I’m happy to report that we’ve seen record levels of hours viewed in the days that have followed the Wild Card Game itself, including launching Ted, our new comedy series. That’s been the most watched original series for Peacock in its first seven days yet on the platform, which speaks to the benefit of getting that much engagement at the moment we were launching that, and likewise the second season of the reality show, Traitors, premiered right afterwards, and it’s also the biggest original reality season launch for us through its first four days on the platform. I think that’s the way I look at the total picture there. Brian, I think you want to chime in?
Brian Roberts: I just want to say that we thank the NFL for having the confidence in picking our total company to carry this out. The entire industry cooperated and participated, and it was a very proud moment for, I think, the U.S. internet industry. It worked flawlessly, and I think it’s just another proof point of all the investments that have been made. Thank you again, we’ll see how the results all turn out, but we’re really, really pleased.
Marci Ryvicker: Thanks Craig. Operator, next question, please.
Operator: Thank you. Our next question today is coming from Jessica Reif Ehrlich from Bank of America Securities. Your line is now live.
Jessica Reif Ehrlich: Thank you. Mike, I have a two-parter. As Brian just said, you have a unique mix of assets, so can you talk a little bit about your longer term video strategy from all sides of the company, from both cable and NBC-U, meaning do you have any plans to take Peacock global, your recent Paramount affiliate renewal deal kind of seems like status quo? Then as a separate question, you kind of touched a little bit on Epic. It’s only one year away. Can you give us some color on size and scope and how differentiated the offering will be? Thank you.
Mike Cavanagh: Hey Jessica, thanks. On Peacock in particular, let’s take video in a couple of pieces. On our streaming ambitions, clearly we view it, and we’ve talked about it for a long time, we want our existing media assets to have a strong future in a world where consumer behavior is taking people more to streaming, because that’s the way they want to experience it, so our strength, obviously in video distribution from the NBC side, has been U.S. focused, and I think we are focused--very focused on getting domestic scale. What we’ve done internationally and what we might do one day is a separate story, but for now, we have been focused on making sure through partnerships, JVs, whether it’s Sky Showtime, whether it’s Peacock-type content that makes its way onto Sky platforms, we’ve got a venture partner in MultiChoice in Africa, so we’re looking for ways and a rational approach economically to scale up Peacock domestically while not giving up too much in terms of economics that a lot of people talk about as having global scale. We want to win here first and get to the place we need to go, and that’s really where we’re most focused. In terms of what’s happening on the domestic side through video distribution, I think we continue to be a big player in the space with our own content from NBC, but also I think the best partner given the scale of our reach in broadband for both traditional linear, but at the same time streaming partners. We’ve seen a lot of progress and a lot of collaboration with players and partners that want to reach the kind of customer base we have with our broadband customer base, the natural point of engagement with them, aggregating content and acquiring new content if they don’t have it through Xumo, X1 and the platform that Dave and team have built. I think we’re really well positioned to play a part in that as well.
Dave Watson: And Jessica, this is Dave. I just would add, when you think about the overall video approach, it’s linear, streaming, on-demand, still DVR. It’s all of them that I think we are in a unique position to be able to tie together. Back to the Wild Card Game, it’s an example of great broadband being able to handle it, and at the same time what’s really important in video is the experience matters. The experience getting connected to the overall network performance is so critical, finding what you want easily and simply and being able to engage. The platforms that we’ve built over time, starting with X1, now Xumo, very important to us in the long run.
Brian Roberts: One thing I would add - it’s Brian - on Epic, just to touch on that part of the question. It’s completely original. It maybe the most exciting project, I’ve seen since we bought NBC-Universal getting built. I think it’s the first new entire theme park in decades in the U.S., and we’re so excited, we’re taking the board of directors to see the construction in the next couple of weeks, which is something we haven’t ever done before. So, I think you’ll all want to be there. Sometime, I think ’23 and ’24, are the peak CapEx years for the construction. We expect to open in ’25, and I give Mark Woodbury and the entire team at Universal incredible kudos to coordinate something of this scale and magnitude that’s being built.
Marci Ryvicker: Thanks Jessica. Operator, next question please.
Operator: Our next question is coming from John Hodulik from UBS. Your line is now live.
John Hodulik: Great, thanks. Two questions, if I could. First on the ACP commentary, I think you guys had to contact ACP subscribers this year. Any way you could quantify the size of the base, or maybe the financial impact, and should we see anything this quarter? Or is it really something, if it doesn’t get renewed, that we could really expect for, say, second quarter? Then over on the media side, it looks like you guys saw some real ad strength, so just any commentary on what you’re seeing in the ad market? It looks like if you sort of look at core advertising, it was actually up this year, and I’m wondering if that’s just strength in NFL and maybe Big 10, or just what some of the underlying factors are there would be great. Thanks.
Dave Watson: Hey John, it’s Dave. Let me start with ACP. To specifically answer your question, we have 1.4 million customers that have benefited from this program which we obtained through the national verifier program, so feel good about the credentials of these customers. Most of these customers in this customer base were already our customers prior to the ACP program. We’ve been very consistent on this. We want the program to continue, but I think we’re very well positioned to support these customers if it does not. We have a good business and model in place and a history with knowing how to segment our customer base and have products and packages at a variety of price points to serve our customers well, including well over for a decade and that would include internet essentials. We’ll evaluate this as it plays out. It may be a risk, but one we feel is very manageable for us, given how we work with this program and how we manage our customer base in general.
Mike Cavanagh: John, it’s Mike. On the advertising side, I’d say that the ad market, we have seen it remain stable, and we’re definitely pleased with our performance in the fourth quarter. When you exclude 2022 World Cup and normalize for that, we did grow ad revenue even with the difficult comparison to last year’s political quarter. We are seeing a few encouraging signs, like stabilization across most categories, CPG and retail too that improved in particular. We’re not seeing any pressure, any real pressure on cancellations from last year’s up-fronts, which is good, and scatter premiums are pretty healthy, double digit increases is what we’ve seen recently. But I would say that it’s too early to say that there’s a sustainable rebound going on. Too much remains uncertain on the macro side and we’re heading into a period, for us at least, that has less sports programming in the early part of the year. But regardless of the full year ahead, whether the environment macro-wise gets better from here or it doesn’t, we feel like we’re well positioned with our must-see tent poles, which include obviously the Olympics coming up, the elections, and then going back to your earlier point of now being much more scaled at Peacock, we’re seeing nice progress on the capacity and inventory that we have there. So those are the dynamics I think we’re seeing in advertising.
Marci Ryvicker: Thanks John. Operator, next question please.
Operator: Thank you. The next question is coming from Jonathan Chaplin from New Street Research. Your line is now live.
Jonathan Chaplin: Thanks. Two for Jason. You mentioned that if you saw opportunities to expand your footprint with good economics, you’d do it in a heartbeat. Are you referring to the opportunity in BEAD, and is that something that you expect could potentially hit later this year, or is that more of a 2025 impact? Then on repurchases, we saw the reauthorization of $15 billion. You’re going at a pace of $3.5 billion a quarter at the moment. Should we expect that to continue through 2024?
Jason Armstrong: Yes, thanks Jonathan. Let me take them in reverse order and then potentially tag team with Dave, if he wants to, on the footprint side. Buybacks, you’re right - we reauthorized or re-upped this morning for $15 billion. Never meant to be guidance when we do this, but nonetheless healthy reauthorization. Saying that, I think the formula that’s been in place for very strong capital returns continues to be in place, so I think we’re comfortably within our leverage range, as I stated, which is right around 2.4 times, continue to generate very strong free cash flow, and if you look at the recent history since mid-’21, since we started buying back or restarted the buyback program, we’ve bought back 15% of our stock in that time frame, so very good metric there, so more capital returns to continue, feel very strong about the trajectory into 2024. I think on the footprint side, we’ve been very clear that, to the extent--you know, first and foremost as we talk about capital intensity in Dave’s world, right around 10%, it’s been there for the last couple years. The expectation is that it will be there again in 2024, but we’ve also been very clear, that’s not necessarily a constraint on the business. To the extent we can move faster, we’ll do that, and we’d like to. I think as you look at the past couple years on homes passed, we did 850,000 homes passed in 2022, we were able to accelerate that in 2023 up to 1.1 million, and we gave guidance this morning for 1.1 million or slightly higher next year, so we think we can further accelerate that. Most of that in terms of the guide for 2024 is self-funded, but we have been making our way into the ARPA program and had some success there. To the extent we’re successful with BEAD, and I think we certainly expect to be, that would be more 2025 and beyond.
Dave Watson: This is Dave. I would only add that when you do these programs, and we have started and we are aggressively pursuing opportunities, as Jason said, at this stage mostly self-funded, but we are working with local governments on programs like ARPA and others. We are going for opportunities where it makes sense. The great part, and a little bit what Brian mentioned right from the get go, there’s just been terrific execution as we scaled operationally, getting ready for this, so the 1.1 million that we did this past year, looking to do that or more into ’24, we are on it and this is a real opportunity for us. Having said that, the nature of these projects, it takes a while to build them up and then driving penetration, and I would look for more of the benefit in ’25. BEAD, we plan to participate where it is consistent with our business goals, but the process, quite frankly, with BEAD is still in flux.
Marci Ryvicker: Thanks Jonathan. Operator, next question please.
Operator: Certainly. Our next question is coming from Steven Cahall from Wells Fargo. Your line is now live.
Steven Cahall: Thanks. Maybe first, I was wondering if you could expand on your Xfinity Mobile plans for 2024. One of your peers has been more promotional. I think that’s something you’ve kept an eye on, and we saw you get a bit more promotional last year with the iPhone deal. You also talked about broadband ARPU being the biggest driver of broadband revenue, and I know that can suffer on a GAAP basis if you do lean into mobile, so I’d love to just hear more about how you’re thinking about the broadband and mobile strategies coming together. Then Jason, just the severance that you took in the quarter, the lion’s share fell at connectivity and platforms. How should we think about the benefits to opex in 2024? You said five out of the six buckets decreased last year, so maybe you can give us a bit of a view of what non-programming opex looks like for connectivity and platforms this year. Thank you.
Dave Watson: Steven, this is Dave. Let me start with wireless. I think we’ve been consistent on this one, too - the wireless is one of the key long term growth drivers for us, and pointed out in the six that the team has talked about. It is absolutely a great companion to broadband. It has good standalone economics and a great runway ahead for penetration mobile to the broadband base. You know, it’s performing well - our domestic revenue was up over 15, we have over 6 million lines, including the 310,000 that we added in the quarter, and we’re only at 11% penetration, as Jason said, to the broadband base, so a lot of runway ahead. It is absolutely a key part of all our go-to-market activity, whether it’s acquisition, case management, upgrade activity to the base, as you noted, Steven. We have been very focused on upgrade activity and retention, so our results have been consistent right around 300,000 new lines per quarter - pretty healthy run rate for a considerable period of time. Having said that, I think we can improve on these results. We are consistently in the market trying new offers, both in terms of broadband and mobile together, and we segment the opportunity, so we do have unique opportunities that we evaluate. We continue to be hopeful that some of these offers will accelerate our line additions over time and as the year progresses. We have a great road map in terms of innovation and offers between Wi-Fi and mobile, and we want to leverage both and continue to build a better product and service. Our mobile service, our core service offering delivers better value day in and day out. We really like, though, our capital-light approach with the MVNO, and I think we’re in a great position to win in convergence, so I think we have a leg up on the competition with this capital-light strategy that doesn’t have to involve customer and/or network trade-offs. We’ll continue to be opportunistic in evaluating progress, but I think there’s upside.
Jason Armstrong: Steven, let me just round that out quickly, because part of the question seemed like, are we governing wireless at all as it relates to broadband ARPU growth and GAAP realization of broadband ARPU growth. The two are not connected. We will do what’s right for the business, first and foremost. To the extent we’re finding ways to accelerate wireless, I think we’ll have opportunity to do that and not be held back by what it means for broadband ARPU, although we do see, and just to reiterate, broadband ARPU growth in both the fourth quarter and for the full year, 3.9%, high end of our historical range of 3% to 4%, and we guided to the coming year to still be in that range of 3% to 4%, so consistent and strong ARPU growth. On the severance question, as we step back, we’re focused on investing capital and resources in our key growth areas, so we’ve identified six key growth areas where investments in opex are being directed while managing carefully businesses that are important to us, but face secular headwinds. I think you saw that in the fourth quarter with severance actions - we took these actions to get ahead and position ourselves for continued transitions in these businesses in 2024 and beyond. I would point out--you know, you mentioned connectivity and platforms specifically - that’s where the bigger severance charges were. You’re right - five out of six categories of expense were down year-over-year in 2023. These types of actions in transitioning our business and managing the expense base are a big part of that, and if you look at margin expansion, which we’ve seen for a long period of time in the C&P business and gave an outlook that we expect to continue that, this is all part of that, taking action to sort of get ahead of these transitions. I will point of what we also said in the prepared remarks, if you look back in the last six years, we’ve taken 50% of our truck rolls out of the system, so truck rolls versus 2017 are down 50%, so cut in half, and transactional volumes, if you will, or interactions are down 40%, so pretty significant expense opportunities relative to that, that we see continuing as well.
Marci Ryvicker: Thanks Steve. Operator, we have time for one last question.
Operator: Thank you. Our final question today is from Sebastiano Petti from JP Morgan. Your line is now live.
Sebastiano Petti: Hi, thank you for the question. Just wanted to see if you could provide additional color on perhaps the content and experiences segment capex expectations as we look beyond Epic. I think Jason, you did say in ’25, capital intensity in content and experiences should tick down as the Epic build finishes, but as we think about your plans for regional parks in the U.S., headlines about a U.K. park construction perhaps over the next several years as well, any color on how we should be thinking about is there a parks capex holiday before a reacceleration? Then just a housekeeping question on Peacock - obviously very strong net adds inside of 2023. Mike, you did say that you do expect sub growth beyond that to kind of continue, but could you perhaps quantify what the benefit of the conversion from Comcast bundle subs from free to paid was within the year and as we’re kind of thinking about organic or underlying growth that will benefit from the NFL playoff game, Oppenheimer, and some of the other stuff you listed? Thank you.
Mike Cavanagh: Sure, hey Sebastiano. On parks, it’s as Jason said - we are going to remain at the elevated level around Epic with the two expansion parks, Hollywood Horror Nights and the Universal Kids in Frisco, Texas underway at this stage, so we’ll remain elevated in 2024 and then as we come to completion of Epic in 2025, rolling into 2025, we’ll ease off from there. I think the easing off is--I wouldn’t necessarily call it a holiday, so much as much like we talked about adding additional passings in cable, if we see these projects pencil out for good return, we’d be excited in the years that follow, I can’t predict when, to continue to give the parks and experiences business whatever capital it requires. But right now with the visibility we have for what’s in the pipeline, what Jason described as the trajectory is the right trajectory. Then on Peacock, I think we did a good job converting our Comcast free subs to paid subs, and they are now rolling into--after a few months at a lower price, are rolling into the full price, so I think we did a great job across the company on executing that.
Marci Ryvicker: Thanks Sebastiano. That concludes our call. We appreciate all of you joining us this morning.
Operator: Thank you. That concludes the question and answer session and today’s conference call. A replay of the call will be available starting at 11:30 am eastern time today on Comcast’s Investor Relations website. Thank you for participating. You may all disconnect. |
TSLA | 4 | 2,023 | 2024-01-24 22:38:03 | Martin Viecha: Good afternoon, everyone, and welcome to Tesla's Fourth Quarter 2023 Q&A Webcast. My name is Martin Viecha, VP of Investor Relations, and I'm joined today by Elon Musk, Vaibhav Taneja, and a number of other executives. Our Q4 results were announced at about 3.00 pm Central Time in the Update Deck we published at the same link as this webcast. During this call, we will discuss our business outlook and make forward-looking statements. These comments are based on our predictions and expectations as of today. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent filings with the SEC. During the question-and-answer portion of today's call, please limit yourself to one question and one follow-up. Please use the raise hand button to join the question queue. But before we jump into Q&A, Elon has some opening remarks. Elon?
Elon Musk: Thank you. So the Tesla team did an incredible job in 2023. We achieved record production and deliveries of over 1.8 million vehicles in line with our official guidance. And in Q4, we were producing vehicles at an annualized run rate of almost 2 million cars a year. This is really a phenomenal achievement. Looking at just the Fremont factory alone, we made 560,000 cars. This is a record. In fact, it's the highest output of automotive plants in North America. And people are often surprised that the highest output factory, car factory in North America is in the San Francisco Bay area. It's a little counterintuitive, perhaps. And it's really had an incredibly positive impact on that entire area. What would have been a rundown strip mall is the highest productivity car plant in the Americas. Think about that. It was derelict when we got it, and now it's the most productive plant in this entire part of the world. And it's enriched the community in so many different ways. It's really a gem. So I'm super proud of the people that work there. Model Y became the best-selling vehicle globally, as predicted. The best-selling vehicle of any kind, not just electric vehicles with over 1.2 million units delivered. The energy storage business delivered nearly 15 gigawatt hours of batteries in 2023, compared to 6.5 gigawatt hours the year before. So tremendous year-over-year growth, triple-digits. And yeah, I think we'll continue to see very strong growth in storage, as predicted. I said for many years that the storage business would grow much faster than the car business, and it is doing that. Free cash flow remains strong at $4.4 billion in 2023, in spite of record spending on future projects. So we had record CapEx expenses as well as record R&D. This brings us to 2024. There's a lot to look forward to in 2024. Tesla is currently between two major growth waves. We're focused on making sure that our next growth wave, driven by next-gen vehicle, energy storage, full self-driving, other projects, is executed as well as possible. For full self-driving, we've released Version 12, which is a complete architectural rewrite compared to prior versions. This is end-to-end artificial intelligence. So another bit nets basically photons in and controls out, and it really is quite a profound difference. This is currently just with employees and a few customers, but we will be rolling out to all customers in the U.S. who request full self-driving in the weeks to come. That's over 400,000 vehicles in North America. So this is the first-time AI is being used, not just for object perception, but for path planning and vehicle controls. We replaced 330,000 lines of C++ code with neural nets. It's really quite remarkable. Yeah, sort of, as a side note, I think Tesla is probably the most efficient company in the world for AI inference. Out of necessity, we've actually had to be extremely good at getting the most out of hardware, because Hardware 3 at this point is several years old. So I think we're quite far ahead of any other company in the world in terms of AI and inference efficiency, which is going to be a very important metric in the future in many arenas. So, the new Model 3 is now available globally. So we did an updated Model 3. While the car looks similar, a lot of work has gone into the vehicle to make it better in every way. It is significantly quieter, more refined, better equipped, has longer range and many other improvements, and I recommend taking it for a test drive. If you have not driven a Model 3 in a long time, you should really try the new one. So, steady improvements. And we're very far along on our next-generation low-cost vehicle. This is an earnings call, not a product announcement. So there'll no doubt be many questions that try to ask us about new product, new products coming. But we reserve product announcements for product announcements not earning calls. So -- but we're very excited about this, and this is really going to be profound, not just in its design of the vehicle itself, but in the design of the manufacturing system. This is a revolutionary manufacturing system significantly, far more advanced than any other automotive manufacturing system in the world, by a significant margin. Several years ago, I said, perhaps the most important competitive characteristic of Tesla in the future will be manufacturing technology and you will really see that come to bear with our next-gen vehicle. The first manufacturing location for this will be at our Gigafactory and headquarters in Austin, Texas, and then we'll follow that up with other locations around the world. Probably the factory we'll build in Mexico will be second, and then we'll be looking to identify a third location, perhaps by the end of this year or early next outside of North America. In conclusion, we had a great year with record production, record deliveries, and a strong free cash flow in spite of a very high interest rate environment. And we are focused on exciting new projects that will -- I think, ultimately if we execute on all these things, and it is very hard to do all these things, it's not a sure thing. But I do see a path where Tesla could one day be the most valuable company in the world. I do emphasize that is not an easy path and a very difficult one, but it is now in the set of possible outcomes and previously I would not have thought it is in the set of possible outcomes. And thank you, again to all of our investors, our employees, and our suppliers for a strong year, and looking forward to a great 2024 and years to come. Thank you.
Martin Viecha: Thank you. And our CFO, Vaibhav has some opening remarks as well.
Vaibhav Taneja: Thanks, Martin. Good afternoon, everyone. As Elon mentioned, we had a record year in terms of both production and deliveries for our auto business as well as record deployments in our energy business. This was achieved despite 2023 being a challenging year in terms of higher interest rates and higher inflation. Big thanks to our customer for being with us through this challenging period. I would also like to thank the whole Tesla team for their resolve and dedication throughout. In terms of 2023 financials, we ended the year with over $96 billion of revenue and generated $4.4 billion of free cash flow to end the year with over $29 billion of cash and investments on hand. Our 2023 GAAP net income was impacted by the recognition of one-time non-cash benefit of $5.9 billion from the release of valuation allowance on certain deferred tax assets. This was due to our recent history of sustained profitability and is similar to several other companies who have recently gone through a similar change in their account. Accordingly, starting with Q1, our book tax rate will now be more in line with other companies in the S&P 500. In our vehicle business, we continue to see improvements in our per unit cost despite us being in the early phase of Cybertruck ramp. As a result, our auto gross margin improved sequentially. That said, predicting auto gross margins is extremely challenging since there are many moving parts to this equation, some of which are out of our control like the change in tariffs or local incentives to name a few. While the teams are focused on cost reductions, we are approaching the limits within our current platforms. On the demand front, as promised, we made investments in digital campaigns in 2023. We fully appreciate the importance of customer education as we are still in a customer acquisition phase. Our data suggests that around 90% of our vehicle buyers in 2023 never owned a Tesla before. We are being creative in figuring out ways to bring in new customers and educate them about the benefits of owning a Tesla versus gas-powered vehicles. The key among them being total cost of ownership. This concept is mostly overlooked for just the upfront cost. We will be rigorous in evaluating our campaigns, curating the content, and optimizing spend accordingly to support the overall demand. There are two additional things I would like to mention as it relates to the US market. First, for customers who qualify for the IRA buyer credit, we now offer that as a point-of-sale benefit for Model Y, which means an immediate reduction of $7,500 at the time of purchase to the end customer. Secondly, we continue to offer very attractive lease rates for Model 3 and Y using our Partner Leasing Program. Note that the sales under this program are recognized as upfront revenue and reported within automotive sales. Our energy storage business had another record year with deployments more than doubling and revenues increasing by more than 50%. This business is poised to again surpass our auto business in terms of growth rate in 2024. This has been in the works for quite some time with us laying the foundation a few years back by building our Megafactory in Lathrop. I would like to thank the whole Tesla Energy team for their efforts to make this a reality. Our services and others business also started contributing meaningfully to our results and our fleets -- as our fleet grows. As we expected the fleet-based revenues from supercharging, used cars, and services continue to increase. For 2024, our focus is to continue growing our output, continuing our cost reduction efforts, and increasing investments in our future growth initiatives. Accordingly, we are currently expecting our capital expenditure for 2024 to be in excess of $10 billion. We believe this would be critical in helping us lay the foundation for the next phase of growth. Once again, I would like to thank everybody at Tesla, our investors, and our suppliers for being with us in this journey. We can open it up to questions, Martin.
A - Martin Viecha: Thank you. Let's go through investor questions. Question number one is from Michael. Given that you moved the start of the next-generation compact vehicle production to Austin, has the timeline improved so that we might see next-generation platform vehicles in 2025?
Elon Musk: I mean, I would certainly say things with they should be taken with a grain of salt, since I am often optimistic. I don't want to blow your minds, but I'm often optimistic regarding time. But our current schedule shows that we will start production towards the end of 2025. So sometime in the second half. That's just what our current schedule says. But there's a lot of new technology like a tremendous amount of new revolutionary manufacturing technology here. The reason I wanted to put this new revolutionary manufacturing line at Giga Texas was because we really need the engineers to be living on the line. This is not sort of off the shelf, just works type of thing. And it's just a lot easier for Tesla engineering to live online if it's in Austin versus elsewhere. So -- but we are currently expecting to start production second half next year. That will be a challenging production ramp. Like, as I can emphasize we'll be sleeping on the line practically. In fact, not practically. We will be. But I am confident that once it is going, it will be head and shoulders above any other manufacturing technology that exists anywhere in the world. It's next level. So it's always difficult to predict what that S-curve of manufacturing looks like. So it always starts off real slow, and then it grows exponentially. So -- and predicting that intermediate S-curve is difficult, so I don't know. It's hard to say what the unit volume would be next year. We're not going to make any predictions on that front, but it does seem quite likely that we will start production next year.
Martin Viecha: Thank you. The next question is from Michael again. What has been the barrier to ramping 4680 cells into the multi-million cells per week rate and when do you expect to get there?
Elon Musk: Karn?
Karn Budhiraj: Yeah. First, I just want to allay any concerns regarding 4680 limiting the Cybertruck ramp, because I've seen some people commenting about that. To date, 4680 production is ahead of the ramp with actually weeks of finished cell inventory. And the goal is to keep it that way, not only for Cyber, but for our future vehicle programs. And as Elon said, it is an S-curve here too. It's hard to predict these things, but I'm just describing our goals.
Elon Musk: It's a hard problem.
Karn Budhiraj: Yeah.
Elon Musk: There are entire companies where all they do is make battery cells. That's, like, all they do.
Karn Budhiraj: Indeed, indeed.
Elon Musk: We do a lot of other things, and we got a lot of breakthrough technologies that take time to figure out with 46. It's not just that it's a 46 millimeter diameter by 80 millimeter [Indiscernible] cell. That's just the dimensions. There's tremendous amount of new technology in the cell itself.
Karn Budhiraj: And manufacturing technology.
Elon Musk: Yes, exactly.
Karn Budhiraj: And just regarding what the team was able to do in Q4, Texas successfully swapped line one from the Model Y design of the cell to the Cybertruck design of the cell, which was the 10% cell energy increase I've mentioned before. And as with any major new product introduction, the factory and engineering teams collaborated to ensure quality of the new design and the process changes as their first priority. And now our focus returns to cost and production ramp in Q1. And in terms of what we're doing, we're currently running one production line, one assembly line, using two assembly lines in addition for yield and rate improvement trials, and we have a fourth in commissioning, and four more will be installed starting in Q3 this year. So definitely this is a big year for ramping 4680.
Elon Musk: But we also do want to emphasize that we also expect to ramp orders from our suppliers.
Karn Budhiraj: Yeah.
Elon Musk: So this is not about replacing our suppliers, it's about supplementing our suppliers.
Karn Budhiraj: Yes.
Elon Musk: So we are very appreciative of our suppliers. Panasonic, obviously, is our longest supplier. They're an amazing company. We've got CATL, we've got LG and BYD.
Martin Viecha: Thank you. The next question is from Adam. Should retail shareholders be concerned that Elon has stated that he is uncomfortable expanding AI and robotics at Tesla if he doesn't have 25% of voting?
Elon Musk: Yeah, I guess. Let me explain what my concern is here, which is that I see a path to creating an artificial intelligence and robotics juggernaut of truly immense capability and power. And my concern would be, I don't want to control it. But if I have so little influence over the company at that stage that I could sort of be voted out by some sort of random shareholder advisory firm. We've had a lot of challenges with institutional shareholder services, ISS, I call them ISIS, and Glass Lewis, which -- and there's a lot of activists that basically infiltrate those organizations and have strange ideas about what should be done. So I want to have enough to be influential. Like, if we could do a dual-class stock, that would be ideal. I'm not looking for additional economics. I just want to be an effective steward of very powerful technology. And the reason I just sort of roughly picked approximately 25% was that's not so much that I can control the company, even if I go bonkers and if I'm, like, mad, they can throw me out. But it's enough that I have a strong influence. That's what I'm aiming for, is a strong influence, but not control. If there's some way to achieve that that would be great.
Martin Viecha: Thank you. The next question is, what is your expectation for automotive gross margin ex-regulatory credits for the full year?
Vaibhav Taneja: Like, I said in my opening remarks, we're focused on reducing the cost of our vehicles. This is very extensive and involved exercise whereby we look at not just the component cost, but down to the packaging used to get the materials to the production flow. Each element of the cost is scrutinized to optimize further. A few pennies saved at the subcomponent level, whether through engineering redesign or from many other things which I mentioned leads to cost reduction. This is a constant exercise and we just have to chase down every penny possible. We have a strong team which is hyper-focused on this. However, this is a very difficult thing to predict precisely because there are lots of...
Elon Musk: We don't know. We don't have a crystal ball, so it's difficult for us to predict this with precision. If the interest rates come down quickly, I think margins will be good. And if they don't come down quickly, they won't be that good. Yeah. It's always important to remember that the vast majority of people buying a car is about the monthly payment. It's not that people don't want. We have tons of -- we have lots of people who want to buy our car but simply cannot afford it. And as interest rates drop and that monthly payment drops, then they're able to afford it and they buy the car. It's pretty straightforward and there are no tricks around to get around this.
Martin Viecha: Okay. Thank you. The next question is, does the company anticipate a 50% volume CAGR to be realized in either of 2024 or 2025? If not, why not?
Vaibhav Taneja: As we have said in our prior guidance, there will be periods where we won't be growing at the same rate as before. We are between two major growth waves. The first one began with the global expansion of Model 3 and Y, and we believe the next one will be initiated with the next generation platform. In 2024, our volume growth will be lower, as we have said, because we are trying to focus the team on the launch of the next generation vehicle.
Martin Viecha: All right. Thank you very much. The next question is from Michael. When will Tesla start construction on the Giga Nevada expansion and Giga Mexico, and when can we expect each of these to produce their first products such as 4680 cell, Semi, and next-gen vehicles?
Karn Budhiraj: We have recently broken ground for the next phase of Giga Nevada expansion to incorporate Semi and other projects. But as said earlier, as regarding Mexico, we want to first demonstrate success with the next-generation platform in Austin before we start construction. Therefore, we have started the long lead work to get the basics ready and plan to follow our recipe from the 3/Y ramp with Shanghai, where we started with learnings from Fremont and ramp really quickly.
Elon Musk: Yeah, exactly. It's important to emphasize that I mean, Model 3 production was three years of hell, I've said it before, some of the really worst years of my life, frankly. I still have mental scar tissue from those three years, as do many. And then Model Y was somewhat of a variant on Model 3. So a much easier situation. And then we were able to actually do an improved -- slightly improved versions of, in some cases, significantly improved versions of the Model Y production line in Shanghai and Berlin. And that's the right, I think the sensible way to go about things is kind of figure out the core technology of the manufacturing line and then replicate it with improvements throughout the world.
Martin Viecha: Thank you. The next question from Michael is, has there been any progress made with an FSD licensing agreement with another company?
Elon Musk: I really think lots of car companies should be asking for FSD licenses. And we've had some tentative conversations, but I think they don't believe it's real quite yet. I think that will become obvious probably this year. And I do want to emphasize that if I were CEO of another car company, I would definitely be calling Tesla and asking to license Tesla full self-driving technology. It's definitely the smart move.
Martin Viecha: Thank you. The next question from Siddharth. What is the timeline for Optimus first production off volume production line and what are the barriers to getting there?
Elon Musk: Optimus, obviously, is a very new product, an extremely revolutionary product, and something that I think has the potential to potential to far exceed the value of everything else that Tesla combined. When you think of an economy, economy is productivity per capita times capita. But what if there's no limit to capita? There's no limit to the economy. And the technologies that we've -- AI technologies that we've developed for the car translate quite well to a humanoid robot because the car is just a robot on four wheels. Tesla is arguably already the biggest robot maker in the world. It's just a four-wheeled robot. So Optimus is a humanoid robot with arms and legs. It's by far the most sophisticated humanoid robot that's being developed anywhere in the world. I think we've got a good chance of shipping some number of Optimus units next year. But like I said, this is a brand new product. A lot of uncertainty -- when you have -- when there's a lot of uncertainty in your uncharted territory, it's obviously impossible to make a precise prediction. But we will be updating the public with progress on Optimus every few months, and you can see that it's advancing very quickly. I was just in the Optimus lab, actually, until late last night, like red night or something, finally left the Optimus lab. The team's doing amazing work. That's obviously a case where we want to make sure that Optimus is safe, especially at scale, and that there's no -- it should be impossible for any centralized control to upload malware to a humanoid robot. So we're going to want to pull then localized shut off that cannot be updated from a central server. That's the case where we really have to give extreme thought to safety. But like I said, I do think it has the potential to be the most valuable product of any kind ever, by far.
Karn Budhiraj: Just to comment on the barrier, I think the barrier, and we've talked about this, is like getting it to actually do something useful. Like, we can get it to walk around, we can get it do things, but it's like that utility part.
Elon Musk: We can already do some useful things.
Karn Budhiraj: But like, to making millions of these things, it's like utility. Got to get the utility of it.
Elon Musk: Yeah. A smart robot that can do -- that's capable of doing generalized tasks is what it will be in terms of doing moderately specialized tasks. Well, it can already do that. It'll just get better through the course of the year. As we improve the technology in the car, we improve the technology in Optimus at the same time. It runs the same AI inference computer that's on the car. Same training technology. I mean, we're really building the future. I mean, the Optimus lab looks like the set of Westworld. Admittedly, that was not a super utopian situation.
Karn Budhiraj: Yeah. Not the best reference.
Elon Musk: Yeah. The creators of Westworld, Jonathan Nolan, Lisa Joy Nolan, friends, old friends of mine, actually. And I invited them to come see the lab. I think they'll come see it, hopefully soon. It's pretty wild, especially the sort of subsystem test stands where you've just got like one leg on a test stand, just doing repetitive exercises and one arm on a test stand. Pretty wild. Yeah.
Karn Budhiraj: We're not entering Westworld anytime soon.
Elon Musk: Right. You take safety very, very seriously.
Martin Viecha: Thank you. The next question from Nermin is, how many Cybertruck orders are in the queue and when do you anticipate you will be able to fulfill existing orders?
Karn Budhiraj: First of all, I want to thank all the Cybertruck reservation holders for their patience. The reservation to order conversion rates so far has been very, very encouraging. If the trend continues as it very likely to be, we will soon sold out all the builds in 2024. And also, we have new orders come in after the launch. The auto numbers keep growing. So we're now all hands on deck, focused on ramping so we can fulfill all the demands in a reduced wait time.
Elon Musk: Yeah. It's important to emphasize that this is very much a production-constrained situation, not a demand-constrained situation. And obviously, we could dramatically raise the price, but that doesn't feel right to us to sort of gouge people for early delivery. So -- but really, the demand is off the hook. As long as the price is affordable, I mean, I see us ultimately delivering on the order of 0.25 million, something like 0.25 million Cybertrucks a year in North America, maybe more. But give or take roughly on that time frame, and it sure is a head-turner.
Vaibhav Taneja: Definitely is. Anywhere you go, people look at you, they give you thumbs up.
Elon Musk: Yeah. It's like finally, the future. Looks like the future. It's just -- for the other trucks on the road there, which -- there's some very good trucks on the road, but if you were to switch out the brand name, you wouldn't hardly know which company made them, but you definitely would know the Cybertruck. That's our best product ever.
Martin Viecha: All right. Thank you. The next question is, can we get Tesla Energy volumes reported in the production and delivery release?
Karn Budhiraj: Yeah. We will strive to do so starting from this quarter. And just a brief update from the business perspective. Megapack continues to see strong demand signals globally, driving consistent growth trajectory through '24 and '25. We want to thank all of our partners who've put their trust in the Megapack team to execute on critical infrastructure around the world. And I would like to personally thank the Megapack engineering and production teams for their strong 2023 execution. Lathrop continues to ramp through 2024 with the operation of a second final assembly line to double capacity from 20 gigawatt to 40 gigawatt hours by the end of the year.
Martin Viecha: Thank you. And the last investor question is from Siddharth, what are the preliminary results and return on investment of your ads and education campaign? Given that many people still lack awareness that Tesla average price is less than the average non-luxury car price of $45,000, will you expand educational ads?
Unidentified Company Representative: As Elon mentioned, the ultimate solution to increase EV adoption is really address the affordability issue. But at the same time, we do aware there's awareness issue as well. So in Q4, we ran a series of digital campaigns, very targeted digital campaigns across different geos and different channel. The target of these tests is really just to drive awareness and ultimately measure the return of investment on those digital channels. The messaging we're driving has really focused on our product and also try to address some of the misconception of the EV, such as safety, affordability. And one particular awareness campaign we run in Texas will reach the audience, about 10 million unique viewers, and generated close to 0.5 million visits to our website. A large number of these viewers are first-time visitors to our website. The traffic through these digital channels actually behaved very similar to those organic traffic come to our website. So going forward, we're just going to keep exploring different channels and doing our trials to get a better understanding of this effectiveness of these digital campaigns.
Vaibhav Taneja: But I would also like to caution that we'll be very careful that we don't want to overspend on this side. We want to make sure people are aware. But that's where we'll keep tweaking our methodology about how and where we spend the money. Because we understand the importance of increasing awareness, but at the same token, we don't want to spend a lot of money on just creating awareness.
Elon Musk: Yeah. I mean, there are some geographies where our market share is remarkably low. Like Japan, for example. Now, we also need to make sure that we have superchargers in the right locations and the service centers are there, and the product works well in Japan. But Japan is the third largest car market in the world of any country, and we should at least have a market share proportionate to, say, other non-Japanese car makers like Mercedes or BMW, which we do not currently have. So I think that's a case -- when I talk to friends of mine in Japan, they're like -- there is quite a lack of awareness of Tesla. So that's a case where we definitely need to increase awareness in countries and regions where there is, yeah, not that much awareness.
Martin Viecha: Thank you. Let's go to analyst questions. The first question comes from Pierre Ferragu from New Street Research. Pierre, go ahead, please. Feel free to unmute. Pierre, can you hear us?
Pierre Ferragu: Okay. Wow. It's really tough to find the unmute button on Team's guide. I'm sorry for being late. So, yes, my question would on the cost reduction, you've talked about it already a lot. And if I look at it, over the last like, five, six quarters, on average, the COGS per car has been coming down, like, more than 2% sequentially, on average. So that means you are, like, on a trajectory of COGS per car going down 10% a year. So that's probably, like, unheard of in the auto industry. I don't think any car manufacturer ever achieved that. But that's very mundane, and it's a good performance, but it's a very normal performance in a lot of other manufacturing industry, like microelectronics or consumer electronics. And so I'd love to hear your thoughts about whether you consider yourself closer to the latter to, like, a microeconomics business where you have this ability to actually always improve costs. You have more control on how things are pulled together into your cars, and you see yourself sustainably taking costs down with that kind of pace or do you think your ability to take down cost is actually going to become more like in line with the rest in the industry over time?
Vaibhav Taneja: Yeah. I think I covered this in a pretty lengthy detail, even in my opening remarks and in a previous question. But to just further clarify, we are constantly looking for what we can do to reduce cost. Like I said, it's a game of pennies. We've talked about it before as well. And the team is constantly going and checking, where can we reduce the cost further. And do I believe that we will have the same pace which you've seen over the past few years? Probably not, because remember, we were coming out with a period wherein commodity prices were rising, so then we did see benefits coming from that. So those are more or less taken care of. But there is more which we're still chasing. And I would say a big kudos goes to the team out here at Tesla, both the engineering team as well as the supply chain team, because every time we give them a challenge, they go gangbusters to try and figure out whatever they can to take out further cost. But yes, I would -- like I said, I would want to caution that do not project the previous cost reduction at the same pace completely in the future, because with our current platform, we are getting to a place wherein there are limitations.
Karn Budhiraj: Yeah. The increased scale also sort of helps us there. As we introduce new products, we have the opportunity to go renegotiate existing suppliers for better pricing. We're looking at every penny, like Vaibhav and Elon mentioned. Just to give you an example, our inbound logistics cost has come down by 22% year-over-year. And this is because of optimization on using returnable packaging as opposed to cardboard, which is even better for the environment, optimizing trucking routes, negotiating better pricing with shipping companies, with trucking companies, going with full truckloads and just doing that, sort of. The bigger we become, the more we put thought into these things and the more efficient we become as a result of it. So those work streams are going to continue.
Unidentified Company Representative: And we are also getting into the tiers of supply chain to see if there are opportunities, getting into the tier 2, tier 3, tier 4 levels, and then negotiate those pricing as well to get more efficiency out of the system.
Karn Budhiraj: And then on the design side, we're not static, right, like, especially in areas where the technology is still improving rapidly. Power electronics is a great example. We continue to bring improvements there that are like fundamentals, sort of driven from the device up, that result in cost reductions, generation over generation. And they don't only go into the new vehicles, they come to the old vehicles as well. So that's closer to what you were talking about with the microelectronic space. Some of that exists in the vehicle.
Lars Moravy: Yeah. Certainly our car is more computer than car in many ways and has a lot of new tech over the last 100 years of automotive production that everyone's trying to scrape pennies from.
Elon Musk: We have a crazy amount of compute in our cars compared to anyone else. It's like orders of magnitude.
Karn Budhiraj: And we get to ride that down, right?
Elon Musk: 1,000 times more. Some nutty number.
Karn Budhiraj: I mean, if I just look at the main microcontroller that makes the motor truck go, for example, when I think about what it costs when we stuck it in a roadster in 2006, it costs now. There's no comparison. So we've definitely been riding that electronics cost wave.
Elon Musk: Yeah.
Lars Moravy: And then even on the like non -- what you call traditional vehicle side, we do things that no other automakers do to bring cost down through breaking down the way structures are built and the way we put our cars together. And I think that mindset that we have is very much closer to the microprocessor or power electronics industry than the automotive industry.
Martin Viecha: Thank you. Pierre, do you have a follow-up?
Pierre Ferragu: Great. Yes, a quick one. You mentioned this phase in which you are between two big growth periods. I'd love to hear you about what you consider the size of your addressable market. With the portfolio you have today, like the three, the Y, the X, and the S, what's your estimate of your addressable market? You're shipping like, probably about like a 2 million unit run rate today and given the price points of these cars, what kind of market share of what you address with these cars do you think you've already achieved today?
Elon Musk: I don't know, if anybody -- I actually don't think we have a firm idea of this. That's hard to say exactly.
Vaibhav Taneja: Yeah. This -- I won't say there's -- I mean, one way to think about it is look at the automotive industry as well. EVs still contribute a very small market share. So, yes, our goal is to try and take as much market share out of that pie. But do I have a specific number to give you? I don't think we can say that with certainty.
Andrew Baglino: And it's a growing pie as well.
Vaibhav Taneja: Exactly
Andrew Baglino: It's like its 9% today, but it could be 20% in a couple of years or in the future.
Elon Musk: Yeah.
Andrew Baglino: Certainly, like the way we've looked at it, and we've always said this, it's not about how many EVs we sell. It's how many great cars you can sell, how many vehicles you can sell. And that market is 100 million a year, and we're barely 2% of that. I still think there's 98% more to get.
Elon Musk: I mean, it's worth noting that if you look at, say, the average selling price of the other top-selling vehicles in the world, they are much lower priced than a Model Y.
Andrew Baglino: Yeah.
Elon Musk: So like Toyota RAV4.
Andrew Baglino: Corolla.
Elon Musk: Corolla, Honda Civic, that kind of thing. They're much lower priced than ours. So people are really stretching their wallets to be able to afford a Tesla. It's quite a difficult thing for them to do, and remarkable that it's the best-selling car in unit volume, despite being much more expensive than other high-volume cars.
Martin Viecha: Thank you. Let's go to the next analyst. The next question comes from Adam Jonas from Morgan Stanley.
Adam Jonas: Hey, everybody. So I can't wait to see the Optimus lab. I'm sure everybody on this call feels the same way. Your last AI Day, Elon, was September 2022. Can we expect a Tesla AI Day this year? It seems like a lot has changed in that realm. And is this year the time?
Elon Musk: Yeah, it's a good question. We have found that when we do these AI Days, some of our competitors literally look at what we do on a frame-by-frame basis.
Adam Jonas: They do.
Elon Musk: And then we find these things being copied.
Karn Budhiraj: Same thing with Battery Day.
Elon Musk: Same thing with Battery Day. So we have to be a little cautious about revealing the exact recipe of the secret sauce. But I think some kind of update would be good to do. I'll talk it over with the team, and yeah, I think we might do something later this year. Our main goal with these AI Day things is recruiting and to sort of change the perception of Tesla as people thinking of Tesla as a car company when they should be thinking of Tesla as an AI robotics company.
Adam Jonas: Maybe as a follow-up. Elon, I'd love your thoughts on the topic of China-based OEMs expanding into Western markets. As the China market kind of gets saturated and there's a tremendous growth in the supply, how much success should Tesla investors allow for this competition to achieve in Western markets? And can you envision a scenario where Tesla could partner with a Chinese OEM to help accelerate sustainable transport in markets like Europe and the United States? Thanks.
Elon Musk: Well, our observation is generally that the Chinese car companies are the most competitive car companies in the world. So I think they will have significant success outside of China depending on what kind of tariffs or trade barriers are established. Frankly, I think if there are not trade barriers established, they will pretty much demolish most other car companies in the world. So they're extremely good. We don't see an obvious opportunity to partner. Certainly, we're happy to, except on the supercharger front. We're obviously happy to give any electric car company access to our supercharger network. We're also happy to license full self-driving, perhaps license other technologies, and anything that could be helpful in advancing the sustainable energy revolution.
Martin Viecha: Thank you. And the next question comes from Dan Levy from Barclays.
Dan Levy: Hi. Good evening. Thank you for taking the questions. First, I'm wondering if you can just walk through some of the gating factors required to unlock your next-gen platform. You talked about a number of cost initiatives back at the Investor Day a year ago, things in manufacturing and powertrain. Maybe you can just give us a sense of where these initiatives stand. And do you believe -- we know that there's a number of new features and technologies in Cybertruck, things like 48 volts architecture, really employing your 4680 batteries. To what extent do you think Cybertruck is really a proving ground for the next-gen platform and is really going to be a gating factor to unlocking the cost reductions needed for the next-gen platform?
Lars Moravy: Yeah, I don't think that anything on Cybertruck should be considered gating for the next-gen platform. We're obviously doing a lot of manufacturing innovation, as Elon said, for a next-generation vehicle. When you do something at that scale, you have to prove it out. You don't just throw it on the line and just build it. So we're going through those validation phases for all those new manufacturing technologies now. Sure, 48 volts was definitely something we wanted to carry forward, and it's something we hope the industry adopts as well. We're also open to partnering.
Elon Musk: Yeah. 48 volts.
Lars Moravy: On that if everyone wants to do that.
Elon Musk: Certainly. Man, the people that really know that this is like the inside baseball thing. But man, 48, it's so high time that the water industry moved from the 12 -- the random number of 12 volts to 48 volts.
Lars Moravy: Random number of 48 volts.
Elon Musk: Yeah. Well, it's much less random.
Lars Moravy: Slightly less random based on human injury, but...
Elon Musk: I mean dramatically reduces the amount of copper you need in the vehicle and also moving to sort of higher bandwidth communications, sort of ethernet level communications versus CAN Bus, which is pretty...
Lars Moravy: Pretty slow.
Elon Musk: Pretty slow. So it's really just bringing cars to...
Lars Moravy: The 21st century.
Elon Musk: Yeah, pretty much.
Lars Moravy: So, certainly like...
Elon Musk: It's not exact -- it's like normal for a laptop. Yeah.
Lars Moravy: Certainly bringing that like is an evolution in our architectures of vehicles, but it's not gating by any means. The gating work is just to finish the design and manufacturing of the car, test them out and get them going.
Karn Budhiraj: Yeah, programs and execution mode, right?
Lars Moravy: Yeah.
Karn Budhiraj: So it's talking about like, tooling lead time, manufacturing equipment lead time, factory lead time, and executing those programs.
Elon Musk: There's a lot of specialized machines that make the machine for a next-gen vehicle. So these are not machines you can just order from anyone. You have to design a machine that has never existed to build a car in a way that has never existed.
Karn Budhiraj: Yeah. So you don't just have like a design validation phase, but you have an equipment design validation phase as well.
Elon Musk: It does make it very hard to copy us because you have to copy the machine that makes the machine that makes the machine.
Lars Moravy: Talk about tiers.
Elon Musk: Yeah, exactly. Manufacturing exception. So I do think it's quite a powerful sustainable advantage because there just is no place to go to order the machines that make our next-gen car that don't exist.
Dan Levy: Great. Thank you. As a follow-up, your release does not mention Dojo. So if you could just provide us an update on where Dojo stands and at what point you expect Dojo to be a resource in improving FSD or do you think that you now have sufficient supply of Nvidia GPUs needed for the training of the system?
Elon Musk: I mean, the AI hardware question is, that is a deep one. So we're obviously hedging our bets here with significant orders of Nvidia GPUs. Or GPU is the wrong word. There really needs to be -- there's no -- it doesn't -- you can't produce graphics, so that's what. It's not a graphics processing unit. Neural net processing unit or something like that. Yeah. GPU is a funny word, like Vestigial. A lot of our progress in self-driving is training limited, something that's important with training, it's much like a human. The more effort you put into training, the less effort you need in inference. So just like a person, if you train in a subject, sort of classic 10,000 hours, the less mental effort it takes to do something. If you remember when you first started to drive, how much of your mental capacity it took to drive. It was -- you had to be focused completely on driving. Then after you've been driving for many years, it only takes a little bit of your mind to drive and you can think about other things and still drive safely. So the more training you do, the more efficient it is at the inference level. So we do need a lot of training. And we're pursuing the dual path of Nvidia and Dojo. But I would think of Dojo as a long shot. It's a long shot worth taking because the payoff is potentially very high. But it's not something that is a high probability. It's not like a sure thing at all. It's a high-risk, high-payoff program. Dojo is working, and it is doing training jobs, and we are scaling it up, and we have plans for Dojo 1.5, Dojo 2, Dojo 3, and whatnot. So I think it's got potential, but I can't emphasize enough. High risk, high payoff. So I think it still makes sense given the -- even if it's a low probability of success -- I'm laboring the subject. It's a very interesting program. It has the potential for something special. There's also our inference hardware in the car. So we're now on what's called Hardware 4, but it's actually Version 2 of the Tesla-designed AI inference chip. And we're about to complete design of -- the terminology is a bit confusing. We're about to complete design of Hardware 5, which is actually Version 3 of the Tesla-designed chip. Because the Version 1 was Mobileye, Version 2 was Nvidia, and then Version 3 was Tesla. And we're making gigantic improvements from Hardware 3 to Hardware 4 to Hardware 5. I mean, there's a potentially interesting play where when cars are not in use in the future that the in-car computer can do generalized AI tasks, can run a sort of GPT-4 or GPT-3 or something like that. If you've got tens of millions of vehicles out there, even in a robotaxi scenario where they're in heavy use, maybe they're used 50 out of 168 hours, that still leaves well over 100 hours of time available -- of compute hours. It's possible with the right architectural decisions that Tesla may in the future have more compute than everyone else combined.
Martin Viecha: Thank you. The next question comes from Colin Langan from Wells Fargo.
Colin Langan: Great. Thanks for taking my questions. As we're thinking about going into 2024, the press release talks about hitting 36,000 or slightly above in Q4. And the comments in the release talk about approaching the natural limits. And it sounds like you're continuing to try to whittle that away, but that sort of implies there's not much left. In addition, you have the hourly wage increase. I guess we'll add to that into next year. And I thought you said raw material costs are kind or -- that benefit is sort of almost played out. So is there an opportunity to continue to go below the 36,000, or should we kind of be modeling that it kind of stays at this level into '24?
Vaibhav Taneja: We are definitely aware of the cost increases which are coming through because of the wage increases. But like I said, we keep looking at other cost opportunities and try and figure out where else can we cut down. So there is definitely more opportunity to bring down costs further. I won't specifically guide to a number which we will try and get to, but there's definitely more opportunity there.
Andrew Baglino: Yeah. We're chasing lots of cost opportunities on the design side still for 2024, north of eight figures is what we're just in my organization, and Lars has got a bunch. And then from a commodities perspective, it's such a long cycle time through the whole material supply chain that even with what we've already seen to this point...
Vaibhav Taneja: There's more to come.
Andrew Baglino: There's more to come on commodities reductions.
Lars Moravy: And there's still some tailwind left on the commodities.
Andrew Baglino: That's what I mean.
Lars Moravy: Aluminum and steel.
Andrew Baglino: Yeah and battery material.
Elon Musk: It boggles my mind to think that if we make a 1% improvement in costs, that's $1 billion. So it's like, on average, if we reduce the cost by one penny, $1 billion.
Andrew Baglino: What?
Elon Musk: And we started off that long ago that we were only making like 10 cars a week. And yeah, so where does it lead ultimately? With good execution, like I said, it's not a slam dunk, but if we execute very well, I think Tesla could be the most valuable company in the world.
Martin Viecha: Thank you, Colin. Do you have a follow-up question?
Colin Langan: Yeah. Just a quick follow-up. In the commentary, you mentioned the taxes would go to the S&P 500 level. I think you've been trending slightly below 10%. S&P, I think, is typically 25%-ish. Is that going to -- should we expect that to jump right up next year when we're modeling next year or would it be like a gradual change over the next few years and any cash impact from that tax change as well that we should be considering?
Vaibhav Taneja: Yeah. So there's no impact on cash taxes from the release of the valuation amounts, which I spoke about. What it does is, it's how you account for taxes on your books? So it's basically an accounting change wherein there are certain jurisdictions because we had enough NOLs, etc., wherein we didn't have to accrue book taxes. Now that the valuation allowance has been released and we have recognized deferred tax assets on the books, that means your tax rate immediately goes up.
Martin Viecha: Okay. I think that's all the time we have for today. Thank you so much for all of your questions, and we'll speak to you again in three months. Thank you. Bye-bye.
Elon Musk: Thank you. |
NFLX | 4 | 2,023 | 2024-01-23 19:26:03 | Spencer Wang: Hello, and welcome to the Netflix Q4 2023 Earnings Interview. I'm Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Co-CEOs, Ted Sarandos and Greg Peters; and CFO, Spence Neumann. We do have a few changes to our interview format this quarter. First, we are live streaming this over YouTube. So hopefully it's working. I guess we'll find out shortly enough. Second, we've collected questions from the analyst community, and I'll be reading those questions and moderating the interview. As a reminder, we'll be making forward-looking statements, and actual results may vary.
A - Spencer Wang: With that, let's dive first into the first set of questions, which is about our new partnership with WWE that we announced this morning. For Ted, the first question comes from Dan Salmon. Can you please expand on the decision to acquire WWE Raw rights? Is the WWE audience, one that is underpenetrated for Netflix today? And can you expand on the economics or the cost of the deal, please?
Ted Sarandos: Thanks, Dan. If I could raise a single eyebrow one at a time, I would lean into the camera with the single eyebrow and do my best wink. But I'm going to say instead that we are thrilled to bring this WWE Live programming to our members around the world. WWE Raw is sports entertainment, which is right in the sweet spot of our sports business, which is the drama of sport. Think of this as 52 weeks of live programming every week, every year. It feeds our desire to expand our live event programming. But most importantly, fans love it. For decades, the WWE has grown this multigenerational fan base that we believe we could serve and we can grow. We believe that WWE has been historically under distributed outside of North America. And this is a global deal. So we can help them and they can help us build that fandom around the world. And not to - I should add that this should also add some fuel to our new and growing ad business. We're very excited about this deal.
Spencer Wang: And Ted, did you want to comment on the economics or the cost of the deal?
Ted Sarandos: No, we don't comment on the economics of any of our deals. I would just say this is a long-term deal that we're really happy to be in with the WWE.
Spencer Wang: Right. Our next question comes from Rich Greenfield of LightShed. Rich, first wants me to say great quarter to you all and his question is, should we think about the WWE deal as fitting into your existing plans to spend roughly $17 billion a year in programming? Or is this expansion into live going to drive overall spending higher? And lastly, could you talk about the opportunities to create shoulder programming around WWE similar to Drive to Survive?
Ted Sarandos: Well, expanding into live event programming is something we've talked about for quite a while, and this has been in the works, so we used to look at this as fits inside of our $17 billion programming spend now. So - and in terms of building on it, you should think about Formula One as - like this is almost the inverse of Formula One, which is a very big and passionate U.S. fan base and a lot of room to grow outside of the U.S. And we could build that as we have with Formula One, and other sports like through our shoulder programming, like Drive to Survive, like Full Swing, like Breakpoint, like Quarterbacks, like Tour de France. And now with this great storytelling the events itself are the storytelling of the WWE. So this is a proven formula for us that we're excited to jump into. This is sports entertainment, very close to our core. The deal is long term. We're super excited about it.
Spencer Wang: Great. And the WWE partnership has spurred a lot of questions around our broader approach to sports, including a question from Ben Swinburne, but I'll read Michael Nathanson's question since he got it in first. So Ted, given the news today, is it safe to presume that you will now be interested in similar types of global sports rights like the NBA or UFC, why is the WWE more attractive than those rights?
Ted Sarandos: So unique to those other opportunities, WWE is sports entertainment. So it's really as close to our core as you can get of that sports storytelling. So - and in terms of the deal itself, it has options and the protections that we seek in our general licensing deals and with economics that we're super happy with globally. So I would not look at this as a signal of any other change or any change to our sports strategy.
Spencer Wang: Great. Thank you, Ted. I'll move this along now to a series of questions regarding our results and the forecast. First, coming from Mark Mahaney of Evercore and this is for Spence. How should we think about ARM growth going forward? Is mid-single-digit percentage increase a reasonable benchmark? And what are the factors that could create either upside or downside to that growth outlook?
Spencer Neumann: Sure, sure. Thanks, Mark. So well, first, stepping back, 2023, as a reminder, was a pretty unusual year for us. It was essentially all member-driven growth because our pricing and plans focus in '23 was on rolling out paid sharing. We had almost no price increases until late in the year in '23. And even then, it was just a partial quarter impact. As we look to '24, as we noted in the letter for 2024, we expect healthy double-digit FX-neutral revenue growth, including growth in FX-neutral ARM. So we expect continued member growth powered by a grade slate, including the full year impact of our 2023 net adds carrying into 24 and no change to our pricing philosophy. You saw some of that pricing action already in the past quarter. And we should get some help from extra members and starting to scale our ads business. But as we said, ads won't be a primary driver in '24. So when you look beyond in general, over kind of multiple years, '24 and beyond, we're focused on continually improving our service. If we do that well, we'll have more members or more value that we can occasionally price into and lots of engagement to build a big and profitable ads business. So healthy revenue growth with a mixture of volume and ARM, that's really the output. And I'll probably disappoint because I'm not going to provide a specific guide on ARM because we managed overall revenue growth, but we want ARM to be a component of that growth. Just that it could move up or down based on things in any given year like FX, like the place at which we're scaling our ads reach and some lag that could happen in terms of monetizing that reach and just generally, our pricing and planned strategy more broadly in a given year.
Spencer Wang: Thanks, Spence. Our next question is from Steve Cahall from Wells Fargo for Greg. The question is once a subscriber and ARM benefits from paid sharing begin to diminish in 2024 what do you think are the biggest incremental opportunities to continue to drive subscriber and revenue growth, what types of additional content or additional member benefits provide the best ROI to help sustain healthy revenue growth?
Greg Peters: Well, we're excited to be at the point where we've operationalized that paid sharing product work. So it's integrated in everything we do. And we're iterating and improving on it just like we would any other significant part of our product experience. So we think of this essentially as having built a more effective engine for translating the entertainment value that we're creating for our members into revenue. But I think it's critical to understand that, that engine works on top of, and we see it working on top of, very healthy organic growth. You can see it in things like better than forecasted churn, we see better-than-expected impact from the recent price changes we did. And that's the model, essentially, right? If we continue to improve our core offering, that means more diversity and more quality from our members' perspective in our films and series, now adding the live events programming to add even more value, continue to grow games and the entertainment value that we're delivering through those, then our paid sharing work and our ads work creates a more effective engine to translate all that value into revenue growth. And will support increased conversion of our addressable market in many years to come.
Spencer Wang: Thanks, Greg. The next question is from Doug Anmuth from JPMorgan. And I'll direct this one to Spence. The $13 million plus pay net adds in Q4 was strong overall and across all regions, but EMEA seemed to drive particular upside. Is there anything specific to point out there, perhaps the ad tier or specific content or localized pricing perhaps?
Spencer Neumann: Yes, thanks. Well, actually, EMEA is sort of a perfect example of a little bit of what Greg was just talking about. So first, it starts with great slate performance, a great content performance. We had a really strong slate across EMEA from The Crown finale in the U.K., to - in France, we had Blood Coast and Lupin and Class Act. We had Berlin, Elite and Nowhere in Spain and Poland, 1670 and much more, frankly. So it starts with that strong slate. And then by channel, Greg's last answer that kind of better value translation engine, if you will, which drives even more growth through our paid sharing solutions and our monetization engine. So that helped as well. So it really all came together in EMEA this past quarter. And I'll say, very importantly, it's not just net ads. It's again, our primary focus is on revenue growth. We had very strong revenue growth as a result of that in EMEA this past quarter. 13% FX neutral growth in Q4.
Spencer Wang: Thanks, Spence. Doug also has a follow-up question around paid sharing, which I will direct to Greg. How far along are you in terms of the paid sharing benefits? Do you still believe paid sharing will add subscribers for several more quarters? And is there any way to quantify what percentage of the 100 million borrower household population have either become extra members or full paying subscribers?
Greg Peters: Yes. As I mentioned, we've gotten to the point where paid sharing, the paid sharing product experience is just something we do at this point. But also, I think it's important to say that like many other things that we do, we also see a real opportunity to continue to materially improve that value translation engine. So we definitely delivered interventions to new cohorts in the last quarter. We're going to continue to deliver to new cohorts in 2024. But increasingly, I sort of don't think about it as like going after these certain pools, but more about just finding the most effective way to convert folks who are using the service, the right call to action, the right nudge at the right time. And those might have been historical borrowers or folks that are new to the service as well. And we're going to continue to improve that engine. That will continue to improve our growth for years ahead, not just 2024.
Spencer Wang: Great. I'll now transition us to a series of questions around advertising. For Greg, Dan Salmon from New Street Research. His question is, what are some of your most important milestones for the advertising business in 2024? Do you have a target level of MAUs or ad member households, what sorts of improvements to ad tech or measurement are you seeking and perhaps any new country launches for your ads plan?
Greg Peters: Yes. Our top ads priority, you've heard us say before, I think you'll hear us say it again, is scale. We saw a 70% quarter-on-quarter growth last quarter. That's after 70% quarter-over-quarter for the quarter before and then 100% the quarter before that. So that's a good trajectory to be on. We're now at 23 million MAUs, and we see that continuing to grow in the quarters ahead. As to your point about what's the target, every market is different. There's not a magic MAU number, but I think it's fair to say that we've still got plenty of room to grow in all the markets that we operate in. And we're focused on the additional work that we can do in that space. That means making the ads plan more attractive. We've added streams, higher resolution, downloads. It means engaging partner channels. You see us do more of that. Shifting our plans and pricing structure in other places where we think it's appropriate. So all that works ahead of us. We know we can do tremendous amounts in that space, and we're going to go do it over the next quarters. Second priority, you mentioned this, which is really growing the technical advertising features and growing our go-to-market capabilities. And these are features like targeting, improved ad relevance. That's good for members. It's good for brands. We've got tons to do on improved measurement. We want to launch more ads products. We've got binge ad sponsorships now. And we have to build increasingly the capability to be better partners with advertisers and serve their needs. So this is better sales teams, ad operations and just more capability to meet brands where they need us and how they need us. So we're focused on the long-term revenue potential here. We're very optimistic about it. It's a huge opportunity, $180 billion of ad spend ex-China and Russia, $25 billion alone on Connected TV. We know ad dollars follow engagement. We've got the most engaged audience. So we believe we're well positioned to capture some of that ad spend that shifts from linear to streaming.
Spencer Wang: Great. And Greg, any thoughts to Dan's question around launching an ads plan in other countries in addition to the 12 countries we're in today?
Greg Peters: Thanks for reminding me on that one. I would say we got a ton of work ahead of us on just getting to the level of maturity and impact to the business from the countries that we're operating in today. I would say, never say never on expanding beyond that, but it's worth noting that the countries that we are currently operating in represent about 80% of global ad spend. So we're already working in the spaces where there's the majority of opportunity. We'll see in the fullness of time, but I'd say we've got years of work ahead of us to take the ads business to the point where it's a material impact to our general business.
Spencer Wang: Thank you, Greg. From Steve Cahall from Wells Fargo. How do you think about the efficacy of continuing to use a third-party relationship for ad sales versus the opportunity to invest in your own ad tech and ad sales infrastructure? Do you have a sense of what kind of investment would be required to transact more directly with advertisers?
Greg Peters: Yes. And just to clarify, we are already in partnership with Microsoft developing part of the technology that supports our ads experience. So they've got a large team working on some of those features that I just mentioned, but we've got a smaller, but growing team, working on the areas where we can differentially contribute to. And then similarly on the ad sales and the go-to-market side of things, we're building out our own teams that cover a portion of the sales and operations activities. So I think you asked in terms of what's the size of investment, we have plans to continue to grow those teams. So those are both growing at a pretty strong clip and growing that investment. But we've modeled out where what we think we need. And even with those investment levels and the growth that we expect that we see, we expect the margins on the ad business to remain very high.
Spencer Wang: Great. Thanks Greg. A question from Rich Greenfield on advertising. Later this week, T-Mobile's subscriber benefit called Netflix on Us, will convert to Netflix's ad tier unless subscribers upgrade to an ad-free tier? Is it reasonable to assume that your U.S. ad-supported subscriber base will roughly double as a result of this change? And assuming it is, how quickly will you be able to fill that inventory?
Greg Peters: Yes. I won't get into the specifics of a particular deal or provide a forecast for a particular deal, but I'll just say that just as we've done for many, many years, leveraging partner channels is an important part of our subscriber growth strategy. We're applying the same techniques and approaches to scaling our ads membership. And we love having this additional tool. It's very effective, very useful for us because that lower consumer-facing price means that we got room now to bundle the ads plan into a set of lower-priced partner offerings where it was hard to make the economics work for everyone previously. So it opens up a whole new range of opportunities. It's great for new members as well who are leveraging those bundles. They get a better plan than basic, more streams, higher resolution with downloads. And of course, the real benefit is they get access to all these amazing stories at a lower effective price through the bundle. So we really think of this as a win-win-win and we're going to continue to leverage these bundles going forward. And I think Rich asked how we think about - how could we fill the supply. I mean when you're building - growing as fast as we're growing right now, it creates a lot of challenges you might expect to then fill behind that. But I'd much rather be in that position where we're growing that inventory and then racing behind to fill it and improve our monetization than the reverse. So I'm happy to have that challenge.
Spencer Wang: Super. I'll now move us along to a series of questions related to content. So Ted, from Jason Helfstein of Oppenheimer. Are you shifting the mix of your content spend to more licensed second-run content? And if so, how should we think about this mix impacting Netflix's operating margins?
Ted Sarandos: So we've always had a healthy appetite for licensing content from others for our members. I don't see any meaningful change in that mix. And the current margin outlook contemplates a healthy mix between originals and licensed titles. It might be that we can deliver more on our programming spend with some licensed titles, but we also believe that we deliver an incredible amount of value, excitement and differentiation with our original series. Remember, our original series made up the number - we're the number 1 most watched original 48 of 52 weeks last year. So we really don't have any plans to move away from those investments.
Spencer Wang: Great. And another question for you, Ted, from Rich on content. While Netflix data clearly shows that new original movies outperformed licensed titles in terms of viewers and viewed hours, it doesn't appear that new movie - those new movies are having the same cultural impact the TV series have. Do the recent management departures or the willingness of Hollywood Studios to license post theatrical movies on Netflix, signaling sort of meaningful shift in our film strategy towards licensing away from original production?
Ted Sarandos: Yes. No, look, our original movies are attracting some of the biggest audiences in the world. Look at Leave the World Behind in Q4. Look at all those crazy names about the creepy deers they were all over the place when the movie came out or look at Society of the Snow from Spain right now this morning was nominated for two Oscars or even look back last year, Jennifer Lopez's great movie, The Mother. By some accounts, it was the most watched movie in the world last year. So I think about it that fans really don't care much about budgets and windows. They just want a movie that they love. They want a movie to make a cry or make them laugh or giving something great to talk about over dinner. As you point out, our original films do outperform those license films, and they do uniquely distinguish us from the competition. Just this morning, our original films got 18 Oscar nominations across 10 different films. So we do not plan to change our strategy or the mix. It's always going to be that kind of blend of first window, second window and deep catalog. We think that formula works best to entertain the world.
Spencer Wang: Great. And as a follow-up to that question around licensing, Ted, your competitors have largely abandoned their opposition to licensing catalog content in Netflix. We've seen, for example, NBC Suits, HBOs, Six Feet Under and more recently, a series of Disney TV titles on Netflix. Do you think your competitors should begin licensing you their new original series as well versus keeping them exclusively to their own streaming services?
Ted Sarandos: Yes. I mean I guess I'd call you back to that history again and just say we've got a rich history of helping break some of the TV's biggest hits like Breaking Bad and Walking Dead or even more recently with Schitt's Creek. Because of our recommendation and our reach, we can resurrect a show like Suits and turn it into a big pop culture moment but also generate billions of hours of joy for our members. So I think you got to remember the studios have always been in the business of selling their content to others, including direct competitors for years. I believe because, again, of our distribution heft and our recommendation system that sometimes we can uniquely add more value to Studios' IP than they can. Not all the time, but sometimes it does, and we're the best buyer for it. So I am thrilled that the studios are more open to licensing again, and I'm thrilled to tell them that we are open for business.
Spencer Wang: Great. And a question on animation and animated features from Rich Greenfield as well for Ted is, Leo, Netflix's most successful animated film to date. It's been heavily watched based on our top 10 data. Is there any color you can provide on repeat viewing the film? And why has this animated feature film resonated versus other Netflix animated feature films?
Ted Sarandos: I think Leo has resonated for the same reason that CB's did last year. It's great. People really love it. It brings a lot of joy to families. And yes, they do watch them over and over again, which drives a lot of engagement, but also drives a lot of attachment. I think that Leo and CB's are proof points that we have the flywheel to create original IP in that animated space, and there is so much appetite for animated feature. Seven of the top 10 most watched movies since Nielsen has been tracking streaming are animated features. So I'm super thrilled with Leo. We're kicking around the Leo 2 right now and a film that works on so many levels. The animation - the art of the animation is beautiful. The comedy is funny and families just really love it. So we look forward to a lot more. We have Spellbound coming up next year. We're just really thrilled with our - that the animation team is now firing on all cylinders.
Spencer Wang: Moving along to engagement. This question is from Bryan Kraft of Deutsche Bank, and I'll direct this one to Ted. What have the engagement trends been like globally and domestically? Has it been steady, increasing or decreasing? And how has paid sharing impacted engagement per member?
Ted Sarandos: Yes. So we're really thrilled with our engagement trends domestically and globally. This is really a story about viewing moving from linear television to streaming. The story has been constant and it continues. It's also a story about Netflix kind of leading the way with professional film and television and now games. Our engagement is a bit impacted by our paid sharing. Think about it like fewer households using the same account. So as those folks spin off and get their own accounts and we win them over with our programming, that will normalize and continue to grow. We're really pleased with our engagement. We have shown you in graphic detail what that engagement looks like on a title-by-title basis in this engagement report we just released. And I think you see in that report about two hours of daily engagement with our members, which is great. And you've seen that some of our hits and even our near hits are attracting enormous audiences. So we have to keep pleasing them, and we have to do that in multiple languages in multiple countries and all over the world. And that's we're excited about, and it's showing up in that engagement.
Spencer Wang: Great. Let's move on to gaming. A couple of questions on gaming. First from Justin Patterson at KeyBanc for Greg. The gaming portfolio expanded significantly last year and even added more mainstream titles like Grand Theft Auto Trilogy. How are you thinking about sizing the investment in this area how has engagement changed over the past year? And what are the signals you're evaluating to gauge when it's time to monetize?
Greg Peters: Yes. Well, we're stoked by the performance of GTA. We had high hopes, but it exceeded even those high hopes. So that's a - it's a great place to be. So the biggest download and engagement numbers that we've seen so far. We were in the top mobile game downloads for several weeks, which shows it was not only big for us, but big numbers for mobile gaming in general. And beyond any specific title, we've tripled game engagement over the last year. So that's a solid growth trajectory for us. Games, it's a huge opportunity, $140 billion in consumer spend, ex-China and Russia. And we believe we can build games as strong components, and other content category to deliver entertainment value to our subscribers. But to your question on size of investment, we thought about this as we've got to allocate enough to the initiative to ensure that we're playing to win, that we have enough activity in the space that we're learning and growing, but also recognizing that we had a tremendous amount to learn and a tremendous set of institutional capabilities to develop. And we wanted to make sure that we weren't growing that investment significantly before proving to ourselves that we can actually effectively translate that investment into member value. So things are going well. We continue to see this level of engagement growth and we continue to see what we've been seeing so far, which is evidence, as we would expect, that, that engagement leads to business benefits like increased retention, then we'll be able to scale that investment appropriately. Having said all of that, it's still, I'll use the early days, words that we love to use. And it's worth noting that our games investment is a very small fraction of our overall content budget right now.
Spencer Wang: Great. Greg, a second question on gaming from Michael Packer of Wedbush. He asked, given the outperformance of Grand Theft Auto Trilogy on the Netflix service, will you reconsider your focus on games available exclusively on the service? Asking you will seek to emulate the success of Grand Theft Auto by offering games like Candy Crush or Fortnite on Netflix as well?
Greg Peters: Yes. Licensing games, existing games with often with some form of exclusivity, that's been a key part of our strategy, and it's going to continue to be so. We've clearly seen, one of the things that we've learned is that recognizable games, that's either existing popular game titles or game franchises or games that are based on well-known IP, and in many cases, that's IP from our own films and series, those are the ones that are working the best for us right now. So we're going to continue to find the right opportunities to bring those kind of titles to our members. We're going to look for more great licensing and some exclusive licensing, so we can do things more like what you've seen us do last quarter with GTA, but also other titles like Football Manager 2024, which performed very well for us. Money Heist or La Casa de Papel, which was great. You'll see it this quarter with titles like Virgin River, so that's definitely the strategy that we're on, and you'll see us do more of that work.
Spencer Wang: Great. We have a question also from John Hunlock of UBS. This one, I'll point to Greg, but Spence, you can feel free to join in as well. The question is, how should we think about pricing changes in the rest of the world now that you are through the majority of the password sharing implementation and in light of the recent price adjustments in the U.S., U.K. and France?
Greg Peters: Yes. As we had talked about previously, we largely put price increases on hold while we were rolling out the paid sharing work because we saw that as a form of substitute price increase. Now that we're through that, we're able to resume our sort of standard approach towards price increases. You've seen us do that in the U.S., U.K. and France. Those changes went well, better than we forecasted. And we'll continue to then monitor other countries and try and assess when we've delivered enough additional entertainment value, we look at engagement retention acquisition as a signal is there. so that we can go back to members and ask them to pay a bit more to keep that positive flywheel going. And we can invest in more great film series and games for those members. So the summary statement might be back to business as usual. And Spence, I don't know if you wanted to add anything there?
Spencer Neumann: I think you nailed it, you're on a roll. So it's good.
Spencer Wang: Great. I'll move us along now to a couple of questions on competition and the competitive landscape. The first question comes from Maria Ripps of Canaccord Genuity. With ads coming to Prime Video at the end of this month, and given Amazon is making it the default option for its prime members, could you talk about how you are positioning Netflix relative to the competition when you're speaking with advertisers? Could you also comment on if Netflix considered making the ad tier the default option similar to Amazon? And what were some of the puts and takes about that decision? So I'll turn that one over to you, Greg.
Greg Peters: Yes. We did consider making it the default option. But given our long history of not having ads, we thought it was better for our members rather than force them into a change and give them ads. But better to attract them to the ads plan for the ones that wanted it based on the benefits, more streams, higher resolution downloads and of course, the lower price to be able to access all these incredible stories. So I mentioned the growth numbers we were seeing previously and the rate of growth we are on. So I think that approach is generally working well for our members, and we haven't seen any big backlash as a result, which is positive as well. And then in terms of competitive positioning, probably the most important thing to start with is the market's big, right? We talked about over $25 billion in CTV ad spend alone. So there's room for multiple players, clearly. And when we think about how we compete for some of that ad spend, I really think we need to play to our strengths. We've got an incredibly engaged audience, the most engaged audience who are watching the most culture-defining films, series and live events. That is an important place for brands to be, and it's something that differentiates us from our competitors. So that's the space that we're going to play in.
Spencer Wang: Super. Another question on competition. This one probably best for Ted and Spence to take. It comes from Eric Sheridan from Goldman Sachs. How does the current competitive landscape or content impact the trajectory of Netflix's own content spending in 2024 and beyond? Is it possible that the company could widen its competitive moat on the same or lower absolute amount of content spend?
Ted Sarandos: I think it's always been a competitive place for the top programming. I think that will continue. And that's really what I think what you're talking about is whether when the top titles come to market when the big packages come and everyone's duking it out for them is going to remain to be pretty competitive. I think that we are reinvesting at a very healthy rate. We see that in the engagement. We see that in the retention, and we see that in the subscriber growth. So I don't think this would be the time to try to test that. And Spence, do you think differently, but...
Spencer Neumann: Yes. I would just say - just to reinforce that, I mean, we've seen the benefits over time of continuous improvement, great execution and focus and kind of gradually building our business and doing it really well and thrilling our members. And so you see it like we are increasing our content spend and coming out of the strikes in '23. We're trying to get back up to as much as $17 billion of cash content spend this year. And as we've also said over the last few years as we kind of reaccelerate our revenue growth, which we're seeing in the business, we hope to sustain that healthy revenue growth, grow profit and profit margins over time and then reinvest a good portion of that back in the business, which means increasing our content spend. So we do plan to do that, but we want to do it in a smart, judicious, responsible way. And obviously, today's even announcement with WWE is a case in point. We believe we have room to do that while still staying very disciplined in terms of our overall content spend in our business performance.
Ted Sarandos: Yes. I think the perception of overserving thrilling content to our members has served us pretty well.
Spencer Neumann: Yes. And we've got lots of room to grow, obviously. And so we just want to do it in a disciplined way. No question, yes.
Spencer Wang: Another question from Eric Sheridan from Goldman Sachs. A bigger picture question. Given the scale of audience that has been built by Netflix, how do you think about the potential for new areas to widen your exposure to verticals or formats of media consumption? I think maybe Eric is referring to short-form content or, things like that, Ted.
Ted Sarandos: I would kind of call back to something that Greg alluded to earlier. In the areas of business that are in our core, movies, television and now games, the - that business, we're getting - we're capturing about 5% of consumer spending. In our most mature markets, we're getting about 10% of TV time. So in our very core business, we still have an enormous room to grow. So when I look at that, it doesn't make me think about searching for more inorganic growth in different kinds of programming. There's so much room to grow in this bit of programming that we're kind of hopefully getting better and better at it for our members every day. So there's a lot of adjacent businesses that are not necessarily competitive and are certainly complementary in some ways. Some of those platforms that you're talking about maybe in the user-generated space have turned out to be great marketing tools for our professional content. So I think we're rightfully focused, I think, on the core of professional storytelling.
Spencer Wang: Great. I'm going to move this over to a few questions around capital allocation. The first is from Brian Pitz of BMO Capital Markets. Basically, the question for Spence is, can you help us frame your M&A views over the next 12 months? Is there the possibility for mobile gaming, aqua-hire or what other sorts of M&A activity would Netflix be interested in?
Spencer Neumann: Well, thanks, Brian. We're not going to speculate on kind of potential M&A activity. But as you know, our historical bias is to build and not buy. We try to be very responsible in terms of our capital allocation philosophy. We hold a modest amount of debt. We're currently holding $10 billion to $15 billion of gross debt. We fully fund our business and new initiatives. You see that in terms of our investment into ads, into live, into games, while still growing the business. And we'll look at selective accelerators to that organic growth. We have done that. But we're not interested in some of the big linear assets that may or may not be available. We also noticed that - noted that in the letter. And so I think that's how you should kind of think about our out there to go after.
Spencer Wang: And staying with you, Spence, another question on the capital allocation. This one coming from Alan Gould of Loop Capital. We know your general rule of thumb is to have cash equal to two months of revenue. How big of a factor is the current stock price and your buyback activity and some of your debt begins maturing over the next few years? What do you believe is the optimal leverage ratio to maximize shareholder value?
Spencer Neumann: Yes, sure. So I'm glad you asked because I missed the last piece of our capital allocation philosophy, which is to hold about two months of revenue in the form of cash on the balance sheet and then to return the excess cash to shareholders over time. We've done that in the form of buyback. And so with a little over kind of $7 billion of cash on the balance sheet at the end of the year. And with, as you say, the kind of the - our expectation for strong cash flow build in the year, roughly $6 billion is what we're projecting at current FX rates for 2024. You can expect that we'll continue to return excess cash to shareholders through the buyback. We don't try to time the kind of stock price. So we really are caught in more in a, call it, more of a price averaging sort of approach and that we buy back over time as we have excess cash. And then in terms of optimal leverage ratio, look, we are fortunate to you have continued to strengthen our balance sheet. We had a recent upgrade from Moody's in Q4. We continue to grow into that investment-grade balance sheet. But we we're pretty intentionally underleveraged, frankly. We think the optimal - without getting overly specific, we think - essentially, as I said, our capital allocation strategy has served us well and that philosophy served us well over the past handful of years. And we think that flexibility in the balance sheet also serves us well to adapt to a quite dynamic industry.
Spencer Wang: Great. I think we'll wrap up with one final question. It's actually one question we've gotten from several different analysts. And in the spirit of WWE, probably a good one for Ted and Greg to tag team on. The question is, what are your key 2024 priorities? Maybe, Greg, first to you?
Greg Peters: Sure. I think you've heard us express this multiple times this call. But we just - we see so much potential and so much opportunity ahead of us in our core business. We got hundreds of millions of qualified households out there that are still yet to sign up for Netflix. I can't believe it, but they're there, and we've got to win them over. There's many hours, like billions of hours of TV time that we are not currently winning. Growing along those two dimensions, more households and more moments of truth. We call them more entertainment value delivered is the key priority for us. We want to improve our entertainment offering to do that. That means delivering more stories that our members love. Films, series, games, now live events. That's the key to that success. And then on top of that, we're focusing on improving how we translate all that additional entertainment value into revenue and improved operating margin. It means growing our ads business. It means growing general plans and pricing optimization. That's the major area of work there. So that's where we're going to be focused on for 2024, and we're super excited to do it. So with that, I'm - I'll tag team to my partner, co-CEO.
Ted Sarandos: We'll do that instead of a sleeper hold. Look, I think everything you said is 100%, Greg, and I think it all is built on the foundation of movies and TV Series and games that people love, can't live without, talk about, can't wait to get back to post about that drives the conversation, that drives this love for programming and entertainment. So we're to start with that with next week. Griselda, brand new show from the makers of Narcos starting Sofia Vergara, that's insane. It's so good. Following the success of One Piece, we've got a brand-new Avatar, The Last Airbender coming for fans. We've got The Three-Body Problem based on one of the top-selling science fiction books of all time from the creators of Game of Thrones. We have a new show from the U.K., from Guy Ritchie called The Gentleman that's insanely fun. And we're back with returning seasons of Bridgerton of Emily in Paris of Diplomat of Squid Game. And on top of that, great movies, like the second part of Rebel Moon coming up, Damsel with Millie Bobby Brown, Jennifer Lopez's new film, Atlas, Hitman which drove everybody crazy at Sundance last night. And Eddie Murphy and Beverly Hills Cop 4 from Axle Foley and so much more. It's just - it's so fun and this is a never-ending mission to continue to improve this for our members and make sure that we're bringing them all the joy that we can. I want to thank all the teams at Netflix, who have made that possible in 2023 and will in 2024. So I'm very excited, and I'll throw it back to you, Spencer.
Spencer Wang: Awesome. Thank you so much, Ted. Thank you, Greg. Thank you, Spence, for entering the questions from analysts. I also want to thank our audience for tuning into our first ever live streamed video format. We look forward to your feedback and in the spirit of continuous improvement and Netflix on everything, we look forward to getting better at this over time. So thank you all again, and we'll see you next quarter.
Greg Peters: Thank you, everybody. |
TXN | 4 | 2,023 | 2024-01-23 19:10:03 | Dave Pahl: Welcome to the Texas Instruments Fourth Quarter 2023 Earnings Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Financial Officer Rafael Lizardi. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. In addition, today's call is being recorded and will be available via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description. I'd like to provide some information that's important for your calendars. Next week, on Thursday, February 1, at 10 a.m. Central Time, we'll have our Capital Management Call. Similar to what we've done in the past, Rafael and I will summarize our progress and provide some insight into our business and our approach to capital allocation as we prepare for the opportunity ahead. Moving on, today we'll provide the following updates. First, I'll start with a quick overview of the quarter. Next I'll provide insight into fourth quarter revenue results with some details of what we're seeing with respect to our end markets. I'll then provide an annual summary of revenue breakout by end market. And lastly, Rafael will cover the financial results and our guidance for the first quarter of 2024. Starting with a quick overview of the quarter. Revenue is $4.1 billion, a decrease of 10% sequentially and 13% from the same quarter a year ago. Analog revenue declined 12% year-over-year and embedded processing declined 10%. Our other segment declined 25% from the year-go-quarter. Now I'll provide some insight into our fourth quarter revenue by end market. Our results reflect increasing weakness in industrial and a sequential decline in automotive as customers work to reduce their inventory levels. Similar to last quarter, I'll focus on sequential performance as it's more informative at this time. First, the industrial market was down mid-teens as we saw that increasing weakness. The automotive market was down mid-single-digits after 3.5 years of very strong growth. Personal electronics was about flat. And next, communications equipment was down low-single-digits. And lastly, enterprise systems grew low single digits. In addition, as we do at the end of each calendar year, I'll describe our revenue by end market. As a percentage of revenue for 2023, industrial was 40%; automotive was 34%; personal electronics 15%; communications equipment 5%; enterprise systems 4%; and other was 2%. In 2023, industrial and automotive combined made up 74% of TI's revenue, up about 9 percentage points from 2022, and up from 42% in 2013. We see good opportunities in all of our markets, but we place additional strategic emphasis on industrial and automotive. Our industrial and automotive customers are increasingly turning to analog and embedded technologies to make their end products more reliable, more affordable, and lower in power. These trends have resulted and will continue to result in growing chip content per application, which will drive faster growth, compared to our other markets. Rafael will now review profitability, capital management, and our outlook.
Rafael Lizardi: Thanks Dave, and good afternoon everyone. As Dave mentioned fourth quarter revenue was $4.1 billion. Gross profit in the quarter was $2.4 billion or 60% of revenue. From a year ago, gross profit decreased primarily due to lower revenue, higher manufacturing costs associated with planned capacity expansions, and reduced factory loadings. Gross profit margin decreased 650 basis points. Operating expenses in the quarter were $898 million, up 4% from a year ago and about as expected. On a trailing 12-month basis operating expenses were $3.7 billion or 21% of revenue. Operating profit was $1.5 billion in the quarter or 38% of revenue. Operating profit was down 30% from the year-ago quarter. Net income in the fourth quarter was $1.4 billion or $1.49 per share. Earnings per share included a $0.03 benefit for items that were not in our original guidance. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1.9 billion in the quarter. Capital expenditures were $1.1 billion in the quarter. In the quarter, we paid $1.2 billion in dividends and repurchased $65 million of our stock. We also increased our dividend per share by 5% in the fourth quarter, marking our 20th consecutive year of dividend increases. In total, we have returned $4.9 billion in the past 12-months to owners. Our balance sheet remains strong with $8.6 billion of cash and short-term investments at the end of the fourth quarter. Total debt outstanding was $11.3 billion with a weighted average coupon of 3.5%. Inventory at the end of the quarter was $4 billion, up $91 million from the prior quarter and days were 219, up 14 days sequentially. Now let's look at some of these results for the year. In 2023 cash flow from operations was $6.4 billion. Capital expenditures were $5.1 billion. Free cash flow for 2023 was $1.3 billion or 8% of revenue. Our free cash flow reflects the strength of our business model, as well as our decisions to invest in 300 millimeter manufacturing assets and Inventory to support our overall objective to maximize long-term free cash flow per share, which we believe is the primary driver of long-term value. Turning to our outlook for the first quarter, we expect TI revenue in the range of $3.45 billion to $3.75 billion and earnings per share to be in the range of $0.96 to $1.16. We now expect our 2024 effective tax rate to be about 13%. In closing, we will stay focused in the areas that add value in the long-term. We continue to invest in our competitive advantages which are manufacturing and technology, a broad product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash per share growth over the long-term. With that, let me turn it back to Dave.
Dave Pahl: Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?
Operator: Thank you. And at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Hi, good afternoon. Thank you so much for taking the question. My first question is on your Q1 outlook, I think at the midpoint you're guiding revenue down 12% or so which is you know clearly well below what we consider to be typical seasonality. Any end markets or regions or device types that you can call out that's driving that view? Or is it broad-based weakness across all applications?
Dave Pahl: Yes, I'll take that, Toshiya. Thanks for the question. In fourth quarter, we did see weakness in industrial, increasing weakness there. We saw the sequential decline in automotive. And as the guide would suggest, we believe that we'll just continue to operate in a weak environment and one where customers are continuing to rebalance their inventories overall. So, but nothing specific to comment on. You have a follow-up?
Toshiya Hari: I do, thanks Dave. Just on gross margins, I think you guys did a good job in explaining what's driving it. Still, I'm a little bit surprised with the year-over-year, kind of, drop through, if you will? Gross margin dollars essentially dropping as much as your revenue. I understand the underutilization, the increase in depreciation. But what are you seeing from a pricing perspective? Is it more pricing than volume that's driving the revenue decline and the decline in gross margins? Or if you can kind of speak to your strategy from a pricing perspective, what you're seeing in the marketplace? That would be helpful. Thank you.
Dave Pahl: Yes, Toshiya and I'll remind everyone else, I know you know the industry well, but you know pricing just doesn't move quickly in our markets overall and nor is it the primary reason why a customer chooses our products. So and as we've mentioned before our pricing strategy hasn't changed and of course, we're always regularly monitoring the market and pricing our products appropriately. And as we've talked about now for I think a couple of quarters, as we expected supply and demand to come more in balance, that we would expect pricing to revert back to how it's behaved over the last 10 or 20 years. And over the last six months or so, that's what we've seen. So somewhat of a low-single-digit decline is what we're expecting out in time and wouldn't describe that as unusual. Thanks for the question.
Toshiya Hari: Great. Thank you.
Dave Pahl: We’ll go to the next caller please. Thanks.
Operator: Our next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. I wanted to ask about factory loadings. Dave, gross margin was down maybe 250 basis points. It's kind of implied to be down 250 basis points. Even if I strip out depreciation, it's down about 100 basis points for March. So it seems like utilization is coming down a bit. And CapEx also came in a little bit lower too for December. So the first question on that is, can you talk about loadings? Is March going to be the bottom in loadings and we should see inventory begin to come down also in March? And then I had a follow-up on that too.
Rafael Lizardi: Yes, so, no, thanks for the question. So step back in third quarter, at the end of third quarter, we talked about this. As we have near our inventory levels, then we have adjusted our factory loadings accordingly. So in third quarter, we did some of that and that had an impact on gross margins on underutilization. Fourth quarter adjustment was bigger than third quarter. And now going into first quarter, we're taking that adjustment further. So the first quarter adjustment on underutilization will be bigger. But we continue to have an upward bias on inventory as we continue to build the right buffers for the right parts to be ready on the other side of the cycle. So, follow-up?
Timothy Arcuri: I did, yes. So then on CapEx, can you talk about that? It was a little lower. It's running actually quite a bit below the $5 billion run right now. So are you actually cutting CapEx now since you're bringing down factory loading? Thanks.
Rafael Lizardi: No, we're not. In fact, CapEx came in as expected $5.1 billion, and we've been talking about $5 billion per year. So it was right on target. And you should expect, and we expect, to continue running at about $5 billion per year through 2026 as we complete the investment plans that we've been talking about.
Dave Pahl: Great. Thanks, Tim. We'll go to the next caller, please.
Operator: Our next question comes from the line of Chris Danely with Citibank. Please proceed with your question.
Chris Danely: Hey, thanks guys. Just a follow-up on the utilization rates. So is the target, I guess, inventory level. Has that not changed for you guys? And so do you expect utilization rates to bottom in Q1? Or do you think you might have some more inventory adjustments going into Q2 for TI?
Rafael Lizardi: Yes, no, thanks, Chris. So broadly speaking, our inventory targets have not changed over the last six, nine months through this cycle. So we still have some ways to go, clearly less than we did six months ago. But we still have some ways to go on that front. At one point, I talked about $4 billion to $4.5 billion worth of inventory. So that's in the ballpark, and we just finished just shy of $4 billion. But as far as when, underutilization bottoms, that's going to depend on revenue expectations. And at this point, we're only, as always, we only give one quarter at a time. So we'll see where we are 90-days from now and we'll tell you about that.
Dave Pahl: Yes, maybe I'll just add that our target inventory is set really by device. It's -- we look at things like how many customers are buying the product, what the buying patterns look like, how long it takes us to manufacture the product. So it's really a bottoms up plan built on that very, very specifically. So that's what drives that target overall and we want to have inventory position to support growth over the long-term. This is a side comment. So, a follow-on, Chris?
Chris Danely: Yes, thanks guys. I guess just a little bit of color on the end market commentary, thanks for that. On the industrial side, it sounds like most of the downside is due to excess inventory, not demand. I was hoping you could confirm that? And then with automotive weakening, is there any reason why automotive wouldn't fall under the same issues that the industrial end market/inventory would as well?
Dave Pahl: Yes, so I'll start and Rafael if you want to add anything. I would say that the demand signals that we get from customers are orders that they place, whether that's either directly or through consignment feeds. So that's the data that we can see. We actually can't see their inventory levels. We can anecdotally, as we see a market like personal electronics is down 30%, 40%. We know handsets and PCs, that market hasn't gone down as much as that. So we know anecdotally that we're shipping below demand. So we believe that, that's what's going on in industrial. We have customers who have told us that they have built inventory and plan to correct that. So having a real clear picture of what their demand looks like and their channel inventories look like isn't something that we can see directly overall. So and the comment on automotive, we know that customers there did want to build inventory. And we believe that they're in a good position now, so it wasn't surprising that we saw a sequential decline there. So thanks Chris, we’ll go to the next caller please.
Operator: Our next question comes from the line of Tom O'Malley with Barclays. Please proceed with your question.
Tom O'Malley: Hey, and thanks for taking my question, guys. I just wanted to understand the linearity of the industrial and automotive declines? When you set out in the quarter, baked into your expectations, were you kind of looking at these two businesses, both a little bit better than they came in or was one a bit worse than the other versus your expectations? And then just in terms of the timing of the quarter, it looks like your finished goods inventory went up a bit more than your other buckets. And I just wanted to understand, is that just because later in the quarter customers were signaling some weaker trends or is there any reason behind the dynamic there? Thank you.
Rafael Lizardi: Let me start with the second part of the question. And Dave, you want to take the first one? No, the second part, that's just a reflection of our ability to build those inventory buffers that we were talking about. And what you're seeing there is on the finished goods side. That's one, Dave alluded to earlier, that's one set of targets that we have. That's at the finished goods level. Remember, we have 100,000 different parts, and the vast majority of those are what we call catalog, which means they sell to many, many customers. So we want to build a certain finished good level for each one of those parts. But we're also building at the chip level. Think of you know a chip can go into two, three, 10 different finished goods so it works out well to have some chip level inventory operationally, but you also have want to have finished goods. So that's what you saw there.
Dave Pahl: Yes and by end markets, Tom, our guidance, as you saw, where our revenues came in, we were, I think, less than 1% from the midpoint of the guidance range. So the business came in about as we expected and nothing unusual versus our expectation in industrial or automotive overall. So… do you have a follow-on for that?
Rafael Lizardi: No it’s two part question. Yes, that counts as good.
Tom O'Malley: Yes.
Rafael Lizardi: Okay.
Tom O'Malley: All right. Thank you. We appreciate it. Thanks.
Dave Pahl: Next caller, please.
Operator: Our next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi, guys. Just wanted to ask about the product side, the analog versus embedded. Embedded had a significantly better year, dropping 3% versus the analog down 15%. I know there's very different end market exposures for those, but were there other competitive dynamics, pricing dynamics, strategic focus dynamics, anything else to explain the difference between the performance of those two segments?
Dave Pahl: Yes, Ross, I think your instincts are spot on that the first lens to look at things is through the end markets and embedded has is heavied up in industrial and automotive, so revenues there were stronger for a longer period of time. The second consideration is that embedded relies on foundry wafer supply more heavily. Most of our analog businesses done internally. So there the constraints lasted longer and have now been resolved and are behind us, so that created some of the lag between there as well. So, and as you know, our CapEx plans and spend will have more of our wafers overall built internally, which is inclusive of embedded. You have a follow-on?
Ross Seymore: Yes, I do and it's kind of a cyclical question. You guys are astute students of cyclicality of this whole industry. I think this is going to be including your guide the sixth quarter of negative year-over-year comps. Do you see anything that's TI specific, that's different this cycle, you know, pricing just got so good before, now it's a bigger headwind, you kind of addressed the pricing dynamic a little bit before, but what's making this duration so much longer and is any of it TI specific?
Dave Pahl: Yes, Ross, you know, I think I'll make a comment and Rafael if you want to add anything. You know, what all cycles are the same and they're all different right as we've all studied them over time. What's clearly different this time is how the markets have behaved in the bifurcation. We saw personal electronics begin to weaken second quarter a year ago and automotive you know just we saw the sequential decline this last quarter. So in the other markets somewhere in between. So and then in addition I think that, you know, we've had lots of other noise that's inside of the system, whether that's been pricing, as you mentioned. We've had non-cancellable, non-rescheduled orders and other longer-term contracts that have required customers to take product that they don't need, whether companies are using distributors more heavily than others. So all of that adds noise into it. So I think we just need to let that noise wring itself out over the cycle. And what we're focused on, of course, is investing in our competitive advantages, getting stronger. We believe that we're in a great position to continue to gain share over the long-term.
Rafael Lizardi: Yes, I just want to clarify for those who maybe new on the call, when Dave talked about non-cancellable, non-returnable, or that's not, we don't do that. Many of our competitors have done that. So that, in our view, distorts the market. That wasn't the case with us. And the second point, distributors, same thing. Our distributor footprint is much smaller than with many of our competitors. We're down to 25% or so for our revenue through distribution, so 75% direct, whereas many of our competitors are the opposite, so…
Dave Pahl: Great clarification. Thank you, Ross. We'll go to the next caller, please.
Operator: Our next question comes from the line of Joe Moore with Morgan Stanley. Pleased to see you with your question.
Joe Moore: Great, thank you. I wonder if you could talk about the Chips Act, how that's kind of flowing through both the investment tax credit and then any thoughts you may have on timing of kind of grant issuances or things like that?
Rafael Lizardi: Yes, I'm happy to talk about that. So first, let me address the ITC first and then I'll go to the grant. So the ITC investment tax credit 25% credit on CapEx or manufacturing in the United States. We have accrued to-date over the last year and a half or so $1.4 billion. We expect to get about $500 million of that later this year, probably in fourth quarter as far as the current law and regulations stipulate. And we'll get the rest further down the road, mostly the following year and then after that. And we'll continue to accrue that benefit, just again, 25% on anything we spend in the United States for manufacturing. That's the cash side and the balance sheet. On the P&L, we're already seeing the benefit as lower depreciation. That benefit tends to be small, has been small so far because for example, some of that is for buildings that haven't even started to depreciate, but it will build up over time on that front. So that's the ITC. The grants, we submitted our application for those in December. And at this point, we will wait to hear from the Department of Commerce and see what happens there.
Dave Pahl: Is there a follow-on Joe?
Joe Moore: Yes, I did. So I think, obviously that stuff will help the cash flow down the road, but your free cash flow is below the level of the dividend. Right now, I assume it's pretty important to keep paying the dividend. Where does that leave you in terms of share repurchases and other uses of cash?
Rafael Lizardi: Yes, first, I would point you to our operating cash. Our business model is very strong and our operating cash flow is very strong and it supports our investment for growth through the cycle. So clearly with the levels of CapEx that we have right now, that hits the free cash flow. But big picture understand and look at the operating cash, even in a depressed environment with the revenue, depressed operating cash flow is very strong. We also have very strong balance sheet. And we just finished the year at $8.6 billion. You know, when it comes to repurchases, I would take you to our objectives on capital management for cash return, and our objective is to return all free cash flow via dividends and repurchases. Each one of those has different objectives on dividends and repurchases, but we have a really good track record over many years of doing both of those.
Joe Moore: Great, thank you.
Dave Pahl: Thank you, Joe. Go to the next caller, please.
Operator: Our next question comes from the line of Harlan Sur with JP Morgan. Please proceed with your question.
Harlan Sur: Yes, good afternoon. Thanks for taking my question. Up through Q3 of last spring, the team had seen numerous consecutive quarters of increasing cancellations and push-offs, typical customer behavior in a weak demand environment. I assume, given your commentary, that the team continues to see cancellations, push-outs, activity expanding into the December quarter. You're almost a month into March. Are you still seeing cancellations and push-outs expanding or starting to maybe see some signs of stabilization?
Dave Pahl: Yes Harlan, you know, as you would expect we have seen cancellations in the quarter and fourth quarter had remained elevated. I wouldn't describe them as increasing, but just at higher levels. You know, and we're still early inside of the quarter. I would say all of, you know, what's going on with cancellations and the backlog that we see is all comprehended in our guidance and in our outlook.
Harlan Sur: Okay, Perfect. And then, yeah, from a geographical perspective, China headquarters shipment still about 20% of your sales through the October quarter of last year. This geography has experienced the most significant decline during this downturn. It's down about 33% year-to-date up through Q3 of last year, your total business was down 13%, right? Is this geography continuing to contribute to the weakness stepping into this year, or is the weakness more U.S. and European-based?
Dave Pahl: Yes, I would say when you look regionally this quarter from a -- just from a dollar standpoint you've got sequentially all the regions were down with the exception of the rest of Asia. So nothing unusual with China going on specifically there overall. So again, when we look at our business, I think most of that is explained by the end markets and certainly, we hadn't seen a recovery inside of China that I think most of us were expecting.
Harlan Sur: Okay. Thank you, Dave.
Dave Pahl: Go to the next caller, please.
Operator: Our next question comes from the line of Joshua Buchalter with TD Cowen & Company. Please proceed with your question.
Joshua Buchalter: Hey, guys. Thanks for taking my question. I want to ask you about how you're thinking about OpEx given the extended softness. Any thoughts on getting more defensive with OpEx? Does the weakness last longer than expected? Or you grew OpEx 8% in 2023. Is that sort of the right level that you think you need to be investing in the business for the long-term growth? Thank you.
Rafael Lizardi: Yes, you know, big picture. We have a disciplined process of allocating capital to R&D and SG&A to the best opportunities. And we've held a steady hand throughout a number of years, pre-pandemic, during the pandemic, post-pandemic, where we managed OpEx very well during that time and didn't get ahead of our skis. So we will continue with that discipline process. Remember, of course, these investments, particularly industrial automotive, which is what we're biased in, are investments. They're very long-term in nature. You're not going to -- what you save now is going to would hurt your long-term revenue growth so we're not going to do that so we're going to maintain those investments for the long-term.
Dave Pahl: A follow-on Josh.
Joshua Buchalter: Yes, thank you. I guess I wanted to ask about your fixed cost leverage. I mean, you've been in the past, you've talked about I think 75% gross margin fall through on incremental revenue. Is that still the right metric we should be using given revenues a good amount lower and depreciation is larger? I'd just be curious to hear if anything in the mechanics of that math has changed. And basically when can the incremental 300 millimeter capacity start flowing through the gross margins and be margin accretive? Thank you.
Rafael Lizardi: Yes, so the math is still the same. The fault-through issue used is 70% to 75% that is still a reasonable starting point. You then have to adjust for depreciation, as you alluded to, and our depreciation, I gave you an update on that 90-days ago, but I'll reinforce that in a second, but you have to adjust for that. And then there are always put some takes on any given quarter, like right now it's underutilization, but at some point that goes the other way. Throughout this time, as you pointed out, we will continue to benefit increasingly from 300 millimeter, more 300 millimeter wafers, which have a cost advantage. So, let me go back to the appreciation just to make sure everybody has the right number. It's the same as what I said 90 days ago. For 2024, expect $1.5 billion to $1.8 billion and for 2025, expect $2 billion to $2.5 billion.
Dave Pahl: Thank you, Josh. We'll go to the next caller, please.
Operator: Our next question comes from the line of CJ Muse with Cantor Fitzgerald. Please proceed with your question.
CJ Muse: Good afternoon. Thank you for taking the question. I guess first question, your revenue outlook for March basically gets us back to kind of pre-COVID first-half 2020 levels, yet at the same time your inventory is roughly double. And so curious, how are you thinking about kind of normalized inventory over time? And also, how are you thinking about coming out of the trough, what kind of a gross margin recovery will look like given where your inventory levels are today?
Rafael Lizardi: So that's a multi-part question in many angles to that. What I would tell you, high level, we're very comfortable with our inventory level. Right now we're just shy of $4 billion as I said earlier on the call. We have continued upward bias for at least one more quarter, probably a couple quarters at least, an upward bias on that. But that is good inventory for catalog parts that sell to many customers that last a long time. So I feel really good about that. But we'll see how things play out on the other side of the cycle and depending on demand and different things. But I would expect to continue holding relatively high levels of inventory. We just in a different position than we were even three or four years ago in terms of how much of our revenue and our parts are in industrial automotive, in catalog type of parts that last a long time. So our strategy is such that it makes sense to have that inventory. Our order fulfillment processes have also improved. We have ti.com and different tools that we can leverage to go direct to market. We have a much higher percent of our revenue now 35% is direct. So all those factors play into having more inventory as a real leverage point that we can use to serve our customers even better.
Dave Pahl: A follow-on CJ?
CJ Muse: Thanks, Dave. A quick follow-up to a prior question. I know you can't share too much, but your application clearly in for the Chips Act. I guess we should hear results between now and the summer. I guess is there anything you can share on that front and perhaps how it's kind of impacting your thoughts on the capacity you're bringing online?
Rafael Lizardi: Yeah, no, unfortunately, no, there's nothing we can share. It's really up to the Department of Commerce, we sent our application and we'll see where that goes. What I would say, just like I said before, is when we decided about a year ago to take our CapEx up from $3.5 billion per year to $5 billion per year, and this tremendous plan to build more fabs in the United States, we comprehended Chips grant in that decision. So that was part of our thinking there. But at this point, yes, that's all we can share on that front.
Dave Pahl: All right. Thank you, CJ. And I think we've got time for one more caller, please.
Operator: Our last question comes from the line of Chris Caso with Wolfe Research. Please proceed with your question.
Chris Caso: Yes, thank you. Guys, I just did, just trying to understand a little bit about why the customers may have reacted as they did. Because we know your lead times have normalized well in advance of the rest of the industry. Do you think this is just simply a function of end markets took another leg down here? Do you think perhaps some of your customers were delaying their inventory adjustments until they saw lead times for the rest of the industry come down? Because we know that's also some of your competitors lagged your lead time normalization. Perhaps that was a factor here?
Dave Pahl: Yes. Chris, as you know, you can't pin it on one thing, especially we've got well over 100,000 customers and 80,000 products that we're managing. As Rafael was talking about, building inventory, we've got essentially all of our catalog products, or almost all of our catalog products, now immediately available on ti.com. And our objective with inventory and the capacity we're putting on place is to have our customer service metrics remain high, which means keeping lead times stable. So you know I think in some markets we've seen customers that have told us that they were planning and have built their capacity and their inventories to grow at 25% in the coming year and they showed up and their plans changed and they're only going to grow 10%, right? So they told us they won't be ordering product for some time as they, you know, equalize those numbers. They're still going to have healthy growth, but it's hard to put that across all of those 100,000 customers into one short concise statement. Have a follow on?
Chris Caso: Yes, fair enough. And if you could help us with the impact of the underutilization right now, how much of a headwind is that providing right now on a cost to sales basis? And then on the other side of this, when we finally get to a recovery, what will be the right way to model this? Will there be a bigger snapback as some of the underutilization comes off or do we just kind of go back to sort of those mid-70s incremental margins and the way back up?
Rafael Lizardi: Yes, so what I would tell you first, we don't quantify underutilization, but you can fairly reasonably back into it just looking at our numbers, our midpoint or range, our midpoint and then consider the depreciation, expected depreciation increase and it'd be relatively straightforward for you to back into something reasonable for first quarter on the underutilization impact there. Now after that, it's all going to depend on revenue and revenue expectations because of course, depending what those are in the second-half of the year, let's say 90-days from now, then that will be a big factor in determining how the factories will run. But the bigger picture is, you know, all this deployment of CapEx that we're doing is all on 300 millimeter, which has a 40% cost advantage versus 200 millimeter. Several questions people asked earlier, it has ITC benefits on that. So it's coming in at 25% discount on the ITC and we'll see how much we get on grants. So they fall through on those investments for many, many years will be very positive, I would say. So with that, Dave?
Dave Pahl: Yes, thank you, Rafael. Thank you all for joining us. We look forward to sharing our capital management update next Thursday, February 1 at 10 a.m. Central Time, as I mentioned earlier. And a replay of this call will be available shortly on our website. Good evening.
Operator: And this concludes today's conference and you may disconnect your lines at this time. Thank you for your participation. |
COST | 1 | 2,024 | 2023-12-14 22:00:26 | Operator: Good day, everyone, and welcome to the Costco Wholesale Corporation Fiscal First Quarter 2024 Earnings Call. Today's call is being recorded and all lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Richard Galanti, Chief Financial Officer. Please go ahead, sir.
Richard Galanti: Thank you, Lisa, and good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include but are not limited to those outlined in today's call, as well as other risks identified from time-to-time in the company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and the company does not undertake to update these statements, except as required by law. Comparable sales and comparable sales excluding impacts from changes in gasoline prices and foreign exchange are intended as supplemental information and are not a substitute for net sales presented in accordance with GAAP. In today's release, we reported operating results for the first quarter of fiscal '24, the 12 weeks ended November 26. Reported net income for the 12-week first quarter came in at $1.589 billion or $3.58 per share, up from $1.364 billion or $3.07 per share in the 12-week first quarter last year. This year's results included a tax benefit of $44 million or $0.10 a share related to stock-based compensation. Last year's results included a tax benefit of $53 million or $0.12 per share related to stock-based compensation and also included a charge of $93 million pre-tax or $0.15 per share primarily related to downsizing our charter shipping activities. Net sales for the first quarter were $56.72 billion, a 6.1% increase over last year's first quarter, $53.44 billion. Net sales were benefited by approximately 0.5% (ph) to 1% in the U.S. and worldwide from the shift of the fiscal calendar as a result of the 53rd week in fiscal 2023. The following comparable sales reflect comparable locations year-over-year and comparable retail weeks. In the U.S. reported 2% comp sales ex-gas deflation and FX 2.6%. Canada reported 6.4%, ex-gas and FX 8.2%. Other International reported 11.2%, ex-gas and FX 7.1%. For total company reported 3.8% and at 3.9%, excluding those two items. E-commerce, which was reported as a 6.3% came in at 6.1% excluding FX. Overall, for the first fiscal quarter, fresh foods were relatively strong once again, with food and sundries right behind. Non-food showed improvement over the September October, November time frame as did e-com sales. In terms of Q1 comp sales metrics, traffic or shopping frequency increased 4.7% worldwide and 3.6% in the United States. Our average transaction was down 0.9% worldwide and down 1.6% in the U.S. Foreign currencies relative to the U.S. dollar positively impacted sales by approximately 0.4%, while gasoline price deflation negatively impacted sales by approximately 0.6%. I've gotten more than a few calls in the past few weeks as to how many pies we sold in the U.S. leading up to the Thanksgiving holiday. In the U.S., in the three days leading up to Thanksgiving, we sold 2.9 million of our famous Pumpkin Pies along with 1.3 million apple and pecan pies, so over 4 million pies in total during the three days. Back to the income statement here and next on the income statement's membership fee income. In the quarter, we reported $1.082 billion or 1.91%, that's an $82 million or 8.2% increase and a 4 basis point increase over the first quarter last year. In terms of renewal rates, at first quarter end, our U.S. and Canada renewal rate stood at 92.8%, while the worldwide rate came in at 90.5%. Both of these rates were up 0.1% from those numbers 12 weeks earlier at the end of the fourth quarter. Membership growth continues. We ended Q1 with 72.0 million paid household members, up 7.6% versus last year and 129.5 million cardholders, up 7.1%, with consistent growth throughout the quarters. At Q1 end, we had 33.2 million paid Executive members, an increase of 939,000 during the 12 weeks since Q4 end. Executive members now represent a little over 46% of our paid members and a little over 73% of worldwide sales. Moving down the income statement next is, our gross margin. Our reported gross margin in the fourth quarter was higher year-over-year by 43 basis points, coming in at 11.04%, up from Q1 of last year at 10.61%. That 43 basis point reported number ex-gas deflation would be plus 36 basis points. As I normally do here, we write down two columns and six line items. The first column is reported in the first quarter. The second column is margins, excluding gas deflation. It's the year-over-year change in the first quarter. On a core merchandise, plus 3 basis points reported, minus 3 basis points ex-deflation. Ancillary and other businesses, plus 24% reported and plus 22% ex-gas deflation; 2% reward lower year-over-year, minus 4 basis points reported and minus 3 ex-gas deflation; LIFO, plus 3 and plus 3 and other plus 17 and plus 17 for a total, again, reported year-over-year up 43 basis points and ex-gas deflation up 36 basis points. Starting with the core. Again, it was total company, it was plus 3 and minus 3 reported and ex-gas deflation. In terms of core margin on their own sales, our core-on-core margins were up by 5 basis points year-over-year. Ancillary and other business gross margin, again, higher by 24 and higher by 22 ex-gas deflation. This increase was driven largely by gas and e-comm. Our 2% reward higher by 4 and higher by 3 ex-deflation, reflecting higher sales penetration coming from our Executive members. LIFO plus 3 basis points. We had a $15 million LIFO credit in the first quarter of this year. This compared to a very small $0.5 million LIFO charge in Q1 a year ago. And then, the other line item, the 17 basis points to the positive. As was mentioned earlier, last year in Q1, there was a 17 basis point impact from a $93 million pre-tax charge, primarily related -- primarily for the downsizing of our charter shipping activities. Moving on to SG&A. We reported SG&A of 9.45%, higher by 25 basis points than last year's 9.20%. Again, in Q1, we're right down the two columns. Reported and without gas deflation, operations, minus 18 and minus 14 basis points, minus being -- meaning it's higher year-over-year. Central minus 2 and minus 1. Stock compensation minus 3 and minus 2. Pre-opening expense, minus 2 and minus 2, again, for a total reported margin higher minus 25% year-over-year. I'm sorry, SG&A, not margin, 25 and without gas deflation, higher by 19 basis points. The quarter again was higher by 18 and higher by 14, excluding the impact from gas. This included 12 weeks of this past March's extra top of scale increase in our wages, which represents an estimated 2 basis point hit. And as of September 18, we raised the starting wage in the U.S. and Canada, that estimated impact from those new wages to be roughly 2 basis points as well. Again, central, nothing much to say other than its 1 basis point higher, excluding gas deflation. Again, it was stock comp's, the minus 2x gas deflation and pre-opening. We did have a couple of more openings this year in the quarter than we did last year and that was higher by 2 basis points. Below the operating income line, interest expense was $38 million this year, $4 million higher than last year's $34 million figure. Interest income and other for the quarter was higher by $107 million, coming in at $160 million this year versus $53 million last year. This was driven largely by the increase in interest income, about $100 million of that $107 million due to higher interest rates as well as high cash balances. The small additional impact was a favorable FX year-over-year. In terms of income taxes, our tax rate in the first quarter was 24.5%. This compares to 23.0% a year ago or 1.5 percentage points higher this year than last year. The increase in our rate as of Q1 -- in Q1 is primarily attributable to lower benefit from the stock-based compensation from a year ago. Overall, reported net income was up 16.5% year-over-year in the quarter. A few other items of note. In terms of warehouse expansion in the first quarter, we opened 10 locations, including one relo (ph), so a net of nine increases. That -- those nine included eight in the U.S. and one in Canada. For the full year fiscal '24, we estimate opening -- we're planning to open 33 locations, including two relos, so for a net increase of 31 new warehouses that would be up from 23 that we opened in fiscal '23. For Q2 fiscal '24, we plan four new locations, including our sixth building in China, are early in the calendar year. Regarding capital expenditures, first quarter capital expenditure spend was approximately $1.04 billion. We estimate that fiscal '24 CapEx will be in the $4.4 billion to $4.6 billion range, that's up from $4.3 billion we had in fiscal '23, reflecting a continued increase in the number of the expansion that we're doing. In terms of e-commerce business, e-com sales in Q1 ex-FX increased 6.1%, the first quarterly year-over-year increase in five fiscal quarters and trended well during the three reporting periods of September, October, November. E-comm showed strength in several areas. In food, things like e-gift cards, pet items, snack items were up in the mid-teens. Appliances were up year-over-year in the mid-20s. TVs was actually in the high-singles despite the challenges with other aspects of consumer electronics like computers, and tires were up in the low-teens. So overall, a pretty good showing there. As well, Costco Logistics enjoyed record-breaking deliveries. In the first quarter of fiscal '24, we completed over 800,000 deliveries, which were up 17% versus the comparable quarter last year. And some fun wow items in the quarter in e-commerce. You've probably read about the fact that we're selling gold 1 ounce gold bars. We sold over $100 million of gold during the quarter. We sold a Babe Ruth autographed index card for $20,000. And in addition to e-gift cards on everything from restaurants to golf to airlines, and we just in the last couple of weeks, launched a Disney e-gift card valued at $250 for $224.99. And for you last-minute shoppers out there, there is a Mickey Mantle autographed 1951 Rookie Card in nearly perfect condition and it's on sale online for $250,000. Next, good progress continues to be made with our e-com mobile and digital efforts. No big enhancements and changes to the site leading up to the holiday, mostly holiday prep. We did have 100% site availability during Cyber week, and sales for the five Cyber Days, Thanksgiving, Black Friday, Saturday, Sunday, and Cyber Monday were up year-over-year in the mid-teens. Our app downloads during the quarter were 2.75 million, so total app downloads are now stand at 30.5 million or a 10% increase during the quarter, and that's after up being over 40% increase in all of fiscal '23 versus the prior year. Our site traffic approaching 0.5 billion and just under 10% increase and the average order value being up about 2.5%. So we continue to make progress there. Next couple of comments regarding inflation, most recently in the last fourth quarter discussion. We had estimated that year-over-year inflation was in the 1% to 2% range. Our estimate for the quarter just ended, that inflation was in the 0% to 1% range. Bigger deflation in some big and bulky items like furniture sets due to lower freight costs year-over-year as well as on things like domestics, bulky, lower priced items again, where the freight cost is significant. Some deflationary items were as much as 20% to 30% and again, mostly freight-related. TVs, the average sale prices have been lower while unit's been higher. And talking to the buyers overall, our inventories and our SKU counts are in good shape across all channels. And so far, we've had a good seasonal sell-through during the quarter. Lastly, as you saw in this afternoon's press release, we declared a $15 per share special cash dividend. This is our fifth special dividend in 11 years. The total payout will be about just under $6.7 billion and will be funded using existing cash and not accompanied by any issuance of debt. The special cash dividend will be paid on January 12th to shareholders of record on December 28th. Finally, in terms of upcoming releases, we will announce our December sales results for the five weeks ending Sunday, December 31, on Thursday, January 4th, after market close. With that, I will turn it back for Q&A to Lisa and be happy to answer any questions.
Operator: Thank you. [Operator Instructions] We'll take our first question from Michael Lasser with UBS.
Michael Lasser: Good evening. Thank you so much for taking my question. You had indicated over the last 1.5 years or so that Costco had been raising prices faster than it had throughout its history. So now with prices coming down, what is going to be the posture on passing along those savings? You already noted that inflation is flat to up 1%. So do you expect deflation, especially on the food side as you get through the next couple of quarters?
Richard Galanti: Well, talking to buyers, we've seen that even during the quarter, we saw a trend towards that 0% versus the 1%. But at the end of the day, we don't -- the buyers are looking out three to six months. They have -- on the fresh food side, commodities-wise, they haven't seen a lot. There are a few things that are up and a few things are down, but no giant trend either way. Look, as you know us for a long time, we want to be the first to lower prices. We're out there pressing our vendors as we seek different commodity components come down and certainly on the non-food side, as we saw shipping costs come down, things like that. And so probably a little more than less, but we'll have to wait and see. We don't know.
Michael Lasser: And my follow-up is another point that you've made for a long time is that Costco's going to draft off the profitability of the broader retail sector. If you compare Costco's operating margin over the last 12 months versus where it was prior to the pandemic, it's 300 to 400 basis points higher. And yet, across retail, there are signs that profitability is coming down. So now, what we've seen in the ways of Costco either maintaining this existing rate of operating profit margin or even further growing it from here, so it just simply going to be a function of your ability to drive further sales growth in the -- consistently mid-single digit range or better.
Richard Galanti: Sure. Well, happily, I'm able to say that, that's -- you get to figure that one out. At the end of the day, we're -- as you've known for a long time, we're a top line company, we want to drive sales. Certainly, as there's been deflation in certain products, we've seen units go up. I'm looking at one example here just in the last month, $100 million plus of KS net items where sales were flat to down a couple percent, while units were up in the mid-teens, that takes a little more labor to do. But at the end of the day, that's what we want to do. We want to drive people and frequency. I think as long as we see renewal rates continue to do what they do, as long as we see new sign-ups continue to what they do and hopefully continue to get people to convert to Executive as well and constantly driving the best value out there, we'll be in good stead. And so far, we've been able to do that and I think we'll continue to be able to do that.
Michael Lasser: Thank you very much and have a good holiday.
Richard Galanti: You too.
Operator: We'll take our next question from Simeon Gutman with Morgan Stanley.
Jacquelyn Sussman: Hi, there. This is Jackie Sussman on for Simeon. Thank you so much for taking our question. The core and core margin was up modestly this quarter and it seems like it moderated sequentially. Looking forward to the balance of the year, it seems like the comparison gets a bit tougher. I guess how should we think about your core and core margin? Could it stay expanding and positive for the rest of the year or any color on that would be helpful. Thank you so much.
Richard Galanti: There are so many different moving parts to it. As you've heard me say and I say in the last several years, we want to drive top line first. We're also pragmatic. We want -- we recognize we're a for-profit company and we'll continue to work hard to do both. I wouldn't read much into any number going up a little or down a little, frankly. It fluctuates and there's lots of different components to it.
Jacquelyn Sussman: Got you. Thanks so much. And just a quick follow-up. Was the Black Friday and Cyber Monday gains that you had better than what you were expecting internally? Thanks so much.
Richard Galanti: They’re a little better than we were expecting but we were ready for it.
Jacquelyn Sussman: Thanks so much.
Operator: We'll take our next question from Chuck Grom with Gordon Haskett.
Charles Grom: Hey. How is it going Richard? Good afternoon. I wanted to just dive into the core margins a little bit more and see if you could flesh out some of the category color. If you said it, I missed it, but food, sundries, fresh and on the hardlines parts of the business.
Richard Galanti: Well, without giving you specific basis points, food and sundries was slightly down, very slightly down. Non-food was actually up. Some of that relates to the fact that we are comparing against last year when we had higher freight costs and trying to drive business and fresh was down a little bit. So nothing Earth-shattering in either of those directions.
Charles Grom: Okay. And then on the ancillary up 22 basis points, I think we all get the gas component. But can you just talk about why the e-commerce margins were so much better in the quarter?
Richard Galanti: I think, well, first of all, part of just ancillary in general is a sales penetration issue. Without going into it that the fact that it showed more -- sometimes when you look back over the quarters, they go in opposite directions, the core on core and then the other businesses. And so given that you had higher sales penetration in both and e-com, that helped you, and e-com, we had a lot of strength. We're doing a lot of big and bulky and we're driving that business.
Charles Grom: Okay. Great. And then just bigger picture, I just have a question on the change at the CEO seat with Ron starting in a few weeks and replacing Craig, who replaced Jim. You've had the fortunate opportunity to work with all three. And I guess I'm curious what change, if any, you think we could see from an operating standpoint moving forward?
Richard Galanti: Yeah. Well, I always joke I'm up for review so I'm going to say nice things. But at the end of the day, the reality is, we're staying the course. I remember questions were asked 12-plus years ago when Craig became President, and two years later, Jim retired and Craig became CEO and President. And what's -- who can replace Jim? And I think the same questions asked today, who could replace Greg? And it really is a seamless transition. You have somebody retiring that's been here 40-ish years and it's been in the business both on operations and merchandising for a successful number of years in both. And you've got Ron who's coming in, who started when he was 17 at a Price Club in Arizona. And he already has his 40-year gold patch. And again, 30-ish years in operations, a year in real estate traveling in the world and then six or seven years in merchandising. So I think it is pretty seamless. And to see them, the two of them work together over the last two years, almost two years since Ron became President, it's very similar to what I saw during those two years when Craig became President, and then two years later, Jim retired and Craig took on the CEO role as well. And so that's pretty much steady as she goes.
Charles Grom: Got you. Great. Happy holidays. Thanks.
Richard Galanti: Thanks.
Operator: We'll take our next question from Scott Mushkin with R5 Capital.
Scott Mushkin: Hey, Richard. I guess, I just wanted to think about the potential clubs in the U.S. I know it comes up sometimes, but obviously, you added eight. It just seems like there's maybe more runway you can hear in the U.S. And I wonder if you have any thoughts on that. And then I had a quick follow-up.
Richard Galanti: Sure. Well, if we were to open the 31 this year, that would be somewhere in the low 20s, the 23, 24 in the U.S. And I recognize a few of those are business centers, which is we continue to add as well as regular -- most of the regular warehouses. And I would say that, yes, I guess the story I'd share with you is six or eight years ago when it was roughly 60-40 or 70-30 U.S.-Canada versus the international -- other international. We were asked, what would it be by today? I'd say, well, by today, it will be 50-50. Well, today, you're asking the same question, it's 60-40 or 70-30 today, what will it be? And I think it will trend that way over time, but we are finding more opportunities in the U.S. Clearly, our average sales volume per location is higher today than we would have expected ourselves thankfully, six, seven years ago, what would it be by now. And we are finding those opportunities. So I view that as good news. We still -- we've got a lot of things going on to drive International, but International will be 6 or 7 units this year. And then opportunity to grow last year, international was -- is 9 or 10 and that's more of a timing issue.
Scott Mushkin: So then my follow-up is around traffic and also like the growth you had in appliances and TVs. You're just kind of going in a different direction than a lot of people. So what's driving the share gains in those categories? But also, are you guys doing anything specifically different to drive the traffic numbers you're seeing? Because I mean, they're pretty amazing, given the environment.
Richard Galanti: Yeah. Well, look, I've always said I think the biggest attribute of value is the lowest price, given quantity and quality of good or service and then certainly add to that the trust that our members have. I think as it relates to specific things like I pointed out, like appliances and even tires, its value. We -- and the -- and having acquired Interval three or four years ago now called Costco Logistics, we're doing a lot of business there. And I think we've gotten a better job of communicating what the value is, not just showing what the price of the exact item is at some of the other big retail competitors on some of these big items. But then you add in delivery, take away the old product used, the installation, delivery, take away the old product for disposition, it’s significant savings. Go do a price check of some of those things compared to our competition, that’s where you’ll see the strength.
Scott Mushkin: Perfect. Thanks.
Operator: We'll take our next question from John Heinbockel with Guggenheim.
John Heinbockel: So Richard, I'm wondering if one of the things you may do differently here, we've talked about this before is leaning into personalization more and where you are on that journey, particularly with Ron coming in.
Richard Galanti: Right. Well, we're -- first to our business was fixing the foundation. We're in the middle of re-platforming our e-commerce. It's not a big bank where we're going to put the switch one day, we're bringing things over and that's in progress. It was, I think I mentioned last -- probably last quarter, it's a two-year road map on that, and we're halfway through that. And so I'd say very little so far. If we're in the second inning, maybe we're in the third inning now. But we -- a lot of the focus has been on, first of all, making sure doing small improvements. We certainly got the -- on the 5 star rating, it got up north of 4.5 on that, and we're getting better at the site every time. But I think you would see personalization and, first of all, targeting and then personalization more over the next couple of years, honestly. And we're fine with that. We're the first to our business getting the foundation right. And we've made a lot of progress. I didn't spend a lot of time on this call talking about the new things, the enhancements we've made to the mobile site and the e-com site, but we've done a lot.
John Heinbockel: And maybe as a follow-up, you talked about the international opportunity and it's still very well underdeveloped. So what's the hindrance to getting to -- because you're in a lot of countries now, 15 to 20 annual openings, maybe that's a big ask. But is it just quality of real estate because I would imagine operationally, it's not a human resource issue. Is it purely a real estate issue?
Richard Galanti: I would say it's a combination of issues. In some countries, I mean, if you look at Korea, Taiwan, where we have whatever, 15 or 16 locations in each country, very successful. It's a little harder to find the next location just from a real estate standpoint. We -- if you look in Japan where we have plenty of future opportunity, we've got 30-plus now. And -- but again, it's a little bit of real estate. If you look at places like China or Spain, one of the challenges is you want -- you like to be able to ideally bring over more than a handful of people from the existing locations in the new one. It's a very hands-on operation. I think one of the things that we felt we mentioned that we had success when we first opened our first unit in Shanghai is we had at least 60, 70 people move there from Taiwan for promotions and for interactions, not just in the office and the buying offices, but even in the key supervisor and manager positions within the warehouse. And so it takes a little longer. And -- but we're working hard at it but it's a very hands-on experience.
John Heinbockel: Thank you.
Operator: We'll take our next question from Kelly Bania with BMO Capital Markets.
Kelly Bania: Hello, Richard. Thanks for taking our questions. Just wanted to kind of follow up on Scot's question. I think your average sales per club in the U.S. and Canada is around $300 million at this point. And just curious on the status of how many clubs are doing kind of well over that and are maybe in some need of relief in the form of self-cannibalization and more clubs nearby. And a follow-up as well on International. Just as we think about the next maybe three to five years, are there any countries that might be disproportionately getting more of the growth here?
Richard Galanti: Okay. What was the first part of the question, again?
Unidentified Company Representative: The average sales.
Richard Galanti: Average sales. I don't have the numbers in front of me, but I know in fiscal '23, we had something like 25 or so locations that did over $400 million and another 160 or so that did $300 million to $400 million. Those are huge numbers. And certainly, as we get 350-plus and one of them, by the way, they did over 400 did a few million over $600 million. And so generally, when it starts getting -- when it starts having a three in front of it, certainly at $350 million, we want to start looking to see what we can do to cannibalize it, frankly, and to have more growth in that market. And so hopefully, that's our -- one of our bigger problems and challenges that we have more of those each year. So I think that will continue. Again, if I look back five, eight years ago, even assuming whatever inflation number you want to assume, I think we've done a little better than that in terms of the sales volumes. And so that's good news for us that we'll continue to do that. Internationally, again, I'm just looking at the map of where we are. Certainly, we only have four locations in Spain. We've actually added a few on a base of 30-plus in the U.K. We think we have more opportunity in Mexico. In Japan, where we have something in the low 30s, certainly, it's done well there, and there's many more markets and population there that we can go to. Australia is, whatever two-thirds -- a little under two-thirds of the size of Canada where we have 105 or so locations. And in Australia, we have 15. I'm not suggesting we're going to have two-thirds of 105 there anytime soon. It takes us 35-plus years to get there in Canada. But we think that those are the opportunities. It's not like we're looking for a lot of other new countries at this juncture. We've done a few new countries, those single locations like in Sweden and Iceland and Auckland all being somewhat managed buying wise somewhat operationally by host country in the case of Scandinavia by the U.K., in the case of Auckland by Australia.
Kelly Bania: Thank you.
Operator: We'll take our next question from Scot Ciccarelli with Truist.
Scot Ciccarelli: Good afternoon, guys. So Richard, last quarter, you talked a bit about Costco Next. And I guess my question is, how big of an impact is that program having on your e-com sales at this point, number one? Number two, kind of related to that, any change in your betting of what vendors operate on that program, just thinking about the quality control aspect? Thank you.
Richard Galanti: Well, first of all, it's still very small relative to our company. And the fact is, is that the Costco net sales currently are not in our sales. It's -- we got to commission, so it's kind of like 3P, if you will, 3P sales. And at some juncture, some of their rules -- accounting rules where you can include it in sales based on what risk and what ownership level you have in the items. But at this juncture, those sales, it's more of the market value and just the commission in our number. In terms of how we vet, we do it the same way we vet items. We want items that make sense to provide value, and we have a team that is here that are vetting every -- each and every one of those. I think we're up to about 70 -- about 65 current suppliers on there and we'll certainly have many more as we go forward.
Scot Ciccarelli: So presumably, if that program keeps growing, should that be a natural gross margin driver for you over time? I know it's small now, but if you're just collecting the commission, presumably that's kind of 100% margin, right?
Richard Galanti: Essentially, yes. Much like the travel business.
Scot Ciccarelli: Okay. Thank you.
Unidentified Company Representative: Mostly.
Operator: We'll take our next question from Greg Melich with Evercore ISI.
Gregory Melich: Hi, thanks. Richard, I want to follow up on the membership fee hike as I think now we're in extra time. And I wonder how much does the growth in mix and Executive membership driving that high single-digit growth. Is that what it means that you don't have to increase it and you could keep waiting or is there something else?
Richard Galanti: I think it's just us. Again, if I look at the -- if you ask the question, what are the variables we would look at, we would want to look at strong renewal rates, strong new sign-ups, strong loyalty, and we have all that. So I think it's a question is, we haven't needed to do it. We like providing extreme value. Certainly, while we've gone a little longer than the average increase, we feel we certainly have driven more value to the membership. So I'll use my standby answer, my answer, it's a question of when, not if. But at this juncture, we feel pretty good about what we're doing.
Gregory Melich: And a follow-up on inflation. I just want to make sure I got that right. You said 0% to 1% for the quarter. Did it trend towards 0%? Did we exit near the bottom? And you mentioned some categories that were deflationary, which ones are stubborn in terms of inflation where it's hardest to get it out?
Richard Galanti: Which inflation -- which categories are stubborn in inflation?
Gregory Melich: Yeah. Where you can’t get that?
Richard Galanti: CPG, obviously.
Gregory Melich: All the branded packaged stuff?
Richard Galanti: There wasn't a big trend. I think at the end, it was a little lower than the beginning, but not a big trend.
Gregory Melich: Okay. So it's not like we exited 0%. We're still slightly positive.
Richard Galanti: Right. But recognize, the LIFO charge is an inventory cost of sales charge. [Multiple Speakers]
Unidentified Company Representative: Year-over-year number. LIFO [Multiple Speakers]
Richard Galanti: Right. The 0% to 1% is from the beginning of the fiscal year. Now it's from -- I'm sorry, the beginning of -- the 0% to 1% is versus a year ago.
Gregory Melich: Year-over-year, got it.
Richard Galanti: Yeah.
Gregory Melich: Great. And then just last, what is the auto renewal rate now?
Unidentified Company Representative: Around 60%.
Richard Galanti: In the U.S., it's around 60%.
Gregory Melich: Perfect. Thanks. Have a great holiday guys.
Richard Galanti: You too.
Operator: We'll take a next question from Rupesh Parikh with Oppenheimer.
Rupesh Parikh: Good afternoon. Thanks for taking my question. So I just want to go to operating expense growth. So operating expense growth is still high. Would you expect the growth rate to moderate once you lap that March wage increase? And then anything unusual within that line item that's still driving pretty high growth?
Richard Galanti: There's not a lot unusual. I think it gets back to the question of low inflation, which creates a little bit more of a challenge, right? My extreme -- and again, that was a very extreme example I gave you on nuts. But when you had a slight 0% to 2% decline in sales and a 14% increase in units, you got more labor involved, more hours stock of the shelf. I mean that's at the 40,000-foot level. And that's an extreme example. But I think overall, it is sales base. You should also remember, if you remember going back to fiscal '19 and the first part of fiscal '20, before COVID, our SG&A percent was -- for all of ‘19, it was at 10 04. In the first quarter of 2020, it was a 10 34, And for the whole year, it was a 10 04 for both of those two years. And we used to think to ourselves will we ever be able to get it back below 10%. And in 2022, which was the kind of month seven through 18, if you will, that 12-month period after that full fiscal year for us of COVID, we reported an 8 88 for that year. So even at the 9 45 that we just reported, we're still quite a bit lower than we had been historically, a function of a lot of things, including higher sales productivity and all that. So I think we're doing pretty well. I think certainly, that's the challenge. How do we reduce that and how do we manage that? And certainly, the biggest way to manage is driving more sales.
Rupesh Parikh: Great. And then maybe just one follow-up question. So just curious how you're feeling about the healthier consumer. So it was interesting to hear that TVs did well this past quarter.
Richard Galanti: Look, I think when we're asked that question, we're fortunate to answer it that we're, first of all, looking at the consumer through somewhat rose-colored glasses here. The we have enjoyed great value. And again, we're convinced it's value. We've got -- I think on the margin, there's a few extra things that we've done. We've improved the site of the website. We've gotten a little better communicating stuff, not completely. But I think overall, it's -- and we've been good merchants. I think the merchants have done a great job of bringing in new stuff. And not being shy when we see an industry category down a lot, that we can still -- if we're driving people in, we've got a better chance of getting them to buy something.
Rupesh Parikh: Thank you. Happy holidays.
Richard Galanti: Thanks.
Operator: We'll take our next question from Oliver Chen with TD Cowen.
Thomas Nass: Hi. This is Tom Nass on for Oliver. Just a quick question on the trend of Kirkland relative to last year. If you could just remind us how that's trending maybe across categories. And then if you have any notable callouts, any recent innovations? Just curious if this is essentially driving any efficiencies and supplier negotiations that can position Costco for stronger gross margin ahead.
Richard Galanti: Well, I would say, allowing us to get better deals, which means lower prices. But look, I think we -- Kirkland signature (ph) relative to non-gas sales is in the high-20s. And I think it was probably a good year ago when inflation was in the 8 and 9 range, if you will, if you remember. And we talked about that year-over-year, we saw probably the biggest increased penetration of KS at Costco. It was 1, 1.5 percentage points, when historically, it has been 25 basis points to 50 basis points a year. I think we're back to that, but we've maintained that higher level and we're back to seeing smaller increases in penetration every year, but nonetheless still driving that business. But we've got -- yeah. I think that helps with some of the deflationary certainly with KS stuff, we're closer to the supplier. We're not the only -- we're the only customer buying that item and we can drive a little bit more business. So I think it just continues to work that way for us.
Thomas Nass: Great. And then just a quick follow-up on any notable behavioral trends you've seen in consumer shopping this holiday season?
Richard Galanti: Some colleague in my room said they're buying gold. But no, that's actually online mostly. But no, I think -- again, I think the traffic thing is the thing that we're happily surprised about that we're continuing to drive people in on an increasing basis. We know we benefited during those, call it those two years, kind of March, April of '20 to March, April of '22, the kind of the two years of COVID, we benefited in many ways from more members and more volumes. And we’ve not only kept it, we’re continuing now to add to those levels, so we feel very fortunate in that regard.
Thomas Nass: Thanks.
Richard Galanti: One of my colleagues here just mentioned that discretionary merchandise trends are getting a little better. And that’s not only on big ticket but in general, nonfood stuff. I think that corresponds with my comment earlier that we feel good about the seasonal -- how we’ve done seasonally.
Thomas Nass: Great. Thank you.
Operator: Thank you. We'll take our next question from Mark Astrachan with Stifel.
Mark Astrachan: Yes. Thanks and good afternoon, everyone. I guess I wanted to ask on the Kirkland products, specifically maybe on the CPG that you mentioned. How has pricing or how has prices trended on those versus the branded products? Have you seen any deviation there, given you're closer? Are you able to lower prices? I suppose to the extent that, that has happened, do you notice any more market share changes within those CPG categories?
Richard Galanti: I think it's slightly -- it's deflationary. It's a little more deflationary in the KS than in the CPG, which drives more value to KS, frankly. But we're seeing some -- our ability to work with our CPG suppliers as well, but just a little stronger ability to do that with KS.
Mark Astrachan: Got it.
Richard Galanti: And it is, again, a comment in the room here. We've had -- it's allowed us to do some new item introductions on the KS side as well.
Mark Astrachan: Great. And then just following up on the last question. Anything you can call out amongst the newer memberships cohorts in terms of renewal rates versus the average?
Richard Galanti: Generally speaking, if you compare, everybody was always concerned. I remember 10-plus years ago, people would ask you, how are you going after millennials? And then it's how you go after the next gen or whatever, the Gen Zs or whatever? At the end of the day, when we look at the different cohorts, if you just change the names, the curve seems to be about the same in terms of getting new younger members. They buy less, they buy more as they get older into that 40- to 55-year-old sweet spot. I don’t know in terms of renewal rates. I think the rates are – our overall rates are improving so I think we’re probably doing a better job there. Certainly, things like, frankly, auto renewal helped that as well.
Mark Astrachan: Got it. Thank you. Happy holidays.
Richard Galanti: Same to you.
Operator: We'll take our next question from Corey Tarlowe with Jefferies.
Corey Tarlowe: Hi. Good afternoon. Thank you for taking the questions. Richard, you mentioned about the wage increases that you've taken recently. I'm curious to get your thoughts about the wage increases that you've taken within the context of now the lower inflation that you're seeing as well as what could be potential deflation further ahead. So curious about the ability for Costco to maybe maintain a more nimble margin structure amid what could be some volatility on the pricing side.
Richard Galanti: Frankly, we look at the wages in a vacuum, and we want to do as much as we can for our employees. And certainly, there were several increases starting with the frontline worker premium during the initial year of COVID. We kept half of that in there, which we kept $1 of those $2 now in there, which was like $400 million a year. Again, we've also benefited from stronger sales and productivity so we're able to afford that. But we look at them independently and we'll continue to do that to look at it. To the extent inflationary pressures are down, that means there's probably a little less inflationary pressure on wages. But we give -- over half of our employees are top of scale and they're getting increases irrespective of some of the extra things we talked about every March. And then as you go from a new employee over the first 9,000 or 10,000 hours, you're getting constant increases that are more -- significantly more.
Corey Tarlowe: Understood. And then just piggybacking off of that, and I understand it may be difficult to attribute a cause and effect relationship to this. But do you think that perhaps the moderating inflation that we've seen in the need-based categories like fresh and food and sundries may have unlocked a little bit of extra wallet to spend in the non-food category? And they have driven some of the momentum that you've seen in categories like TVs and others?
Richard Galanti: I think it can't hurt even with gas prices have come down a little bit. That's top of mind every week when somebody fills up their tank. So those things help. I think I'm sure on a macro basis, that's the case but it's a guess on our part.
Corey Tarlowe: Understood. Great. Thank you very much and best of luck.
Richard Galanti: Thank you.
Operator: We'll take our next question from Dean Rosenblum with Bernstein.
Dean Rosenblum: Hey, Richard, guys. Thanks for taking my questions. There's really two big debates that clients are asking us about. First one is on gross margins, and in particular, the potential for a gross margin impact from mix shift back toward things like appliances and TVs, which are notoriously lower gross margin, at least in the marketplace versus fresh and food and sundries. As you see the sort of big ticket discretionary starting to come back a little bit, do you expect any overall impact on gross margins from that mix shift away from food and sundries to big ticket discretionary?
Richard Galanti: First of all, our margin range is so much more compacted than traditional retail, different categories of traditional retail. I mean, if you think about it, we have, what, 12%, 13% gross margin, 11%. I'm thinking markup, and in theory, it ranges from 0% to 15%. In reality, it's -- there's very few things that are below 5% and a lot of things hover around the 8% to 12% range. And so I don't think it's as big of an impact to us in terms of those mix changes. And I got to say it's always all saying it's always something. There's always something that hurts you and there's another thing that helps you. And it's a really -- it's a mixture.
Dean Rosenblum: True. And then the other big debate that's contrasting about is the relative profitability of new stores versus existing stores. There's sort of two themes there. One is new U.S. versus existing U.S. and then the relative profitability of new stores internationally. I was wondering if you could speak to that a bit.
Richard Galanti: Well, first of all, when you look at like at an ROI, the eye on the denominator on an older building is a lower eye (ph). If 10 years ago, the typical building in the United States property equipment and building fixtures, I'm shooting from the hip here, was $30 million to $35 million and now it's $45 million to $50 million. So you've got a different eye. But generally speaking, when we look at the ROI of each of our eight U.S. regions, our two Canadian regions, new units come in, start a little lower and get up there over time. You'll have some outliers because of some units that are 30- and 40-years-old even with eye (ph) increase because we expanded the unit and upgraded it and remodeled it. The fact of the matter is the higher volume is really shine through there. On an international standpoint, we've always, I think, talked about the fact that there's a few different things that the ROIs in some of these other countries tend to be a little higher. The return on sales tends to be even more -- even higher than that in some of these countries because a combination very little related to gross margin, some related to membership fees, some related to wages and some related to benefits, health benefits. U.S. health care costs dwarf every other country that we're in.
Dean Rosenblum: Got it. Thanks so much. Appreciate it. Good holidays and thanks for the pie.
Richard Galanti: Thank you.
Operator: We'll take our next question from Joe Feldman with Telsey Advisory Group.
Joseph Feldman: Hey, guys. Thanks for taking the question. Wanted to first ask on Executive member penetration seems like it continues to inch higher. And I was just wondering how you guys think about that. And like how high should that be? I mean presumably, you want everybody to be an Executive member. But is there like kind of a natural level where you think it can still go from here beyond the 46%?
Richard Galanti: I think -- well, there's always going to be another country or two we add. You need a certain number. In our view, we've always done it after there's 15 or so warehouses in the country. So that will add to it a little bit. But no, I think some of the increase -- it's kind of like getting up to that asymptotic line when you -- one of the things that drove it in the last few years, one, we've done a better job in the last several years of selling it to you as well as auto renewal. When people come in now or sign up online, they're signing up to they want to put their credit or debit card in there and they can opt in to doing it online -- doing other renewal. So I think those things have pushed it along with us being so wonderful. But I think you'll still see it come up a little bit but probably that rate of increase will slow over time.
Joseph Feldman: Got it. Okay. And then maybe just a quick follow-up. Anything to talk about on shrink because I know that there was an issue with shrink even for you guys at one point. And I know you guys have cracked down on making sure members are showing their cards when they walk in the store. And obviously, when you leave with your goods, you're checking your receipts. But anything we should think about with regard to shrink going forward and recent trends?
Richard Galanti: Thankfully, nothing at all. It's really -- I think what we already talked about was a combination of, as we went into some self-check out over the last several years and then perhaps more recent things that you read about in the paper, we get less impacted by the latter as well. Maybe we saw a couple of basis point delta upward on a very low number of basis points to start with. So we're fortunate in that regard.
Joseph Feldman: Got it. Thank you and happy holidays, guys.
Richard Galanti: Same to you. Thank you.
Operator: We'll take our next question from Laura Champine with Loop Capital.
Laura Champine: Thanks for taking my question. I wanted to dig in a little bit more into some of those numbers on the column. The ancillary profit improvement, I think that's where you're -- I'm just wondering what drove that. And on the operations line, it sounds like that pressure in SG&A didn't come mostly from wages and I'm wondering where it did come from.
Richard Galanti: Yes. On the ancillary line, it's gas and e-com and it's a combination of increased sales penetration and increased margins within those businesses. The thing about gas is I think everybody out there that has gas stations, what we have found is we've been able to see improved profitability not just in the last quarter or two, but over the last few years -- last three to five years, improved profitability in gas because others are making more, and we're allowed to make a little more. When we do our competitive price shops on gas, which we do weekly at every gas stations, we operate with our neighboring competitive gas stations. On the e-comm side, I think driving more sales has helped us in the margins there as well.
Laura Champine: Thanks. And then just on the operations...
Richard Galanti: Yeah. On the wages, while we pointed out – I pointed out on the call, I think there was like four or so basis points in total from those two distinct increases, we do other increases like over half of our employees are top of scale. They get an increase every March that’s significant as well, significant relative to basis points. When you have lower sales figures. I mean, and – the rest of it is all the other lines like energy costs and the like.
Laura Champine: Got it. So most of the pressure is probably coming from wages, not just those two discrete callouts you had?
Richard Galanti: It’s more than half. I don’t have the exact figures with me.
Q – Laura Champine: Got it. Thank you.
Operator: Thank you. And there are no further questions at this time. I’d like to turn the call back over to Richard Galanti for any additional or closing remarks.
Richard Galanti: Well, thank you, Lisa, and thank you, everyone on the call. We’re around to answer questions and have a happy holiday. And I think this is a record time of finishing this call. So enjoy the holidays. Thank you very much.
Operator: Thank you. And that does conclude the presentation. Thank you for your participation today, and you may now disconnect. |
ADBE | 4 | 2,023 | 2023-12-13 22:40:22 | Operator: Good day, and welcome to the Q4 and FY 2023 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jonathan Vaas, VP of Investor Relations. Please go ahead.
Jonathan Vaas: Good afternoon and thank you for joining us. With me on the call today are, Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; and now Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice-President and CFO. On this call, which is being recorded, we will discuss Adobe's fourth quarter and fiscal year 2023 financial results. You can find our press release as well as PDF of our prepared remarks and financial results on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans is as of today, December 13th, and contains forward-looking statements that involve risk uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call, we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant-currency revenue growth rates unless otherwise stated. Reconciliations between the two are available in our earnings release and on Adobe's IR website. I will now turn the call over to Shantanu.
Shantanu Narayen: Thanks, Jonathan. Good afternoon, and thank you for joining us. Q4 was our first-ever $5 billion quarter, a new record for the company. Adobe achieved revenue of $5.05 billion, representing 13% year-over-year growth. GAAP earnings per share for the quarter was $3.23 and non-GAAP earnings per share was $4.27, representing 28% and 19% year-over-year growth, respectively. Q4 was the culmination of another record year for Adobe, achieving $19.41 billion in revenue, which represents 13% annual growth. GAAP earnings per share in fiscal 2023 was $11.82 and non-GAAP earnings per share was $16.07, both representing 17% year-over-year growth. We exited the year with $17.22 billion in RPO. Our strong performance reflects the mission-critical role our products play in a digital-first world, incredible product innovation and exceptional execution. Adobe Creative Cloud, Document Cloud, and Experience Cloud have become the foundation of digital experiences, starting with the moment of inspiration to the creation and development of content and media to the personalized delivery and activation across every channel. Adobe's mission of changing the world through personalized digital experiences and our delivery of foundational technology platforms, set us up for the next decade of growth. We take pride in being one of the most inventive, diversified, and profitable software companies in the world. We believe that every massive technology shift offers generational opportunities to deliver new products and solutions to an ever-expanding set of customers. AI and generative AI is one such opportunity and we've articulated, how we intend to invest and differentiate across, data, models, and interfaces. We have delivered against this strategy and I'm pleased that a number of our groundbreaking innovations, including our Firefly models and integrations across Creative Cloud, Liquid Mode and integrations across Document Cloud and AI services in our real-time Customer Data Platform and integrations in Experience Cloud, are now seeing tremendous usage by customers. We remain excited about the strategic opportunity with Figma, to jointly advance product design, accelerate collaborative creativity on the web, and redefine the future of creativity and productivity. We continue to engage with the European Commission, the Competition and Markets Authority in the UK, and the US Department of Justice, as they conduct their regulatory reviews. The EC has provided a preliminary statement of objections and the CMA has issued provisional findings of competition concerns. We strongly disagree with these findings and are responding to the respective regulators. As per the current timelines, the EC's decision deadline is February 5th and the CMA’s is February 25th, while the DOJ does not have a formal timeline to decide whether to bring a complaint, we expect a decision soon. I'll now turn it over to David to discuss the momentum in our Digital Media business.
David Wadhwani: Thanks, Shantanu. Hello, everyone. In Q4, we achieved net new Digital Media ARR of $569 million and revenue of $3.72 billion, which grew 14% year-over-year, fueled by innovation in both our Creative and Document businesses. Starting with Creative Cloud, global demand for content is accelerating and continues to be a tailwind for the business. Creative Cloud remains the creativity platform of choice for creators across imaging photography, design, video, web, animation, and 3D. Our rapid pace of product and AI model innovation is empowering a wide and growing base of individuals, students, creative professionals, small-business owners, and enterprises to create and monetize amazing content more quickly and easily than ever before. We were thrilled to come together in person with thousands of creators at Adobe MAX in Los Angeles. And at our MAX event in Tokyo with millions more from our community engaging with us online. We reached a record 300 million social interactions in the month following MAX. Q4 was a record quarter for Creative Cloud, achieving $3 billion in revenue, which grew 14% year-over-year. Net new Creative Cloud ARR was $398 million. Business highlights include strong digital traffic, resulting from product innovation, social engagement, and our continued product-led growth efforts which drove record new commercial subscriptions in the quarter. The general availability of our generative AI Firefly models and their integrations across Creative Cloud drove tremendous customer excitement with over 4.5 billion generations since launch in March. The release of three new Firefly models, Firefly Image two model, Firefly Vector model, and Firefly Design model, offering highly differentiated levels of control with Effects, Photo Settings, and Generative Match. We also introduced Generative Credits as part of our Creative Cloud subscription plans. The general availability of Photoshop Generative Fill and Generative Expand which are seeing record adoption, they're already among the most used features in the product. Advances in Adobe Illustrator with the introduction of Text to Vector beta enabling users to generate icons, scenes, subjects, patterns, gradients. Adobe Premiere Pro advances include a significant performance improvement in the timeline for faster and smoother editing, new color preferences, and improved tone mapping. Premiere Pro is now natively integrated with Frame.io offering faster content sharing and collaboration. The combination of Adobe Express and Firefly is enabling everyone from Creative Pros to beginners to quickly move from ideation to task-based workflows in Express dramatically expanding our reach and widening our top-of-funnel. The family of generative capabilities across Express including Text to Image, Text Effects, Text to Template, and Generative Fill are driving adoption of Express and making it even faster and more fun for users of all skill levels. Express now comes pre-installed on all new Chromebooks, making it accessible to students, educators, and anyone using Chrome OS. Continued strength in Adobe Stock which had its best year ever driven by accelerating demand for high-quality image, vector, video, and 3D content. Creative Cloud, Express, and Firefly integrations with Adobe GenStudio enabling ideation, creation, and stakeholder collaboration as part of their overall content supply chain. Strong mid-market and enterprise adoption driven by up-sell to Creative Cloud offerings with Firefly. Key customer wins include Cyber Agent, Deloitte, Discovery Communications, Nexstar Media, Pepsi, Publicis, and the United Nations. We are thrilled with the momentum we're seeing in the Creative business following a year of unprecedented innovation. Customer excitement around Firefly integrations across our applications has been great to see with community engagement, social interactions, and creative marketing campaigns, driving organic brand search volume, traffic, and record demand. While we started rolling out new Creative Cloud pricing in select geographies in November, the primary driver of growth continues to be new paid subscriptions across our routes-to-market. We are excited to build on this momentum as we enter FY '24. Now turning to Document Cloud, digital documents are essential enablers of our personal and professional lives. Document Cloud is a leader in digital documents powering all common document actions including editing, sharing, reviewing, scanning, and signing. Document Cloud innovations are advancing accessibility, comprehension, productivity, automation, and security in document workflows across web, desktop, and mobile. In Q4, we achieved Document Cloud revenue of $721 million, growing 17% year-over-year. We added a record $171 million of net new Document Cloud ARR with ending ARR growing 23% year-over-year in constant currency. Business highlights include Acrobat Web growth, which continues to be an incredible source of customer acquisition, with monthly active users up over 70% year-over-year. The surge in usage of link sharing for stakeholder collaboration around PDF files, which increased 400% year-over-year, creating a viral growth loop, that is bringing tens of millions of users into the Acrobat ecosystem. This is a great example of how we are scaling our PLG motions. Strong demand for Acrobat on mobile with MAU surpassing 100 million users in Q4. Liquid Mode has now served over one billion files to customers demonstrating how indispensable this technology has become on mobile devices. Adobe Acrobat to Express workflows making it even easier to import, edit, and enhance documents to create visually stunning PDFs. Key enterprise customer wins include Alshaya, Bank of America, Department of Veterans Affairs, Mastercard, State Farm Auto Insurance, and Volkswagen. Much like the Creative business, we expect generative AI to deliver additional value and attract new customers to Document Cloud. Acrobat's generative AI capabilities, which will enable new creation, comprehension and collaboration functionality have already been rolled out in a private beta. We expect to release this in a public beta in the coming months. It's been an extraordinary year for the Digital Media business with the introduction of hundreds of transformative innovations that are reshaping the future of creativity, productivity, and digital experiences. Capping this year’s many accolades, TIME magazine recognized Adobe Liquid Mode, Photoshop Generative Fill, and Generative Expand, among the best inventions of 2023. I'll now pass it to Anil.
Anil Chakravarthy: Thanks, David. Hello, everyone. Digital experiences are indispensable for every business in every category, enabling companies of all sizes to engage and transact with customers around the world. Adobe's Holiday Shopping Report, which analyzes trillions of data points, found that both Black Friday and Cyber Monday sales hit record highs of $9.8 billion and $12.4 billion, respectively, jumping 7.5% and 9.6% from last year. We predicted that holiday 2023 spend will exceed $221 billion in the US alone. Adobe Experience Cloud is optimally positioned to capitalize on this massive global opportunity. Companies across B2C and B2B are turning to Adobe Experience Cloud as the platform to accelerate experience-led growth. Our leading solutions spanning data insights and audiences, content, and commerce, customer journeys, and marketing workflow, empower businesses to drive customer demand, engagement, and growth while simultaneously delivering productivity gains. Our comprehensive set of applications, including Real-Time CDP are built natively on our highly differentiated Adobe Experience Platform, providing companies with a unified profile of each of their customers to deliver personalized, real-time experiences at scale. Generative AI accelerates our pace of innovation across the Experience Cloud portfolio enabling us to build on our capabilities to deliver personalized digital experiences. Our efforts are focused in three areas: one, augmenting our applications with an AI Assistant that significantly enhances productivity for current users, and provides an intuitive conversational interface to enable many more knowledge workers to use our products; two, reimagining existing Experience Cloud applications, like we did with Adobe Experience Manager; and three, developing entirely new solutions built for the age of generative AI, like Adobe GenStudio. In Q4, we continue to drive strong growth in the Experience Cloud business across our enterprise and mid-market customers achieving $1.27 billion in revenue. Subscription revenue was $1.12 billion, representing 12% year-over-year growth. Business highlights include, strong momentum with Adobe Experience Platform and native applications inclusive of Real-Time CDP, Adobe Journey Optimizer, and Customer Journey Analytics. AEP had its first $100 million quarter of net-new business in Q4 and exited the year with a greater than $700 million annualized book of business. Release of Adobe GenStudio, an end-to-end solution that brings together best-in-class applications across Creative Cloud, Express, and Experience Cloud with Firefly generative AI at the core to help brands meet the rising demand for content. GenStudio provides a comprehensive offering spanning content ideation, creation, production, and activation. We're seeing tremendous interest in GenStudio from brands like Henkel, Pepsi, and Verizon and agencies like Publicis, Omnicom, and Havas as they look to accelerate and optimize their content supply chains. Reimagined customer experiences with the all-new Adobe Experience Manager Sites that enable businesses and developers to quickly test and optimize web content, deliver fastest possible page load times, and maximize SEO rankings, lighthouse scores, and conversion. Adobe was recognized as a leader in over 25 industry analyst reports this year, including the Gartner Magic Quadrant for Digital Experience Platforms, B2B marketing automation platforms, and multichannel marketing hubs. In the Forrester Wave for Digital Experience Platforms which was published last week, Adobe received the highest scores for strategy. Key customer wins include Alshaya, Coca-Cola, EY, IBM, Marriott, Riyadh Air, Santander Brasil, Sony, Southern Graphics, Unilever, Vanguard, and Verizon. In our conversations with these and other customers around the world, c-Level executives are continuing to prioritize experience-led growth as a critical business imperative, despite ongoing budget scrutiny. Adobe Experience Cloud is well-positioned to keep winning with innovative products that power end-to-end customer experiences and enable companies to simultaneously drive growth and profitability. We are looking forward to continuing our leadership and momentum into 2024. I'll now pass it to Dan.
Dan Durn: Thanks, Anil. Our earnings report today covers both Q4 and FY '23 results. What a year 2023 was, fueled by a deep understanding of our customers, product innovation, and outstanding execution, we delivered strong financial results and world-class margins, positioning the company for years of continued growth. In FY '23, Adobe achieved record revenue of $19.41 billion, which represents 10% year-over-year growth or 13% growth in constant currency. GAAP EPS for the year was $11.82 and non-GAAP EPS was $16.7; each growing 17% year-over-year. FY '23 business and financial highlights included Digital Media revenue of $14.22 billion, net new Digital Media ARR of $1.91 billion, Digital Experience revenue of $4.89 billion, cash flows from operations of $7.3 billion, RPO was $17.22 billion exiting the year and repurchasing approximately 11.5 million shares of our stock during the year at a cost of $4.63 billion. In the fourth quarter of FY '23, Adobe achieved revenue of $5.05 billion, which represents 12% year-over-year growth or 13% in constant currency. GAAP-diluted earnings per share in Q4 was $3.23 and non-GAAP diluted earnings per share was a record $4.27, growing 28% and 19% year-over-year, respectively. Q4 business and financial highlights included Digital Media revenue of $3.72 billion, net new Digital Media ARR of $569 million, Digital Experience revenue of $1.27 billion, cash flows from operations of $1.6 billion. Adding approximately $1.5 billion RPO in the quarter, our highest sequential quarterly increase ever and repurchasing approximately 1.8 million shares of our stock. In our Digital Media segment, we achieved Q4 revenue of $3.72 billion, which represents 13% year-over-year growth, or 14% in constant currency. Our net-new ARR in Q4 was $569 million, which was a quarterly record in constant currency and we exited the quarter with $15.17 billion of Digital Media ARR. We achieved Creative revenue of $3 billion, which represents 12% year-over-year growth or 14% in constant currency and we added $398 million of net-new Creative ARR in the quarter. Driving this performance was strong customer acquisition throughout the quarter as well as strength during the peak holiday shopping weeks. Fourth quarter Creative growth drivers included individual subscriber growth fueled by targeted campaigns and strong web traffic. A strong quarter for Creative Cloud All Apps subscriptions across customer segments and geographies, with particular strength in emerging markets. Sales of CC single apps, including a strong quarter for Imaging and photography offerings. Continued growth of our Frame.io offering and Adobe Stock which capped off its best year ever in terms of net-new ARR. Customer demand in education driven by back-to-school purchasing as well as migrations to full-priced offerings by graduating students entering the workforce. And typical Q4 strength in the Enterprise, including significant upsell of our new Firefly and Express offerings. Adobe achieved Document Cloud revenue of $721 million, which represents 16% year-over-year growth or 17% in constant currency. We added a record $171 million of net new Document Cloud ARR in the quarter. Fourth quarter Document Cloud growth drivers included, Acrobat's subscription demand across all customer segments routes-to-market, and geographies. Continued strength of our free-to-paid funnels including Reader on the desktop and Acrobat web. Strong performance of our collaboration services including PDF link sharing and Sign, which are virally bringing new users to the Acrobat ecosystem. An outstanding quarter for Acrobat Mobile as a result of increased proliferation, usage, and conversion and year-end seasonal strength in SMB and enterprise. Turning to our Digital Experience segment, in Q4, we achieved revenue of $1.27 billion, growing 10% year-over-year, or 11% in constant currency. We achieved subscription revenue of $1.12 billion, which represents 12% year-over-year growth. Fourth quarter Digital Experience growth drivers included strong year-end bookings across solutions with particular strength in North America, continued success closing multi-solution transformational deals with large enterprises, momentum with AEP and native applications with the FY '23 exiting book of business growing greater than 60% year-over-year, strong net dollar retention for early adopters of AEP, demonstrating the value enterprises are realizing from our real-time data platform and integrated offerings, and strength across our data and insights, content and workfront solutions and growing customer interest and pipeline for our new GenStudio solution. We drove world-class operating margins in Q4 and throughout fiscal 2023 by making disciplined investments in R&D marketing and sales and we're pleased that we grew EPS faster than revenue. Adobe's effective tax rate in Q4 was 18% on a GAAP basis and 18.5% on a non-GAAP basis in line with our expectations. RPO exiting the quarter was $17.22 billion, growing 13% year-over-year. Our ending cash and short-term investment position exiting Q4 was $7.84 billion and cash flows from operations in the quarter were $1.6 billion, after making a previously discussed payment in the quarter of $826 million of US Federal taxes that we deferred from the second and third quarters of FY '23. In Q4, we entered into a $1 billion share repurchase agreement and we currently have $2.15 billion remaining of our $15 billion authorization granted in December 2020. As a reminder, we measure ARR on a constant-currency basis during the fiscal year and revalue ARR at year-end. FX rate changes between December of 2022 and this year have resulted in a $160 million increase to Digital Media ARR balance entering FY '24, which is now $15.33 billion and is reflected in our updated investor datasheet. Factoring in the momentum across our businesses and current expectations for the macroeconomic and foreign-exchange environments, for FY '24, we are targeting total Adobe revenue of $21.30 billion to $21.50 billion. Digital Media net new ARR of approximately $1.9 billion, Digital Media segment revenue of $15.75 billion to $15.85 billion, Digital Experience segment revenue of $5.275 billion to $5.375 billion, Digital Experience subscription revenue of $4.75 billion to $4.80 billion. Tax rate of approximately 18% on a GAAP basis and 18.5% on a non-GAAP basis. GAAP earnings per share of $13.45 to $13.85. And non-GAAP earnings per share of $17.60 to $18. As a reminder, and as is customary, these targets do not reflect our planned acquisition of Figma. We expect normal seasonality throughout the year with a seasonal step-down for new business into the first quarter, sequential growth from Q1 to Q2, typical Q3 summer seasonality, and a strong finish to the year in Q4. We expect our cash tax rate to improve sequentially in FY '24 by 2 percentage points as the amortization of previously capitalized R&D increases our deductions next year for tax purposes, benefiting our operating cash flows next year. For Q1 FY '24, we're targeting total Adobe revenue of $5.10 billion to $5.15 billion, Digital Media net new ARR of approximately $410 million, Digital Media segment revenue was $3.77 billion to 3.80 billion, Digital Experience segment revenue of $1.27 billion to $1.29 billion, Digital Experience subscription revenue of $1.14 billion to $1.16 billion. Tax rate of approximately 18% on a GAAP basis and 18.5% on a non-GAAP basis. GAAP earnings per share of $3.35 to $3.40. And non-GAAP earnings per share of $4.35 to $4.40. While the implied operating margin for Q1 is up sequentially, we expect a typical seasonal margin step-down starting in Q2 as a result of the annual merit increases and disciplined investments to drive growth. In summary, I couldn't be prouder of the company's performance in FY '23 and the momentum we're carrying into 2024 across Creative Cloud, Document Cloud, and Experience Cloud. Our strategy, scale, speed of execution, and profitability position us for years of sustained success. Shantanu, back to you.
Shantanu Narayen: Thanks, Dan. In addition to our financial accomplishments, we are proud to once again be recognized for our industry leadership. Content credentials and Adobe's approach to responsible AI were recognized by Fast Company as one of the year's breakthrough innovations. We were again named to the Dow Jones Sustainability Index, Glassdoor listed Adobe is one of the best places to work and Interbrand ranked us in the top 20 Best Global Brands as the rising brand for the eighth year in a row. Digital remains a massive tailwind as content demand and consumption continues to grow and businesses of all sizes are focused on transforming their customer experiences. Adobe is incredibly well-positioned to lead and capitalize on this opportunity. Thanks to our innovative roadmap expanding global customer base, strong brand, and the best employees in the world. Our fiscal '24 financial targets reflect our confidence in continuing to drive strong topline growth and world-class profitability. I am more certain than ever that Adobe's best days are ahead of us. Thank you, and we will now take questions. Operator.
Operator: [Operator Instructions] We ask that you please limit yourself to one question. [Operator Instructions] We'll take our first question from Kash Rangan with Goldman Sachs. Please go ahead.
Kash Rangan: Hi. Thank you very much. Congrats on the quarter and happy holidays. Shantanu and team, I'm wondering, going into 2024, it definitely feels like the economy is in stable footing and in general, the software metrics are all improving as the year unfolded. And very different from going from '22 to '23, yet your DM - new ARR guidance is about the same as how you started last year, but you got the benefit of generative AI, tailwinds from the economy, and got pricing and Firefly. Can you just help us understand if you isolate for those factors, what has gone into your -- into your guidance, but it seems like, if we exclude the optionality that you have, including the tailwinds in economy that guidance looks like it's very conservative. And maybe that's the right thing to do, but just wanted to understand your thought process. Thank you so much.
Shantanu Narayen: Yeah. Thanks, Kash. I mean, certainly, really thrilled with what a phenomenal year we had across all aspects of the business, whether it was the $5 billion quarter, $5 billion book of business now in DX exiting, and certainly Digital Media ARR performance. Let's -- if you reflect, I mean, you talked about the guidance that we gave at the beginning of '23 and '24, if you recall, we actually had guided to $16.50 first then we opted as you know, to $17.50, and ended with $19.13. And so to your point on the execution front, we have delivered some great innovative products. We've expanded the customer base with new products like Express and Firefly. We're certainly focused on surfaces and making sure all of our flagship products are available across all surfaces. And so we do have multiple growth drivers to your point. And we are focused on monetizing the opportunity. I mean, I would say, we take our guide very seriously, the other way of looking at it, Kash, is it’s our highest annual guide ever in terms of what the guide we've issued, it's the highest Q1 guide ever and we want to go again, execute against this large opportunity and have another record year. So, we're feeling good, the momentum is certainly there in the business. But we take our guidance at this point of the year very seriously.
Kash Rangan: Thank you so much and happy holidays. All the best for 2024.
Shantanu Narayen: Thanks. Happy holidays.
Operator: We will take our next question from Keith Weiss with Morgan Stanley. Please go ahead.
Keith Weiss: Excellent. Thank you guys for taking the question. I think this is in a similar vein to what Kash was trying to get at. But maybe a little bit more focused on Q4 in particular. When we look at the Digital Media net new ARR adds in Q4, it looks like you had a very, very strong Document Cloud, record quarter like you were saying, really strong year-on-year growth in those net adds. Creative Cloud, where we actually saw price increase and we have all the excitement in Firefly, that was actually down on a year-on-year basis. And this is the first time since 2018 we've seen Creative Cloud net new ARR below $400 million. I think that's the surprise for investors -- a negative surprise for investors that we're trying to figure out, was there something dragging the Creative Cloud side of the equation this year, or a tough comp from last year, or something that explains why the price increases in all the positive momentum and innovation out of Adobe MAX isn't translating into net new ARR growth for Creative Cloud in particular.
David Wadhwani: Yeah. Happy to take that. Keith, David here. So first of all, as you've mentioned in the DME business, we're really excited about the results for '24, over $1.9 billion in net new ARR obviously well above the guide. We see an expanding base of customers and a lot of momentum coming from gen AI as you noted. As part of this, we delivered -- what we delivered in Q4 was net new ARR -- was a record net new ARR in constant currency. Now specific to your question on Creative Cloud momentum and how to interpret the numbers that you see there, underlying all of this is very strong momentum because we delivered a record Creative Cloud new commercial subscriptions number in the year. So that is really the foundation and the base of customers coming in and really benefiting from not just what we get in this quarter, but also how we build on that going forward. So it really just sets us up well for FY '24. As you look at the numbers for Creative Cloud ARR, net-new ARR in the quarter, you have to look at it relative -- Q4 FY '23 relative to Q4 FY '22 as you mentioned. You need to consider that FY '22 had two pricing actions, that accrued to Creative Cloud that are much lower now in Q4 FY '23. So, if you normalize for the impact of the pricing that rolled off and the pricing that came on, Creative Cloud net new ARR in Q4 grew on a constant currency basis.
Shantanu Narayen: And Keith, just to punctuate the two points that David made -- David said, first, it was a record for Creative ARR as it related to subscriptions in Q4 of 2023 and Creative ARR would have grown if you had backed out the pricing. So, the business continues to be extremely healthy to your point.
Keith Weiss: Excellent. Thank you, guys.
Operator: We will take our next question from Alex Zukin with Wolfe Research. Please go ahead.
Alex Zukin: Hey, guys. Thanks for taking my question. I guess maybe looking at next year, as we look at how much of the renewal base in Creative Cloud is potentially up for that type of the pricing uplift. And as we look at Acrobat, specifically the AI functionality that you're releasing into public beta. How should we think about the tailwind to both Creative Cloud from pricing and to Document Cloud, specifically from an AI product monetization perspective for '24 -- for calendar '24?
David Wadhwani: Yeah. Happy to take that Alex, a lot packed into that question. So let me try to tease them apart. Let me first start with the question around FY '24 and impact of pricing. Before we jump straight into that I do want to take a bit of a step back and just remind everyone that Digital Media ARR is a mix of a few things, new subscriptions which as I mentioned we had a record number of new subscriptions in Q4, up-sell and cross-sell, which is transitioning people to higher plans from the plan that they're on. And then lastly offer optimization. And as you've noted in the last couple of years, we've really been broadening the number of offers we have all the way down from free price points to the all-apps price points, but even beyond that, we now have capabilities to sell add-ons to all-apps as well. And of course, all of this does include the pricing increases that you had mentioned where we've added more value. I do want to just stress, because I know there's a lot of attention on the pricing impact that we always have seen and continue to believe that the primary growth driver for ARR will be new subscriptions in '24. So, that's why we're so focused on the top-of-funnel and new customer acquisition. But specific to your question on pricing, you need to consider a few things. First, our recently announced pricing changes will impact less than half the Creative Cloud base. So there was a very specific question you asked, hopefully, that gives you the answer, but it also leaves us the opportunity to price in new value in the years ahead as we move forward. Second, the impact will be more visible in net new ARR in the back half of FY '24 as we lap the previous pricing actions that I was talking to Keith about from last year. And as we roll out the pricing over the next few quarters. So the second half of FY '24 we'll see more visibility into the benefits of that to net new ARR. Third, given that we're rolling out these prices across plans and across geos incrementally over the year, the benefit to ARR will actually be spread across FY '24 and FY '25. And fourth, if you really want to have sort of sharpen your pencil, the pricing impact on ARR in '24 is actually lower than the pricing impact was in '23 to Creative Cloud. So hopefully that gives you a sense, but again it comes back to this is why we're so excited about the momentum we're seeing in new subscriptions, which really bodes well for the business this year and in the long term. Hopefully, that gives you a pretty good sense on that. And then really quickly on Document Cloud, we're thrilled with the performance of Document Cloud, a lot of that comes down to our core strategy which has been around integrating the desktop, the web, and mobile into a single ecosystem. And really driving the monthly active usage of Document Cloud up through all of the product-led growth motions we have and converting people on the back-end of that. What we're really excited about as we bring the AI assistant to market, which by the way, as I mentioned, is now in private beta, expect it to come out in the next few months as a public beta and then, GA later in the year. But what we're really excited about there is being able to not just service that paid Acrobat based with that, but also start to bring that to the free reader base. So, lots of opportunity and excitement for the year ahead for Doc Cloud as well.
Alex Zukin: Perfect. Thank you for the very fine point and answer.
David Wadhwani: No problem.
Operator: We'll take our next question from Kirk Materne with Evercore ISI. Please go ahead.
Kirk Materne: Hi. Thanks and congrats on the quarter and happy holidays. David, I guess I'll go back to you again, in the commentary, you all talked about enterprise strength and specifically up-selling of Firefly and Express in your enterprise customer base. Can you just give us some more, I guess, qualitative color on what those discussions are like, are they lead -- is this part of the reason you're seeing sort of an uptick in new subscriptions in the enterprise, in particular? And then on Express. Can you just talk again about sort of what you're seeing in terms of leading indicators of that being an enterprise product that can continue to expand into fiscal '24. Thanks.
David Wadhwani: Yeah. Maybe I'll start and then Anil can add because does crossover our two businesses. So with Firefly and Express, very excited about the momentum that we continue to see. You heard that we crossed 4.5 billion generations now, so we continue to see really, really strong adoption and usage of it. Partially as a standalone business, but also integrated into our Photoshop and Illustrator and these existing workflows. And we're starting to see a lot of interest, not just in the context of using it as part of those existing products, but also using it as part of the ecosystem within enterprises. So, we've been working with a number of customers to not just enable them with Firefly, which is the predominance of the growth that we're seeing in Q4 for enterprise adoption but also have a number of pilot customers already engaged around custom model extension, so that they can bring their own assets and their own content into what Firefly generates. Second, we're also enabling the ability to expose it through APIs, so they can build it into their existing workflows and third, we of course connecting it in tying it all into Adobe Express, which now also has its own Firefly and additional capabilities like things, so that you can not just sort of create content using Firefly, but then start to assemble it, start to schedule, social posts around it, start to do multi-language translations that -- those are all features that are already in there and then create a stakeholder workflow from people working in Photoshop to the marketers that are trying to post externally. So, that's where things get very interesting and exciting in terms of the connection we have with GenStudio and everything that Anil is doing.
Anil Chakravarthy: Just building on that, GenStudio since we announced it at MAX, we've had a tremendous amount of interest both from enterprise customers like Henkel and Pepsi and Verizon, as well as a number of agencies as well. And primarily it goes back to what we discussed at Summit. The demand for content is expected to grow 5x over the next couple of years, and every brand in the world is looking at, hey, how can we speed up the production of quality on brand content, how can we let a number of other people in marketing, other areas of the company create their own content according to the standards -- enterprise standards and the combination of what we have in the Digital Experience portfolio like Adobe Experience Manager and assets as well as what we have in the Creative Cloud, especially around Express and Creative Cloud really let's enterprises, get that kind of agility and the cost-effectiveness of producing content at scale. So that's what we're seeing and we're seeing a tremendous amount of interest for that.
Shantanu Narayen: And maybe I'll just add a little bit to that, Kirk. I mean, I think the exciting thing about what people are doing is they're standardizing on Firefly and the fact that we have responsible generations for the entire enterprise. So the interest level has been around, how do we standardize that for all of the image or vector or other generations that they want to do for all the knowledge workers in the enterprise. So really good adoption of Firefly.
Kirk Materne: Thank you.
Operator: We will take our next question from Karl Keirstead with UBS. Please go ahead.
Karl Keirstead: Thanks. I'd like to ask about a different subject. And that's the creative Express product now that it's being sold into the enterprise. I'm wondering if you could offer some color on the adoption ramp, the competitiveness versus Canva and whether your plans around driving Express revenues versus driving user adoption have changed at all. Thank you.
Shantanu Narayen: Great. Yeah. Happy to take that. Express is off to a great start. As you remember, we went general availability in August with the latest version of it, it's been getting a lot of very, very positive reaction response. And frankly, since then in Q4 too, we've added a ton of new innovation. Firefly integration started with Text to Image and Text to Effects, but we also added Text to Template that will create a fully-formed template for you and generative fill, so you can iteratively change things on the fly. We now let you drawing paint on the campus -- canvas, we've given users much more video support. We've really built an incredible best-of-breed PDF support and workflow with Acrobat in there as well. Some of the other things that now start to bleed into the enterprise also, we have integrated social workflows so that people can schedule their post, we've enabled people to do auto-translations, so you can post to multiple geographies and languages. We've opened up our ecosystem for partner plug-ins and we have now over 50 extensions. And we've added enterprise features like AEM integration and template locking, so that the core, brand police in an organization can manage and make sure that their brand elements that they don't want changing are locked when you disseminate this more broadly. What we've seen is really. I think some very exciting broad-based benefits from this. One is, we've seen new trialists coming in, growing very quickly after this launch, which is exciting to see, we've seen education, users starting to adopt this very quickly as well, the Creative Cloud probe paid base has been coming on and growing very quickly in terms of their usage and then enterprise, as we talked about from a usage perspective and again, Express is a core part of how Anil and team are now selling GenStudio. And the last thing is like this is just setting up the momentum for the year to come. We have a mobile release coming out, which will be very exciting for users to be able to use this on the go. We have thousands of people already using that beta. We announced our Chromebooks partnership. So, anyone that buys a new Chromebook is going to have this. We have partnerships with folks like Wix for their workflows. We're going to be doing deeper integrations into Acrobat. So we are very excited about where this goes. That is a long way to answer a very simple question. We want a lot of people using this. So, our primary focus continues to be around broadening the top of funnel. Of course, as part of that, we are constantly and continually, as I mentioned, journeying people for upsell and cross-sell opportunities to the paid plan, and over to Creative Cloud and other products, but our primary focus continues to be adoption and broad proliferation.
Karl Keirstead: Got it. Thank you.
Operator: We will take our next question from Brad Zelnick with Deutsche Bank. Please go ahead.
Brad Zelnick: Great. Thanks very much. This is for Dan or maybe Anil. As we think about the momentum within the DX business, it's great to hear things like the 60% increase in your AEP, and native apps book of business, the strong net dollar retention. And you talked about overall strong year-end bookings, but what does it maybe about the pipeline ahead, bookings conversion or perhaps other factors that account for the degree of decel that you're guiding for into next year? Thanks.
Anil Chakravarthy: Thanks, Brad. I mean we are really excited about this massive multi-year opportunity, if we would look at any enterprise customers around the world, everybody recognizes the long-term imperative of transforming their customer experiences. And we're seeing that in these transformational deals that we talked about. And as you mentioned, for example, with AEP, our first $100 million net new business quarter and ending with over $700 million in our annualized book of business. With that said, definitely we're seeing macroeconomic impact, just like other enterprise software companies are. Every customer looks at the total cost of deploying the software and then what it would take to get the payback and ROI. And as a result, there is definitely some scrutiny and caution there. But that said, if we look at going into next year, we do see the pipeline across both our industry verticals as well as our mid-market customers. And we continue to be the leader in the market and we did get that recognition from both analysts and customers.
Brad Zelnick: Okay. Thank you.
Operator: We will take our next question from Brent Thill with Jefferies. Please go ahead.
Brent Thill: Dan, if you could just review the broader assumptions in your guide. I think there's still a little concern from the Street in terms of why you're guiding, where you're guiding relative to where the Street was at. And maybe just tying in Shantanu to the guidance, if you could just give us your topline view of -- do you feel like the environment's improving, do you think it's just stabilizing? Just any thoughts in terms of from a high level, what you think is happening as we go into next year?
Dan Durn: Yeah. So thanks for the question, Brent. When we take a look at the guide. If we think about where we're at, at this point in time as we're looking forward in FY '24, clearly we see a lot of momentum in the business, the company's engine of innovation has been incredibly strong. And you see the strong financial performance of the company. That's both from a top line standpoint, as well as profitability and cash-flow standpoint. So, clearly a lot of momentum around the business. As I think about where we sit today, we printed a 46.4% operating margin. As we look forward in to next year, we take into account everything we can see. As Shantanu said, we take the guidance seriously and we set expectations in a prudent way, there is an opportunity to do better than the expectations that we set. Clearly, the company is going to be driving towards that. As we think about the engine of innovation, we think the pipeline is strong, we're going to continue to invest in the drivers of growth. This company is going to orient towards growth. When I think about the investment profile, not only are we going to be disciplined. But we're going to continue to invest in those drivers of growth on the DX side. Anil talked about AEP and Apps strong book of business, strong growth, we're laying the groundwork and content supply chain with the GenStudio solution, scaling that motion, and engaging with customers to go from ideation, to creation to activation, delivering new technologies, products, AEM sites incorporating intelligence into those products. On the DME side, you can see it across the portfolio, AI assistant Acrobat, it's in private beta, and it's going to be in public beta in the coming months, you look at Firefly and Express, natively and deeply integrating these technologies throughout the product portfolio, there is going to be continual investment as it relates to that innovation. As you think about the momentum exiting this year and as you think about the guide into Q1, you can see that momentum continuing, get the operating margin up a little bit, and then throughout the year, as we said at our FA Day and the last year's earnings call, you can see a mid-40s expectation around operating margin for the company as we drive this investment cycle, as we drive leadership in our core markets and our key catalyst in the trends that are shaping those markets. So, again, taking a step back, it nets into account the macro that Anil talked about everything we see from a core business standpoint, and the investment profile that we're going to drive to lead, if there's an opportunity to do better than where we set those expectations we're certainly going to do it.
Shantanu Narayen: And maybe just to add to that, Brent, since you asked. First, let me clarify, there is nothing as it relates to the economic indicators that we saw anything that would give us cause for concern. So, let me start off by saying that, I think at our Investor Meeting, we told you that we would expect a strong quarter, I think you would acknowledge, we posted some really strong numbers and the momentum continues. And I think as it relates to Creative Cloud, it's going to be driven by new customer acquisition, which is the engine that's driven the business and maybe perhaps the sell-side looked at some of the pricing and put more of that in '24 then in '24 and '25 and that will spread out and perhaps they put a little bit more in what percentage of the base that impacts. So from my perspective, the good news about Creative is it's being driven by massive new adoption into the platform. On Document Cloud, really strong results. I think as Dan said, as we put the AI pack on there as well, that should help fuel more adoption and Digital Experience, I mean, I know that Brad also asked that question. I mean it's great to see the adoption of AEP and Apps. I mean, that is clearly the future of digital experiences, driving $100 million quarter, the $700 million in the annualized book of business, which I think will reflect the next-generation customer experience architecture. So we're feeling positive. And we're going go execute against that Brent. So, nothing that we see on the horizon would tell us either from the economic or competition, that we're not poised to have another great year and profitability as well, I mean, look at the numbers that we posted both in terms of Q4, as well as for fiscal '24 and that is that does not in any way mean that we're not going to invest in all of the cloud and the foundation models. So I feel really good.
Dan Durn: And then just one thing to add, Brent, If we were here a year ago, the expectations going into the year where FX was going to be a pretty decent headwind to the performance, you see that in the way we've reported our results and then compare it to a constant-currency basis. We started with a pretty decent spread between the as-reported numbers in constant-currency in Q1. By the time we got to Q4, you saw that spread compress, as I look forward into FY '24, it's more of a neutral footing to maybe a slight headwind. Too early to really call it with precision, but I see that setup being slightly different. And maybe just a slight headwind versus what we were seeing a year ago.
Brent Thill: Thanks for the color.
Operator: We'll will take our next question from Jay Vleeschhouwer with Griffin Securities. Please go ahead.
Jay Vleeschhouwer: Yeah. Thank you. You noted the strength in RPO in the quarter, including the record sequential increase. Can you talk about how you're thinking about RPO for fiscal '24, would you expect it to continue to be able to outgrow revenue growth by several points as you did in fiscal '23 and perhaps talk about the ingredients that will continue to drive RPO, either by segment or any other considerations that you'd like to talk about in that.
Shantanu Narayen: Yeah. Thanks, Jay. As I pull some of the threads together that we've heard on this call. Anil, talked about large transformational deals being the platform of choice with customer experience management, simultaneously driving topline and bottom-line productivity and the investments around driving those are an imperative in the market. We see a similar dynamic with the new technologies that we're bringing to market on the DME side at the business, we're streaming seeing strong pull from the enterprise. And so as I net out that environment and our performance against that opportunity, it goes to produce the type of sequential RPO progression that we saw Q3 to Q4. Every quarter won't be that large, but the backdrop around that dynamic for the company given the setup we see, it should be another strong year for RPO throughout the year.
Jay Vleeschhouwer: Thank you.
Shantanu Narayen: Operator. We're getting close to the top of the hour. We'll take two more questions and then we'll wrap up. Thanks.
Operator: We'll take our next question from Saket Kalia with Barclays. Please go ahead.
Saket Kalia: Okay. Great. Hey, guys. Thanks for taking my question, and congrats on a nice quarter. David maybe for you, I had a question just on Firefly and the subscription packets. I know that the commercial model for commercial -- I'm sorry, for Firefly credit packets, really just started about six weeks ago. But are there any early observations that you've seen just on customers' willingness to add those packets, or maybe how they're consuming the initial credit allocation that they get with the Creative Cloud subscription?
David Wadhwani: Yeah. Happy to take that. First of all I think philosophically, going back to what we said at the investor meeting at MAX, our primary focus here is to drive usage of the generative capabilities and you see that with the 4.5 billion images generated, that strategy is working. Secondly, we price the generative packs -- sorry, we integrated the generative capabilities and credits directly into our paid plans with the Express intent of driving adoption of the paid subscription plans and getting broad proliferation of the ability to use those. And what we are seeing is heavy usage within those paid plans. I think as we've mentioned in the past. I think I mentioned earlier today as well, Generative Fill, for example in Photoshop is the fastest-growing feature that we've put into Photoshop in recent memory. So the usage is great, the utilization is great. I don't personally expect the generative packs to have a large impact in the short-term, other than to drive more usage more customers to our paid existing subscription plans. But what will happen over the course of the year, in the next few years is that we will be integrating more and more generative capabilities into the existing product workflows. And that will drive and we'll be integrating capabilities like video generation, which will cost more than one generation and that will drive a natural inflation in that market and that will become a driver for growth subsequently. But this year is really primarily focused on getting people into the right paid plans of our flagship applications, our Adobe Express, and then drive usage in that sense. And then as that happens, the rest will take care of itself in the years ahead.
Saket Kalia: Makes sense. Thanks, guys.
Operator: We'll take our final question from Mark Moerdler with Bernstein Research. Please go ahead.
Mark Moerdler: Thank you for squeezing me in. I really do appreciate. Dan, I'd like to look a little bit at MAX we discussed how excited you were on Firefly and how it drives Creative Cloud seed and paid seed adoption. Now that you had a bit of time in market, can you explain how you think about how this will drive the paid seed growth, is it how strong it could be and should we expect to seeds going to be lower unit price because they're going to be entry-level, what do you think that we will get offset by these higher-priced Firefly driven sales into the enterprise. Thank you.
Dan Durn: Yeah. Thanks, Mark. I think at the core of bringing this technology to life, as a standalone application to drive an ideation part of the process, but value in deeply integrating these capabilities into the flagship applications and the workflows that define the creation process, it gives us a lot of surface area with customers and meeting them where they are in their particular needs and use-case specific needs. And so bringing people efficiently top of funnel, establishing the segmentation across that product portfolio, driving efficiency into the creation process and allowing the velocity to enter the ideation, creation, activation and then instrumentation of that to really refine how companies engage with customers. So, it lays the groundwork for us to touch more customers where they are in the ecosystem, bring them on board in a use-case specific way and then take them on digital journeys which is something the company has very skilled at with our D-DOM to cross-sell and upsell over the life of their engagement with our ecosystem.
Anil Chakravarthy: From a product perspective, when you think about it, Mark, for us, the biggest thing that we want to do is, how do we further make our products accessible, fun and affordable for increasing set of customers and I think Firefly is one of those inflection points that will help everybody get over the blank screen fear that they have and so first, as you think about Firefly as an ideation and people just coming and want to have creative inspiration. This is, whether you're an individual user, whether you're agencies, we're seeing a lot of adoption of Firefly to just start the entire Creative process and that sort of brings them as an on-ramp into Express, which would be the other part. Express is certainly the introductory pricing, the ability to get millions more into the fold and the ability, right now, it used to be that Express and other offerings in that is to all worry about, do I have the right templates. Well, AI is going to completely change that, we have our own models and so Firefly will allow anybody to take whatever creative idea that they have and make that available, so I think Firefly really helps with the Express offering. On the Creative Cloud, David mentioned this. I mean if you look at the adoption of that functionality and usage, that's being driven, whether it's in Photoshop right now, Illustrator as we add video, both in terms of providing greater value and we certainly will therefore have the uplift in pricing as well as the retentive ability for Firefly. That's where I think you're going to see a lot of the really interesting aspects of how Firefly will drive both adoption as well as monetization. And then if you go at the other end of the spectrum to the enterprise, GenStudio, every single marketer that I know and CFO and CMO, are all worried about how much am I spending on data, how do I get agility in my campaigns and the fact that Firefly is integrated into both Express as well as when we do the custom models for them, so they can upload their own models and then have the brand consistency that they want. So, Firefly really is the fact that we have our own models. A great catalyst for our business, all across the spectrum and the usage and the adoption shows that in emerging markets, as people there in emerging markets are increasingly used to create variance of content and localization of content, that's where we are also seeing a tremendous usage of these particular technologies. So really exciting. And then, you take the same technology that we have in Creative and think about its impact in both Document Cloud when we do that and the ability to have summaries and have conversational interfaces with PDF, thereby making every single PDF as David again said, both for communication, collaboration and creation far more compelling. I think you're going to see that same kind of uplift in usage and therefore monetization on the Acrobat side. And since it was the last question. I mean, for us, we look at FY '23, and we're really proud what we were able to accomplish across all spectrums topline revenue, RPO and driving book of business, Creative Cloud, Document Cloud, and Experience Cloud and profitability, and we think '24 is going to be exactly more of the same, which is continuing to drive great innovation, great product growth, great profitability. Clearly, I think there has been a set of questions around the Digital Media ARR and what I'll take is on that and we're extremely confident about how that continues to be a growth business and perhaps the pricing impact was overestimated. And as we said, this is again new growth business and it will be a multi-year pricing benefit for us as we think about the uplift that we have. So we're really pleased. We appreciate you being on the call. And like many of you wished us, happy holidays and we hope to see you soon. Thank you for joining us.
Shantanu Narayen: Thanks, everyone. Happy holidays. This concludes the call.
Operator: Once again, this concludes today's call. Thank you for your participation. You may now disconnect. |
AVGO | 4 | 2,023 | 2023-12-07 20:11:08 | Operator: Welcome to Broadcom Inc.’s Fourth Quarter and Fiscal Year 2023 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Ji Yoo, Head of Investor Relations of Broadcom Inc. The floor is yours.
Ji Yoo: Thank you, operator, and good afternoon, everyone. Joining me on today’s call are Hock Tan, President and CEO; Kirsten Spears, Chief Financial Officer; and Charlie Kawwas, President, Semiconductor Solutions Group. Broadcom distributed a press release and financial tables after the market closed, describing our financial performance for the fourth quarter fiscal year 2023. If you did not receive a copy, you may obtain the information from the Investors section of Broadcom’s website at broadcom.com. This conference call is being webcast live and an audio replay of the call can be accessed for one year through the Investors section of Broadcom’s website. During the prepared comments, Hock and Kirsten will be providing details of our fourth quarter and fiscal year 2023 results, guidance for our fiscal year 2024, as well as commentary regarding the business environment. We’ll take questions after the end of our prepared comments. Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. In addition to U.S. GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to today’s press release. Comments made during today’s call will primarily refer to our non-GAAP financial results. I’ll now turn the call over to Hock.
Hock Tan: Thank you, Ji, and thank you, everyone, for joining us today. In our fiscal Q4 2023, consolidated net revenue was $9.3 billion, up 4% year-on-year and very much as we had guided at the last conference call. Semiconductor solutions revenue increased 3% year-on-year to $7.3 billion, and infrastructure software revenue grew 7% year-on-year to $2 billion. Overall, while infrastructure software remains very stable, semiconductor is continuing the cyclical slowdown at enterprises and telcos that we have been seeing over the past six months. However, hyperscalers remain strong. Generative AI revenue, driven by Ethernet solutions and custom AI accelerators, represented close to $1.5 billion in Q4 or 20% of semiconductor revenue, while the rest of the semiconductor revenue continued to be rather stable at around $6 billion. Moving on to results for the year. For fiscal 2023, consolidated revenue hit a record $35.8 billion, growing 8% year-on-year. And since 2020, even though we have not made an acquisition, we have shown a robust trajectory of growth, driven by semiconductor growing at an 18% CAGR over the past three years. In fiscal 2023, operating profit grew by 9% year-on-year, and our free cash flow grew 8% year-on-year to $17.6 billion or 49% of revenue. We returned $13.5 billion in cash to our shareholders through dividends and stock buybacks. As you well know, we just closed the acquisition of VMware on November 22, just about four weeks into Broadcom’s fiscal 2024. We are now refocusing VMware on its core business of creating private and hybrid cloud environments among large enterprises globally and divesting noncore assets. Reflecting the consolidation of a restructured VMware into our 2024 outlook, we forecast our fiscal year ‘24 consolidated revenue to be $50 billion. We expect the integration to take about a year and will require close to $1 billion in transition spending, which will largely be done as we exit fiscal ‘24. Regardless, we expect our fiscal year 2024 adjusted EBITDA to be approximately 60% of revenue. Kirsten will give you more details in her section. Now, let me give you more color on our two reporting segments, and I’ll start with software. In Q4, as you know, there’s no VMware revenue and the infrastructure software business of CA, Symantec and Brocade grew 7% year-on-year to $2 billion. Consolidated renewal rates averaged 119% over expiring contracts. And in our strategic accounts, we actually averaged 130%. Over 90% of the renewal value represented recurring subscription and maintenance. For the year, renewal rates averaged 116% over expiring contracts and in strategic accounts, we averaged 124%. Revenue in fiscal 2023 was $7.6 billion, up 3% year-on-year and our expectation for fiscal ‘24 is for this revenue to be $8 billion, which is 4% year-on-year. For the s2024 outlook, we are excited to now include VMware. As we all know, VMware has the leading technology to virtualize entire data centers, not just compute, and by doing so, create private cloud on-prem. Our strategy going forward is simply to enable global enterprises to run their applications across the other data centers as well as on public clouds by consuming VMware’s higher-value software stack. And to attract and keep these workloads across the environment, we are investing in a rich catalog of microservices tools. This will be our focus. And the noncore businesses of end-user computing and Carbon Black will be divested. So for 2024, based on 11 months of contribution from VMware, we expect VMware to contribute $12 billion in revenue. And on a consolidated basis, we expect our infrastructure software revenue in 2024 to be $20 billion. Turning now to the semiconductor segment. Let me give you more color by end markets. Q4 networking revenue of $3.1 billion grew 23% year-on-year, representing 42% of our semiconductor revenue. This was primarily driven by strong demand from hyperscalers for our custom AI accelerators and as well for our networking switches, routers and NICs, Network Interface Cards, dedicated towards scaling our AI data centers. As you know, even as Ethernet is the standard protocol in front-end networks, hyperscalers are also deploying Ethernet predominantly in their AI networks. In fiscal ‘23, networking revenue grew 21% year-on-year to $10.8 billion. If we exclude the AI accelerators, networking connectivity represented about $8 billion, and this is purely silicon, not systems, not cable nor subsystems. In fiscal 2024, we expect networking revenue to grow 30% year-on-year, driven by accelerating deployment of networking connectivity and expansion of AI accelerators in hyperscalers. Moving to wireless. Consistent with the seasonal launch by our North American customers, Q4 wireless revenue of $2 billion increased 23% sequentially and declined 3% year-on-year, representing 27% of semiconductor revenue. In fiscal ‘23, wireless revenue was relatively flat at $7.3 billion, just down 2% year-on-year. The engagement with our North American customers continues to be deep, strategic and multiyear. And accordingly, in fiscal ‘24, we expect wireless revenue to again remain stable year-on-year. Next, our Q4 server storage connectivity revenue was $1 billion or 14% of semiconductor revenue and down 17% year-on-year. In fiscal ‘23, server storage connectivity was $4.5 billion, up 11% year-on-year. And going to fiscal ‘24, we expect server storage revenue to decline mid- to high-teens percentage year-on-year, driven by the cyclical weakness that began late ‘23. And moving on to broadband. Q4 revenue declined 9% year-on-year to $950 million, in line with expectations and represented 13% of semiconductor revenue. And in fiscal ‘23, broadband revenue was $4.5 billion and up 8% year-on-year. Moving on to fiscal ‘24, we expect broadband revenue to be down low- to mid-teens percentage year-on-year and reflecting, again, the further slowdown as the cyclical weakness at service providers that began in late ‘23 continues into fiscal ‘24. And finally, Q4 industrial sales of $236 million was stable year-on-year. In fiscal ‘23, industrial resales were $962 million. In fiscal ‘24, we expect industrial resales to be down low single digits year-on-year. So in summary, fiscal ‘23 semiconductor solutions revenue was up 9% year-on-year to $28.2 billion. Revenue from generative AI in fiscal ‘23 reached 15% of semiconductor revenue, in line with our expectation. And moving on to fiscal ‘24, we forecast semiconductor solutions revenue to be up mid- to high-single-digit percent year-on-year. We expect revenue from generative AI to represent more than 25% of the semiconductor revenue, consistent with prior guidance, which more than offset the lack of growth from non-AI semiconductor revenue. With the consolidation of VMware, bringing our Infrastructure Software segment revenue to $20 billion and the semiconductor segment holding at mid-high single digit growth year-on-year, we are, therefore, guiding our fiscal ‘24 revenue to be $50 billion, which represents 40% year-on-year growth from fiscal ‘23. With that, let me turn the call over to Kirsten.
Kirsten Spears: Thank you, Hock. Let me now provide additional detail on our Q4 financial performance. Consolidated revenue was $9.3 billion for the quarter, up 4% from a year ago. Gross margins were 74.3% of revenue in the quarter, in line with our expectations. Operating expenses were $1.2 billion, flat year-on-year. R&D of $940 million was also stable year-on-year. Operating income for the quarter was $5.7 billion and was up 4% from a year ago, with operating margin at 62% of revenue. Adjusted EBITDA was $6 billion or 65% of revenue, in line with expectations. This figure excludes $124 million of depreciation. Now, a review of the P&L for our two segments, starting with our semiconductor segment. Revenue for our semiconductor solutions segment was $7.3 billion and represented 79% of total revenue in the quarter. This was up 3% year-on-year. Gross margins for our semiconductor solutions segment were approximately 70%, down 110 basis points year-on-year driven primarily by product mix within our semiconductor end markets. Operating expenses were stable year-on-year at $822 million, resulting in operating profit growth of 2% year-on-year and semiconductor operating margins of 58%. Now, moving on to our infrastructure software segment. Revenue for infrastructure software was $2 billion, up 7% year-on-year and represented 21% of revenue. Gross margins for infrastructure software were 92% in the quarter, and operating expenses were $339 million in the quarter. Q4 operating profit grew 12% year-on-year with infrastructure software operating margin at 75%. Now moving on to cash flow. Free cash flow in the quarter was $4.7 billion and represented 51% of revenues in Q4. We spent $105 million on capital expenditures. Days sales outstanding were 31 days in the fourth quarter compared to 30 days in the third. We ended the fourth quarter with inventory of $1.9 billion, up 3% sequentially. We continue to remain disciplined on how we manage inventory across the ecosystem. We exited the quarter with 76 days of inventory on hand, down 80 days in Q3. We ended the fourth quarter with $14.2 billion of cash and $39.2 billion of gross debt, of which $1.6 billion is short term. Now let me recap our financial performance for fiscal 2023. Our revenue hit a record $35.8 billion, growing 8% year-on-year. Semiconductor revenue was $28.2 billion, up 9% year-over-year. Infrastructure software revenue was $7.6 billion, up 3% year-on-year. Gross margin for the year was 74.7%, down 90 basis points from a year ago. Operating expenses were $4.6 billion, down 4% year-on-year. Fiscal 2023 operating income was $22.1 billion, up 9% year-over-year and represented 62% of net revenue. Adjusted EBITDA was $23.2 billion, up 10% year-over-year and represented 65% of net revenue. This figure excludes $502 million of depreciation. We spent $452 million on capital expenditures, and free cash flow grew 8% year-on-year to $17.6 billion or 49% of fiscal 2023 revenue. Now, turning to capital allocation. For fiscal 2023, we spent $15.3 billion, consisting of $7.6 billion in the form of cash dividends and $7.7 billion in share repurchases and eliminations. We ended the year with $7.2 billion of authorized share repurchase programs remaining. With the VMware deal closed, we have resumed repurchasing shares under our existing program. In fiscal year 2024, including the incremental shares from the acquisition of VMware and excluding the potential impact of any share repurchases, we expect the non-GAAP diluted share count to be approximately 494 million. Aligned with our ability to generate increased cash flows in the preceding year and now off of a larger share count base from the acquisition of VMware, we are announcing an increase in our quarterly common stock cash dividend in Q1 fiscal 2024 to $5.25 per share, an increase of 14% from the prior quarter. We intend to maintain this target quarterly dividend throughout fiscal ‘24 subject to quarterly Board approval. This implies our fiscal 2024 annual common stock dividend to be a record $21 per share. I would like to highlight that this represents the 13th consecutive increase in annual dividends since we initiated dividends in fiscal 2011. Now on to guidance. As Hock discussed, with the recent closing of our VMware acquisition and the integration process, which will take at least one year, for fiscal 2024, we will provide our outlook for the full year instead of quarterly guidance. Based on current business trends and conditions, our guidance for fiscal year 2024 is for consolidated revenues of $50 billion. Within this, our fiscal year 2024 semiconductor revenue is expected to grow mid- to high-single-digit percent year-on-year. Our fiscal year 2024 infrastructure software segment revenue from continuing operations is expected to be $20 billion, including $8 billion from CA, Symantec Enterprise and Brocade and $12 billion from VMware. With regard to VMware, our forecast for fiscal ‘24 revenue of $12 billion reflects 11 months of contribution from VMware. This does not include revenue from EUC and Carbon Black of approximately $2 billion, which we plan to divest. We are also converting an installed base of licenses that is over 60% perpetual today to one that will be mostly subscription by the end of fiscal 2024. Offsetting these, our new strategy for VMware will accelerate revenue growth over the next three years. During fiscal ‘24, we expect to incur about $1 billion of spend related to transitioning VMware into the new Broadcom model. This transition spending will be largely completed by the end of the fiscal year as our VMware spending run rate exits fiscal ‘24 at approximately $1.4 billion per quarter, down 40% from a year ago. So, in fiscal year 2024, including VMware, we expect consolidated adjusted EBITDA of approximately 60% of projected revenue. That concludes my prepared remarks. Operator, please open up the call for questions.
Operator: [Operator Instructions] Our first question will come from the line of Vivek Arya with Bank of America.
Vivek Arya: Hock, so yesterday, one of your peers suggested that the market for AI accelerators could be as large as $400 billion. So kind of three related questions. What do you think about that number? And then number two, how does Broadcom participate in that, just beyond your large kind of ASIC project on the compute offload side? And then what does this larger AI accelerator market imply for your Ethernet networking business? I assume that they are correlated, but what is the right way to think about what is presumably a much larger market for accelerators and how it impacts Broadcom’s growth prospect?
Hock Tan: Thank you for those very interesting questions. Starting with the first part, I mean, it’s -- what we’re seeing is a market that continues to grow, to accelerate. What is also very obvious is it’s very, very dynamic as architectures of large language models, software models continues to change, I mean, literally change on the fly. We are also seeing the requirements for compute silicon change. And it’s very interesting, very fascinating for us, but it also presents quite an interesting opportunity, which is to say that if a customer has a business model that is substantial and have resources which obviously supports that, is getting to a stage that it might make a lot of sense to design AI compute engines, which comprises memory as well as the compute engine itself, then that can be tailored or better word, customized for their particular requirements on applications, on their particular LLM model. And we’re seeing this as we all are seeing LLM models continue to change and the face -- the shape of generative AI dynamically change more and more, where training and inference are now starting to, in a way, converge and the chip designs are changing. And we are seeing that in the way we design specific custom chips for hyperscalers. That’s interesting. So that’s a very interesting opportunity for us. And as I indicated in my remarks, we see that revenue as part of networking revenue, $4 billion and networking -- AI networks and going -- doubling almost during 2024. Nothing new. We have said that before. And if anything else, we are reinforcing that particular guidance. Now, networking is particularly interesting as you heard in my opening remarks. It is accelerating as fast as our AI accelerators, the compute engines are growing. And we see that growing hand in hand and particularly so as training -- continuous training of very large language models with very different and very large parameters keep going on and things keep changing. So we’re seeing no slowdown, in fact, in the update on building out this AI networks. If anything else on average, we are seeing a doubling on size of those networks across the board. So, that’s -- to your answer question. Yes, I fully concur with AMD, when they indicate that it looks like demand appears to be accelerating rather than staying stable or decelerating.
Operator: Thank you. One moment for our next question. And that will come from the line of Ross Seymore with Deutsche Bank.
Ross Seymore: Just a quick clarification on the question. The clarification is, is the fiscal year guidance going to be the new protocol, or is that just this quarter? And then the real question, Hock, is on the VMware side of things, Kirsten talked about it potentially accelerating off of that $12 billion base. Can you just talk about the linearity of it maybe throughout the year, or more importantly, how is it going to be accelerating as people start to look at what the VMware Street estimates were before. We know we have to take out the two divested operations. But what are the drivers of acceleration? And how should we consider the magnitude of that as we look forward?
Hock Tan: Yes. We are very -- we are in a very interesting, very exciting situation here as we move into the next chapter of VMware. As I said, we focus the business on VMware Cloud Foundation, which is the full software stack that virtualizes data centers on-prem, not totally [ph] virtualize it, a cloud environment, and we are converting more and more customers step-by-step as they come up for renewal into this higher value stack, and we’re doing it on a subscription basis. So become very focused. So we will kick it off at a much lower rate -- because subscription generally brings down revenues, as you know, in software based on revenue recognition. But we see a trajectory of accelerated growth even in 2024 -- through 2024. And it just doesn’t stop there because it’s the math and the trajectory. And to answer your question, you’re right, we are accelerating from $12 billion, and we’re probably seeing a double-digit growth for the next three years, just by sheer math of selling that higher value virtualization stack versus the very loose component sales in the past, particularly on compute only.
Ross Seymore: And on the fiscal year side, is this a one quarter thing, or is this the new way you guys are going to be doing it?
Hock Tan: Well, that’s a good question. Well, we will -- just to give you an indication, in 2024 because it’s an accelerating trend, our view is that it’s more appropriate and more relevant to getting you guys a sense of where we’re headed to get to turn it to an annual guidance for ‘24. And we will report results every quarter and update our annual guidance ‘24 each time we report the quarterly actuals.
Operator: Thank you. One moment for our next question. And that will come from the line of Harlan Sur with JPMorgan.
Harlan Sur: One quick housekeeping item question. So, even off the lower revenue base starting in fiscal ‘24 for VMware, is the team still targeting $8.5 billion-plus of EBITDA in three years? And then for my main question, Hock. As you mentioned, right, one of the fastest growing workloads in accelerated compute is accelerated compute and generative AI. And all of these workloads are increasing at an exponential rate. You talked about the benefits to your silicon franchise. But given the significant performance requirements of these workloads, right, training, inference, it appears that more of the near-term adoption of running these workloads is on bare metal, GPU, TPU, accelerated servers. So, how is the team exploiting a software-defined data center solutions via either cloud foundations or Tanzu to try to help customers focus on AI sort of drive better utilization, better economics, faster deployments on this very fast growing part of the market?
Hock Tan: Well, as you may be aware, in the last VM Explore in Las Vegas, VMware came out and announced in partnership with NVIDIA, the VMware Private AI Cloud Foundation. Another way of describing it is, the VMware Cloud Foundation Software Stack, the whole VCF stack runs NVIDIA coder, runs the NVIDIA GPU. That is the partnership. So, if you’re an enterprise, it’s a very easy step to get into gen AI analytics because the data center that you as an enterprise own on-prem that runs VCF will by default run the NVIDIA GPU software stack as well. Another way to put it, it virtualizes the NVIDIA GPU. That’s the VMware software stack as well. So it’s a very strong attraction in our -- from our perspective to, in fact, accelerate thinking of a lot of enterprise to adopting the whole VCF site. It’s simply because not only does it virtualize the data centers and make your data on-prem data center much more resilient, easier to manage, lower cost to manage, it has the added benefit, a big attraction this is of being able to right away start running AI workloads.
Harlan Sur: And then, just on my first question, are you guys still targeting $8.5 billion of EBITDA in three years on VMware?
Hock Tan: As Kirsten indicated, as we exit fiscal ‘24, we are practically at a run rate of $8.5 billion EBITDA.
Operator: One moment for our next question. And that will come from the line of Stacy Rasgon with Bernstein.
Stacy Rasgon: Kirsten, along that line, I was wondering if you’re going to do 60% EBITDA margin for the Company for the full year, how should we think about the beginning and exit rates on EBITDA margin relative to that full year total? And I guess, aligned with that, I think I heard you say you -- that VMware OpEx would be down 40% exiting the year versus the entry trade. I’m actually kind of surprised it’s not down more. Maybe that’s the reinvestment. But is that $1.4 billion per quarter for VMware, that’s the right exit rate going for VMware OpEx? And should we sort of go off of that or what?
Kirsten Spears: That’s VMware spending. So that’s total spending.
Hock Tan: Yes, it will be. But, let me tell you, Stacy, you’re missing the biggest point. We are on a -- as I indicated to an earlier question by Vivek, I think, our revenue during this process, even 12 months, 4 quarters, is on the growth trajectory, just because of the way the math works. As we sell more and is on revenue, and we recognize revenue on a ratable basis, our revenue on a quarterly basis is on a growth trajectory. That will keep running and will keep running beyond 2024. But 2024 by itself won’t be on a revenue trajectory that goes up very rapidly. So what you have think about picture is, is a revenue trajectory in ‘24 that is expanding or growing while the expense -- operating expense, total spend because of reduction of transition expenses is declining. And that’s why we are telling you that by the end of -- as we exit fiscal ‘24, we pretty much get to the guidance we gave you at the beginning of when we announced this deal.
Stacy Rasgon: So what’s the total company EBITDA margin, say, exiting the year then, just to level set?
Hock Tan: Well, that’s a total -- we will get pretty close to where we are supposed to, before we started this whole exercise.
Stacy Rasgon: What was that 65%? I can’t remember.
Hock Tan: It’s somewhere between 60% and 65%. How does that sound, Stacy?
Stacy Rasgon: I mean you did say 65% on it. I think I recall you saying you were going to run VMware at 65%. So I guess, 65% is the right exit rate?
Hock Tan: At steady state, you’re right. At steady state, we’ll get to pretty close to 65% on VMware.
Operator: Thank you. One moment for our next question. And that will come from the line of Timothy Arcuri with UBS.
Timothy Arcuri: Hock, in the language for the approvals from China, they noted some restrictive conditions and there were some protections around some sensitive information from your competitors. Can you detail what these are? And does this change your view on the synergies you can drive, either cost or more importantly, revenue? Thanks.
Hock Tan: No. I think those conditions are pretty well laid out in the website of the relevant authorities. I frankly don’t think that it’s very appropriate for me to sit here and repeat all those conditions again. It’s right on the website, and that’s what it is.
Timothy Arcuri: Okay. And it doesn’t make you think any differently about the synergies that you can drive from the business?
Hock Tan: No.
Operator: Thank you. One moment for our next question. That will come from the line of Christopher Rolland with Susquehanna.
Christopher Rolland: Thanks for the question. Congrats on the quarter and closing the VMware deal. I guess, cost of capital has increased since VMware -- since the announcement of the deal. And now that this is closed, I guess, does this affect how you look at your capital allocation strategy going forward? It sounds like you bounced -- you bumped the divi here and you restarted your share repurchase now that it’s closed. Are you going to focus more on repurchases, or is it still same old Broadcom with acquisitions in mind as you delever?
Kirsten Spears: Always with acquisitions in mind, we’re continuing our share repurchase program that we promised. So that’s -- we’re definitely buying back shares. Yes, as being Broadcom, we’ll delever quickly. So, we’ll keep everything in mind essentially.
Hock Tan: Chris, to expand a bit on that. We acquired VMware with part of cash because it took longer. So we got ourselves some part of cash. And with that flexibility, not only are we able to give dividends to the new shareholders from VMware side, we are continuing to complete the commitment we make to you, the shareholders, to -- for the rest of fiscal -- for the rest of calendar ‘23 to buy back that $7 million of shares out there.
Christopher Rolland: Great. Thanks. And maybe a quick follow-up. Thoughts on just why you didn’t offer next quarter in favor of the full year? And if you had any thoughts on the shape of revenue for next year, whether it’s back half loaded significantly or pretty linear?
Hock Tan: We just bought a company that’s pretty sizable. We are restructuring the business model and we’re changing, among other things, the business model to a subscription business model, as Kirsten said. And we see therefore that trajectory of the revenue -- a sharp trajectory of growth for the revenue just by sheer conversion to subscription and the fact that we are also upselling a higher-value product. The combination of that and the new -- in fact it’s company, we -- makes it more -- much more sensible, let’s put it this way, for us to be able to give you a full year number than a three-month guidance. Because spending -- transition spending might slip, might accelerate, revenue might accelerate, might slip. And giving ourselves three months to tell you what it is, especially on a new environment to us, it’s not very, very, I call it -- we are not being good to you guys, the shareholders. But for the full year, I think we have hell a lot more confidence we will attain those endpoints at the exit.
Operator: And one moment for our next question. And that will come from the line of Toshiya Hari with Goldman Sachs.
Toshiya Hari: Hock, I had a question on the semiconductor business and specifically on the non-AI side of things for both networking and server storage connectivity. As you noted, you’re obviously going through a cyclical correction. Historically, you’ve had a pretty good understanding of where customer inventory is. And when we simply look at their balance sheets for the public companies, inventory is pretty elevated, particularly on the networking side. What is your interpretation of where inventory is for your products? And how should we think about the timing and pace of recovery as you look into 2024? Thank you.
Hock Tan: On our books, you can see inventory for our products is pretty damn good, right, especially compared to our peers, and that’s because we keep it tight. Out in customers, and we don’t sell through channels, we don’t sell much through channels. We usually do a lot of it direct to our logic customers. We feel they are in good shape, relatively speaking. We are still in good shape. Now, if you ask me, maybe server storage, that could be a little excessive, but not broadband and certainly not in networking. So overall, on our products, we still feel rather good about it. And the best indication is the level of our own inventory on our own books. But what we do see is customers are perhaps much more cautious about buying more stuff, not just because they have too much of my inventory, I think because they have too much of everybody else inventory out there. We tend to see some caution in the way they choose to buy. Having said that, we’re still keeping to our lead times.
Toshiya Hari: And Hock, any comment on sort of the timing or the shape of the recovery in ‘24?
Hock Tan: If only I know. I mean, I’ll be speculating to say second half of ‘24 things will start looking better compared to the first half of ‘24.
Operator: And one moment for our next question. And that will come from the line of Karl Ackerman with BNP Paribas.
Karl Ackerman: Hock, I was hoping you may discuss the reason for divesting EUC and Carbon Black. And maybe more importantly, as you think about the growth rate off this $12 billion, Kirsten, could you discuss the opportunity you see in front of you as DRAM memory pooling brought in from the adoption of CXL within data centers that would seem to be a very big opportunity for VMware? Thank you.
Hock Tan: Yes. What was the first question again? Sorry. Okay. Why do I chose to sell End-User Computing and Carbon Black? Those are good assets. Let’s make no mistake. They are very sustaining. They are very stable, good assets. And why we chose to sell them is typically our playbook. We focus very much so on -- in any acquisition where we see the biggest value for our business model. And basically, we then do not want to be distracted by noncore focus. And VMware for us is about core. It’s about data centers, it’s about core networks and core compute. And so, we’re now going to invest and focus our sales and R&D on those core areas of VMware Cloud Foundation. And to us, End-User Computing, Carbon Black, good assets as they may be, we prefer now to divest them. We’ll find good homes for them because there are a lot of very interested parties who are more than happy to take those assets. And we’ll be very, very thoughtful about where we put those assets eventually, simply because the customers of many of these two assets, many of the customers are also the same customers to the VMware Cloud Foundation.
Operator: Thank you. And one moment for our next question. And that will come from the line of Matt Ramsay with TD Cowen.
Matt Ramsay: Hock, I guess I’ll caveat my question saying that I’m a semiconductor guy rather than a software expert. But I wanted to ask about the plan to convert the VMware customer base to subscription models and contrast that with what you guys did with CA and Symantec. So, are there -- do you feel like the process is going to be pretty similar in duration and success, or are there differences in maybe the customer base, the length of the long tail outside the sort of Fortune 1000, the type of technologies there? Are there any similarities or differences in the plan there that we should sort of think about and what that might mean for how quickly you can convert that business? Thanks.
Hock Tan: No. These are very different assets, not saying anyone necessarily much better than the other, just different. In CA, particularly where we’re mainframe but also some distributors, we focus very much especially on core customer base, which represented at that time, we bought 70% of the overall revenue of those -- CA. We focus on these customers. We focus on supporting them and they’re continuing to basically give them really good support, feature request growth in the area. And that’s how we then and -- we focus on Symantec too, which is a small core group of customers. And a big part of it is the technology of CA, especially on mainframe is honestly -- is running a lot of legacy applications that are still very, very much alive today, but customers preferring to run it on those mainframe tools simply because it makes no sense to modernize or change for whatever -- for their own good reasons. VMware, however, we’re selling a product of the present and of the future. It is a growth product to be able to create a virtualized cloud environment in your own data center on-prem for any global company. The good thing about going to public cloud is also totally virtualize, but very resilient when you run -- when you run a software-defined environment. We are creating with VMware, the same experience of virtualization of the data center on-prem for those companies, which has workloads, by the way, that are already running VMware products that application that’s already written on VMware Cloud Foundation. This is then giving these enterprises the opportunity to have a hyperscaler on-prem. That’s the plan we’re doing, plain and simple.
Operator: Thank you. One moment for our next question. And that will come from the line of William Stein with Truist.
William Stein: Hock, in the past, I think we’ve all been aware that there’s one major customer on the accelerated compute side. I suspect that he’s broadened and deepened perhaps and hoping you can give us some characterization of that, maybe the number of customers or projects, how diversified it is at this point, that would really help. Thank you.
Hock Tan: Yes, it has. It has, which reflects some of my opening remarks that say that I used to tell you guys, hey, merchant silicon will triumph. But I think with the evolution -- a very rapid evolution I’ve been seeing on the AI, large language model, generative AI large language models and the fact that in hardware one size doesn’t fit all. That is variation depending on the models you run. I would say that if -- for some of those hyperscalers with the resources, with the scale requirements to be able to create customized versions of hardware to match with customization of their foundation models and even their application models, we begin to see the effect of that. Other than that, I’d rather not disclose any more to you at this point because we’re kind of under NDA overall.
Operator: Thank you. One moment for our next question. And that will come from the line of Harsh Kumar with Piper Sandler.
Harsh Kumar: Yes. Hock, first of all, congratulations on closing the VMware deal. I know you’ve been trying to close that for a while. I wanted to -- you’ve had a lot of time. Your management had a lot of time to look at this deal through the process of closing. I was curious what you have seen so far that pleases you the most and what do you think will be the most challenging aspect of the integration over the next 12 months that you highlighted?
Hock Tan: Well, over the past 18 months almost, we had on the journey of closing this deal from the date of announcement. You’re right, we had a great opportunity, and thanks to a very supportive management team from VMware that engages with us very, very well. Again, it’s planning. We can see, we can’t touch, but it has a lot of time to plan and think through. It also gives me a lot of opportunity to go out there. And over the past 12, 16 months, I must have talked one-on-one or in small groups to at least 150 CIOs globally of the largest customers of VMware out there. And one thing is very clear. The VMware core product, the VMware Cloud Foundation software stack that enables virtualization of not just computing, servers, compute, but storage, networking as well as orchestration and management layer over that whole stack is something that CIOs, head of infrastructure of large -- many large companies out there really want. They want to be able to deploy. They want to make their data centers, which is very heterogenous now between virtualization and compute to bare metal and the mix environment and different vendors where each is trying to optimize best-of-breed to one that is managing under a single abstraction layer across a diversity of hardware. That saves a lot of hardware purchases. That creates a lot of cost reduction in a way to manage it. That is the value of the technology VMware brings to bear. And the products are there. For us is focusing and execution, which is what you hear us say that today and which is what you hear Kirsten lay out in the numbers we are looking at just in the first year of completion of this acquisition.
Operator: And that concludes today’s question-and-answer session. I would now like to turn the call back over to Ms. Ji Yoo for any closing remarks.
Ji Yoo: Thank you, operator. In closing, Broadcom currently plans to report its earnings for the first quarter of fiscal ‘24 after close of market on Thursday, March 7, 2024. A public webcast of Broadcom’s earnings conference call will follow at 2:00 p.m. Pacific. That will conclude our earnings call today. Thank you all for joining. Operator, you may end the call.
Operator: Thank you all for participating. This concludes today’s program. You may now disconnect. |
INTU | 1 | 2,024 | 2023-11-28 21:32:11 | Operator: Good afternoon, my name is Chelsea, and I will be your conference operator. At this time I would like to welcome everyone to Intuit's First Quarter Fiscal Year 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. [Operator Instructions]. With that, I'll turn the call over to Kim Watkins, Intuit's Vice President of Investor Relations. Ms. Watkins?
Kim Watkins: Thanks, Chelsea. Good afternoon and welcome to Intuit's first quarter fiscal 2024 conference call. I'm here with Intuit's CEO, Sasan Goodarzi, and our CFO, Sandeep Aujla. Before we start, I'd like to remind everyone that our remarks will include forward-looking statements. There are a number of factors that could cause Intuit's results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2023, and our other SEC filings. All of those documents are available on the Investor Relations page of Intuit's website at intuit.com. We assume no obligation to update any forward-looking statements. Some of the numbers in these remarks are presented on a non-GAAP basis. We’ve reconciled the comparable GAAP and non-GAAP numbers in today's press release. Unless otherwise noted, all growth rates refer to the current period versus the comparable prior-year period, and the business metrics and associated growth rates refer to worldwide business metrics. A copy of our prepared remarks and supplemental financial information will be available on our website after this call ends. And with that, I will turn the call over to Sasan.
Sasan Goodarzi: Thanks, Kim, and thanks to all of you for joining us today. We had a very strong first quarter and have great momentum innovating on our platform across the company. Total revenue grew 15%, driven by Small Business and Self-Employed Group revenue growth of 18% and Consumer Group revenue growth of 25%. This was partially offset by Credit Karma revenue decline of 5%, in line with our expectations for Q1 given the macroeconomic environment. With the strong start to the year, we are reiterating our full year guidance for fiscal year 2024. Consumer Group revenue growth reflects a strong finish to the tax extension season. We remain focused on transforming the assisted consumer and business tax categories with TurboTax Live. Our innovation in tax has accelerated in several areas. First, the Credit Karma platform is leveraging data and AI to deliver personalized experiences and compelling tax offers. Second, is the innovation with TurboTax Live to deliver speed and confidence to prior year assisted customers, particularly with full service, where we can get taxes done in as little as an hour using data, AI and our expert platform at scale. And third, Intuit Assist, our GenAI-powered financial assistance, helping customers in key areas where confidence matters most. For example, understanding their refund or getting answers to their questions as if they're talking to an expert. We ran many experiments during the extension season, and the learnings give us confidence in our game plan to win this tax season. We believe this is Intuit's most exciting era yet. Five years ago, we declared our strategy to be an AI-driven expert platform with data and AI core to fueling innovation across our platform. We're delivering experiences where the hard work is done for you with a gateway to human expertise, powering our customers' prosperity and accelerating penetration of our $300 billion in TAM. The launch of Intuit Assist is the result of years of investment in data and AI. At the core of our platform is powerful, relevant data. Intuit has incredibly rich longitudinal, transactional and behavioral data for our 100 million customers. We have 500,000 customer and financial attributes per small business and 60,000 financial and tax attributes per consumer on our platform. And with our GenAI operating system, GenOS, we empower Intuit technologists to create breakthrough AI experiences across the platform. This includes utilizing our own powerful financial LLM as well as those from other leaders in GenAI which together unlock new opportunities to serve our customers with accuracy and speed in a cost-efficient way. We are creating a future of done for you, a future where the hard work is done automatically on behalf of our customers with a gateway to human expertise, fueling their financial success. Intuit Assist powered by GenAI is critical to delivering unparalleled benefits for our customers over the next decade. Let me share a few updates on Intuit Assist across our offerings. First, Mailchimp. We're rolling out two new GenAI experiences, designed to help our customers grow their revenue and save time. These include AI-driven audience segmentation and marketing automation. I'll share more on those in just a moment. Second, TurboTax. As I shared earlier during the extension season we tested new GenAI experiences to deliver higher confidence for our DIY customers. This includes in-topic accuracy checks and personalized explanations throughout the filing process that help explain a customer's tax outcome. We're excited about rolling out these experiences this season. Third, QuickBooks. We are testing GenAI to help customers save time and run their business with complete confidence, including a digital expert that can surface business insights and allow customers to dig deeper or connect them to a human expert. For example, we're serving our proactive business insights to customers with an actionable business summary. These customers are using the business summary as a launching point to learn, create reports directly using Intuit Assist and take actions to drive their business success. These experiences will be rolled out in the coming months and in the future, we plan to automate these actions and do the work for our customers. Fourth, Credit Karma. We're testing GenAI to help our customers find the products that are right for them in a highly personalized way. For example, based on our research, prime members spend an average of five hours online comparing credit card benefits. With our members' credit data and spending history from accounts they choose to link to Credit Karma, we can use GenAI to help members select the right credit card for them optimized based on their personal spending history. This is designed to increase engagement with our members and help them improve their financial health and drive financial success. These experiences will be rolled out in the coming months. We are excited by Intuit Assist's early progress. It will change our relationship with customers as we move from a transactional workflow platform to a trusted assistant that our customers rely on daily to power their prosperity. We believe Intuit Assist will lead to higher frequency of engagement and monetization across the platform. Let me now highlight progress across two of our five big bets. As a reminder, our five big bets are revolutionize speed to benefit, connect people to experts, unlock smart money decisions, be the center of small business growth and disrupt the small business mid-market. Our fourth big bet is to become the center of small business growth by helping our customers get new customers, get paid fast, manage capital and pay employees with confidence in an omnichannel world. In payments, our innovation continues to drive digitization from creating an estimate to invoicing a customer to getting paid to paying a supplier. Today, easier discovery, auto-enable payments, instant deposit and get paid upfront are all helping drive adoption of our payments offering. Total online payment volume growth was strong in the quarter at 21%. We're also making good progress digitizing B2B payments to accelerate and automate transactions between small businesses and ultimately improving their cash flow. We made our bill pay offering widely available to customers during the quarter. While it's early, we are seeing mid-market customers choosing the paid subscription offering at approximately 2x the rate of non mid-market customers, indicating this paid offering is resonating with larger customers. Turning to Mailchimp. We are well on our way to becoming the source of truth for our customers to help them grow and run their business. As I shared earlier, we're rolling out several features powered by Intuit Assist in time for peak holiday season for many of our customers. Let me highlight two of these impactful benefits designed to help our customers grow their revenue while saving time. First, AI-driven audience segmentation, which allows small businesses to target specific audiences. Many customers don't use audience segmentation today despite the fact that it can drive up to 60% lift in average order revenue or average order value over 12 months. With Intuit Assist, a customer can use conversational language to more quickly build segments and use them as a part of a marketing campaign. Second, AI-powered marketing automation, which are automated workflows that help small businesses reach their customers in uniquely tailored way. Today, many of our customers don't use marketing automation because they are time consuming the setup even though they can help them drive higher revenue. With Intuit Assist, Mailchimp creates marketing automation, which can easily be turned on and e-mail content can be generated and edited. Our fifth big bet is to disrupt the small business mid-market representing a TAM of 1.7 million customers, 800,000 of which are already in our franchise, but using a core QBO or desktop product. Online mid-market customer and revenue growth remained strong and we are driving increased adoption of QuickBooks Advanced, payments and payroll, resulting in ARPC expansion as we serve these mid-market customers with a full ecosystem of services. We are proud of our innovation and the impact that we're making on our customers' lives. We also continue to make an impact on the communities that we serve. This quarter, we launched Intuit for education, a new financial literacy program to provide Gen Z and Gen Alpha students access to Intuit products and teach some personal and small business finance skills. We also announced the first set of winners of our Coalfield Solar Fund, providing grants in [Seven-Eye] (ph) solar energy projects in coal mining communities to help build a sustainable future. Wrapping up, with our durable AI-driven expert platform strategy and focus on innovating with GenAI across our platform, we are more excited than ever about the opportunity in front of us and our ability to power prosperity for our customers. We are also delighted to be one of the only eight Fortune 500 companies named to Fortune's inaugural top 50 AI Innovators list. With that, let me now hand it over to Sandeep.
Sandeep Aujla: Thank you, Sasan. For the first quarter of fiscal 2024, we delivered very strong results that exceeded the high end of our guidance range across all key metrics, including revenue of $3 billion, up 15%. GAAP operating income of $307 million versus $76 million last year. Non-GAAP operating income of $960 million versus $662 million last year, up 45%, GAAP diluted earnings per share of $0.85 versus $0.14 a year ago and non-GAAP diluted earnings per share of $2.47 versus $1.66 last year, up 49%. I am pleased with our early momentum this fiscal year. Turning to the business segment. Small Business and Self-Employed Group revenue grew 18% during the quarter, driven by online ecosystem, which grew 20%. Our results demonstrate the power of our small business platform and the mission-critical nature of our offerings, which continue to resonate with customers as they look to grow their businesses and improve cash flow in any economic environment. with the goal of being the source of truth for small businesses, our strategic focus within a Small Business and Self-employed group is threefold, grow the core, connect the ecosystem and expand globally. First, we continue to focus on growing the core. QuickBooks Online’s accounting revenue grew 19% in Q1, driven mainly by customer growth, higher effective prices and mix shift. Second, we continue to focus on connecting the ecosystem. Online services revenue grew 20% in Q1, driven primarily by Payroll, Mailchimp, Payments, Capital and Time Tracking. Within Payroll, revenue growth in the quarter reflects an increase in customers adopting the payroll solutions and a mix shift towards higher-end offerings. In Mailchimp, revenue growth was driven by higher effective prices and paying customer growth. And within Payments, revenue growth in the quarter reflects ongoing customer growth as more customers adopt our payments offerings to manage their cash flow as well as an increase in total payment volume per customer. Third, we continue to make progress expanding globally by executing a refreshed international strategy, which includes leading with both QuickBooks Online and Mailchimp in established markets, and leading with Mailchimp in all other markets as we continue to execute on a localized product and lineup approach. On a constant currency basis, total international online ecosystem revenue grew 16%. Desktop ecosystem revenue grew 14% in the first quarter, and QuickBooks Desktop Enterprise revenue grew in the high single digits. We are more than two-thirds of the way through a three-year transition for customers that remain on our license-based desktop offering to a recurring subscription model. In conjunction with our business model transition, we also raised prices across multiple desktop products in October, consistent with our principle to price for value. Looking ahead, we expect continued strong desktop ecosystem to revenue growth this year as we complete the remaining part of the three-year transition. Our focus is to continue innovating across our online ecosystem and to help our desktop customers migrate seamlessly to our online offerings. We continue to expect the online ecosystem to be a growth catalyst longer term. Moving to Credit Karma. Credit Karma delivered revenue of $405 million in Q1, down 5% year-over-year. We saw partners taking a conservative approach to extending credit in both personal loans and credit cards during Q1. We -- This performance was consistent with our expectations and a prudent approach to guidance given the uncertain macroeconomic environment. On a product basis, the decline in Q1 was driven primarily by macroeconomic trends across personal loan, auto insurance, home loans and auto loans, partially offset by growth in credit cards and Credit Karma money. Shifting to the consumer and ProTax groups. Consumer Group revenue was $187 million and grew 25% in the quarter and ProTax revenue was $42 million and grew 24%. During the quarter, we saw stronger-than-expected TurboTax return volume from states, both with and without extended tax deadlines and strong performance in share of total returns during extension season. As Sasan shared earlier, we are excited about our innovation across TurboTax. The multiple experiments we ran during the extension season, bolster our confidence in our game plan to win this coming tax season. Now let me briefly touch on our financial principles and capital allocation. Our financial principles guide our decisions that remain our long-term commitment and are unchanged. We finished the quarter with approximately $2.3 billion in cash and investments and $5.9 billion in debt on our balance sheet. In September, we raised $4 billion in secured -- sorry, in senior notes to repay the outstanding balance on an unsecured term loan. These notes carry a weighted average coupon of 5.29%, approximately 1 point lower than the term loan rate at the end of Q4. As a reminder, during Q1, we made tax payments of approximately $710 million that were deferred from fiscal 2023 due to the IRS disaster area tax relief. We also repurchased $603 million of stock during the first quarter. Depending on market conditions and other factors, our aim is to be in the market each quarter. And lastly, the Board approved a quarterly dividend of $0.90 per share, payable on January 18, 2024. This represents a 15% increase versus last year. As I stated earlier, I'm pleased with the early momentum we're seeing in fiscal 2024, highlighting the strength of our platform within the uncertain macroeconomic environment that is consistent with our expectations. We have a proven playbook and a track record of managing for the short and the long term, including controlling discretionary spend to deliver strong results while investing in what is most important for future growth. Our goal remains for Intuit to emerge from this period of macroeconomic uncertainty in an even greater position of strength. Moving on to guidance. We are reaffirming our fiscal 2024 guidance. This includes total company revenue growth of 11% to 12%, GAAP operating income growth of 15% to 18%, non-GAAP operating income growth of 12% to 14%, GAAP earnings per share growth of 11% to 15% and non-GAAP earnings per share growth of 12% to 14%. Our guidance for the second quarter of fiscal 2024 includes revenue growth of 11% to 12%, GAAP earnings per share of $0.62 to $0.68 and non-GAAP earnings per share of $2.25 to $2.31. As a reminder, we are taking a prudent approach with guidance given the continued macroeconomic uncertainty. You can find our full fiscal 2024 and Q2 guidance details in our press release and on our fact sheet. With that, I'll turn it back over to Sasan.
Sasan Goodarzi: All right. Well, thank you, Sandeep. And to wrap it up, we are confident in our AI-driven expert platform strategy and progress across our five big bets and creating a future of done for you with a gateway to human expertise. We believe this will change our relationship with customers, becoming their trusted adviser, leading to higher engagement and monetization. The combination of our assets and our strategy creates a growth flywheel for Intuit to accelerate at penetrating our $300 billion in TAM. With all of that said, let's now open it up to your questions.
Operator: Thank you. [Operator Instructions] Our first question will come from Raimo Lenschow with Barclays. Your line is open.
Raimo Lenschow: Perfect. Thank you. Sasan, on the AI strategy, like obviously, you have like one -- it seems like one big platform that is driving it. Like can you -- what's the kind of opportunity to kind of learn from one segment and use it in the other segment? And as part of that also, like are you impacted by the chip shortage? Will that kind of impact the rollout for you? Thank you.
Sasan Goodarzi: Yeah. Thank you for your question. And I actually think it's a really interesting question that you're asking in terms of how are we learning across platforms. The short answer is we capture best practices and share the insights on a daily basis across our teams. And in fact, I'll just use our staff as an example. We get weekly slacks with documents that share the best practices, the progress that has been made and how that informs the next week across each of the platforms. And we spend 80% of my staff meeting actually doing product reviews of Intuit Assist. A big large part of it is what the key best practices are, learnings are. And I would tell you that there's a lot of commonality in themes across our learnings across the platform, which actually is simply putting us in a position to accelerate our pivot and our progress and innovation and the timing of going GA across the platform. To your second question, no, we're not impacted by the chip shortage. It does not at all impact our launch plans.
Raimo Lenschow: Okay. Perfect. Congrats. Thank you.
Sasan Goodarzi: Thank you.
Operator: Our next question will come from Keith Weiss with Morgan Stanley.
Keith Weiss: Excellent. Thank you for taking the question guys, and congratulations on a really solid quarter. Two questions, one for Sasan and one for Sandeep and really digging into what I think were some of the bigger surprises in the quarter, Sasan, in this environment, I think we're surprised to see strength in a marketing platform like Mailchimp and you called that out as part of the strength in online services. Do you think that's more of an Intuit sort of independent factor of repackaging, marketing more aggressively distribution? Or is it -- the market is better than we expect? And then for Sandeep, operating margins were really strong in the quarter. Any one-time items or pull forward expenses or push out expenses that we should be mindful of in terms of why that type of operating margin performance isn't going to be reflected in the rest of the year? Thank you.
Sasan Goodarzi: Thanks for the question, Keith. I'll take your first one. What you're seeing from us in Mailchimp is entirely execution. We're not getting tailwinds from the macro environment. And as I mentioned, when we closed the acquisition a while back, that our biggest opportunity was to be clear about our product improvements, our lineup and to be able to create one growth platform, develop strength internationally and go to mid-market. And by the way, we've made a lot of progress in all of those areas. We still have a lot of work ahead of us, to be clear. But everything that you're seeing is based on our execution and no macro tailwinds.
Sandeep Aujla: And on the margin question, Keith -- on the margin question, let me start by reiterating our commitment to having our expenses growth lower than revenue and in essence, delivering our margin expansion and operating leverage, which is something that we hold dearly and our guidance of 40 to 60 bps expansion for the year reflects the discipline that we have as a management team. On the margin for the quarter, I would share that, I won't get too fixated on the quarterly number. We had some expenses that moved out of the quarter into later parts of the year, including some marketing expenses. And as I shared during the prepared remarks, we are committed to our full year guidance on our operating income. So that's what I would guide you and the teams towards.
Keith Weiss: Excellent. Really nice job guys. Thank you.
Sasan Goodarzi: Thank you.
Operator: Our next question comes from Siti Panigrahi with Mizuho.
Siti Panigrahi: Thanks for taking my question. Sasan, I wanted to ask about the health of small business. Where do you see right now, strength and weakness in this environment?
Sasan Goodarzi: Thanks for the question, Siti. As you know, we've been in this macro environment for some time now. And the small businesses that we serve are resilient for a couple of reasons. One, they're on our platform. And by digitizing what they do, which is how they grow customers and managing their cash flow, they are far more resilient and as we've shared before, anybody that's on our platform is nearly 20 points higher in their success rate than those that are not on our platform. So we are part of sort of the health that we're experiencing on our platform. With that as context, I would just share a couple of data points. One, the number of companies and the number of employees that our small businesses are hiring still remains strong. Two, our total online payments volume grew 21%, which means that our small businesses are continuing to be competitive. and -- and serving their consumers. I also remind us, by the way, I think, a year ago or more, that growth was in the 30% plus. And so we have seen an impact, but just our overall platform is very resilient. And then the last thing I would say is that the cash reserves of our small businesses is 90% of where it was this time last year. However, it's 128% of where it was pre-pandemic. So their cash flow is stronger than several years ago, but 10% down from last year. And then very specifically, as you know, we serve service-based businesses, which is about 70% of the market. We're not concentrated in any one particular area. But you'll see place things like auto repairs and -- that are doing well, professional services that are doing well. But just like pure construction, those that do lending not doing well. So there's sort of ups and downs across the small businesses that we see. But in aggregate, the health comes from the numbers that I shared with you.
Siti Panigrahi: Thanks for that color, Sasan.
Sasan Goodarzi: Yeah. Very welcome.
Operator: Our next question will come from Alex Zukin with Wolfe Research.
Allan Verkhovski: Hi, this is Allan Verkhovski on behalf of Alex Zukin. Thank you for taking the question. QuickBooks Online accounting growth decelerated another 3 percentage points this quarter. With respect to your growth drivers, is there anything that got meaningfully worse in the quarter? Or something that is worth emphasizing to investors? And that will be helpful for thinking about what growth could look like for the rest of the year.
Sasan Goodarzi: Yeah, that was really driven by a larger price increase last year versus this year. That was really the only -- the driver. We liked what we saw in terms of our acquisitions, our retention. So that's really the variance.
Allan Verkhovski: Okay. And as just a quick follow-up, would you be able to step through the monthly linearity that you saw in Credit Karma through the quarter and in November? Thanks.
Sasan Goodarzi: Sorry, can you ask your question again?
Allan Verkhovski: Just on the Credit Karma, thinking about the linearity of the business through the quarter and November, I was wondering if you could just kind of talk through on a monthly basis what you saw in the underlying trends for Credit Karma?
Sasan Goodarzi: Yeah. Well, I'll answer your question in two ways. One, as you heard in our prepared remarks, we saw and we anticipated further tightening by our partners. By the way, it happened exactly the same time last year. And so we expected that as a -- our partners prepare for the end of the fiscal year and next year, there would be some further tightening, and that's really what we saw. And that was included in our expectations and in our guidance as we thought about the year. That's number one. Number two, there -- not everything is linear because it depends on the number of days like a month like November based on in the US, based on Thanksgiving week, the number of days that people take off that actually impacts certain behaviors. And so there is no linearity. But the quarter just in total was in line with what we expected.
Allan Verkhovski: Thank you.
Sasan Goodarzi: Yeah. Very welcome.
Operator: Our next question will come from Alex Markgraff with KeyBanc Capital Markets.
Alex Markgraff: Hey, thanks for taking my question. Yeah, maybe just be curious to understand, Sasan, as you've done some of the testing around Intuit Assist across product categories, has there been any sort of price testing involved in that as well? And how well received has that been if so?
Sasan Goodarzi: Yeah, sure. Let me answer your question in two ways because I think they're -- it's a great question, and it's connected. First of all, the biggest insight and learning that we have had is, it's really important to have embedded benefits where the customer is doing the work versus sort of something on the side where the assistant is there to help the customer. So what I mean by that is while a customer is looking to build a marketing campaign right within the flow, we, in essence, help them with the audience they should segment, the audience they should target and then we will build their marketing campaign for them, but with them in complete control. So that's a really -- it may sound really obvious, but it's a really important learning, which, by the way, translates to also what we learned in tax, which is within the flow of helping a customer understand their money outcome, helping them understand and doing accuracy checks for them. And if they miss something, calling it out so they can address it right then and there. Those are examples that, by the way, is consistent across all of our platform workflows where embedded matters a lot. The second is depth, depending on the customer and what they're trying to do, there's a level of depth that they want to go to. So an example is within QuickBooks, one of the things that we've been testing and it's been testing really well is a business summary. And the business summary, in essence, provides what we believe are the most important things that, that customer should know and the customer that engages with those business insights and ultimately, will create reports or ask more questions. What we've learned is we're not building propensity models in terms of the timing of when to connect them to an expert. That's a monetizable event for us because if not, you can go on and on having a Q&A and ultimately not get to the benefit as quickly as possible. So those are major insights and learnings and those insights and learnings have led to how we're thinking about monetization. In the case of Mailchimp, having GenAI SKUs based on the things that we can do for customers automatically on their behalf. In the case of QuickBooks and by the way, TurboTax it's a monetizable event because it's a gateway to human expertise and expert help. And then we will be testing GenAI specific SKUs also in QuickBooks. So those are illustrative examples of based on the benefits that we're learning about what's important to customers, that then informs how we think about price testing. And so far, we're pleased with what we're learning and how fast we're pivoting as a company.
Alex Markgraff: That's great. Thank you, Sasan.
Sasan Goodarzi: Yeah. Very welcome.
Operator: Our next question will come from Steve Enders with Citi.
Steve Enders: Okay, great. Thanks for taking the question here. I guess I'm going to ask on the tax business, what you saw with some of those newer product initiatives and maybe what kind of drove the strength there year-over-year and the share gains with some of those newer initiatives?
Sasan Goodarzi: Yeah, sure. Let me answer your question on two dimensions. One, there was a macro element, which there were just more filers in the extension season than we anticipated, both by the way, states that extended and states that did not extend. And these are more complex filers and it's actually our sweet spot. It's why we were able to take share in this extension season. And so that's one element of what drove our better-than-expected results. The three areas that we're excited about, these have been durable priorities where we did a lot of tests and experiments and got a lot of green shoots and learnings that will lead into this coming tax season, it's Credit Karma platform, it's TurboTax Live and its Intuit Assist. And I'll briefly touch on each of them. Within the Credit Karma platform, we have more seamlessly built out the tax experience, whether you want to do it yourself or you want somebody to do it for you. And we've been -- we've developed very compelling SKUs within the Credit Karma platform, which having the opportunity to serve 42 million monthly active users that engage five times a month, was not only a great product, but a great set of SKUs. we saw green shoots and we're excited about that as we look at. The second is TurboTax Live. We expanded the scale of our data, AI and expert network. What that means is, and I'll just point out in two areas. One is the fact that for many customers that want to hand off all their taxes to us, we can get their taxes done within an hour. And that's a very big deal to be able to engage an expert, have your data available and get their taxes done in one setting and then also being able to serve business tax customers, which we'll be launching at scale. Those were areas of green shoots. And the last is Intuit Assist. Two big areas. One is accuracy checks and making sure that in place, we help the customer, in essence, correct something that we believe is a mistake. That's a big conversion driver, by the way. And then the second is just explaining refunds, explaining their money outcome, which is all done and driven by Intuit Assist leveraging our knowledge engineering capabilities and our GenAI capabilities. So those are the three things along with the macro where we saw green shoots that give us a lot of confidence as we head into season.
Steve Enders: Great. Perfect. Thanks for taking the question.
Sasan Goodarzi: Very welcome.
Operator: Our next question will come from Brent Thill with Jefferies.
Unidentified Analyst: Hi, thank you. This is [indiscernible] for Brent. First question on Mailchimp. Wondering if you could share some color on how it's doing in US versus international? And I don't know if you could talk about also about cross-selling synergies with the rest of the small business platform. And second, any update on how the native bill pay is ramping? Thank you.
Sasan Goodarzi: What was your last question, bill pay?
Unidentified Analyst: Yes. On bill pay.
Sasan Goodarzi: Yeah. Got it. Thanks for the question. So I'll start with Mailchimp. As we talked about, one of our top priorities includes international. We've spent quite a bit of time and investment in translating to local languages, building out a team that can focus on EMEA and third, making sure that we've got the right pricing lineup and go-to-market plan. And we're executing against that. We like what we see. And it's contributing to the numbers that we reported. And I would say, for us, it's the balance of focus between US and international. We see an enormous opportunity in US and in international. So we have the right balance focus as we think about the geographies. The second, in terms of cross-sell as we shared at Investor Day, we are a big part of the thesis behind the acquisition was to create one growth platform. And what we shared at Investor Day was that we are building an AI native CRM within the QuickBooks platform. We're continuing to make progress in testing and learning and pivoting to get the product market fit. When we get the product market fit. That's really where the cross-sell takes place. We've not assumed or anticipated any contribution from that in our guidance this year. But it's a very important long-term strategic priority. It's the reason why we acquired the platform is to ultimately have one growth platform where you can grow your customers and manage our cash flow all in one place. So that's on the Mailchimp front. On Bill Pay, we're pleased with the fact that we're GA and we -- and as I think noted earlier, what we're seeing with our mid-market customers is -- mid-market versus non-mid market customers, there's a 2x increase in those that are taking the subscription, the paid subscription. So that just means that we're adding value. We also have work ahead of us in Bill pay, things around batch payments, faster funding, all the things that we know we have to have. It's on our roadmap, and it will be launched in the future. So along with the fact that we're GA, we're clear on what the gaps are and what -- and it's on our roadmap, we're working feverishly to really be able to digitize B2B for our customers because we believe it's a big opportunity for our customers to improve their cash flow and a big growth opportunity for us in the long term. So that's the progress on both fronts.
Unidentified Analyst: Great. Thank you very much.
Sasan Goodarzi: Yeah. You're very welcome.
Operator: Our next question comes from Brad Reback with Stifel.
Brad Reback: Great. Thanks very much. Sasan, as you think about the mid-market opportunity for the QuickBooks and the online ecosystem, given the value prop, is it easier to take share during difficult economic times because of that value prop? Or are customers just hesitant to move and wait for the economy to get better before they'll make a back-office switch? Thanks.
Sasan Goodarzi: Yeah, great question. I'll share two different perspectives in terms of what we're seeing. The first one is, it really doesn't matter what the economic environment is. If it's great, they don't behave differently. If it's challenging like it is now, they don't behave differently. We certainly don't see them -- any of our customers wanting not to switch because the economy is not good, which leads to the second point I wanted to make. So the headline on the first question is, it's not a tailwind or a headwind, whether it's good times or bad times. However, what I would say is we see some green shoots that's early when we do bundling for our customers. When we go to our customers and share with them that they can digitize all of their payments, all of their payroll and the benefits that it will have for our customers from a cash flow perspective, we see that having traction with our customers. And as we've continued to build out our sales team, we're doing, I think, a far better job of account management. And this is an area where if you look back five years ago, we didn't have the kind of value-added account management teams that we're building now where we're engaging our customers, they’re are hearing from us, right? We've been entirely a [self-sell] (ph) platform. And now that we're engaging our customers, a lot of them are starting to realize, wow, you have payments, I didn't realize you have payroll. I didn't you have time tracking. I didn't realize your own Mailchimp. And that is an opportunity for us to drive an increased penetration in wallet share. So I share that just to say that's where we're getting traction. That's where we're seeing progress, and that's where we see an opportunity as we look ahead.
Sandeep Aujla: And Brad, what I'll add is beyond just the QuickBooks side, we also are seeing strong progress on the Mailchimp side in terms of mid-market where historically before we acquired the company was not a focus and now with some of the stuff was Sasan mentioned, including account management, better onboarding, we're seeing better customer acquisition on the mid-market as well as better retention year-over-year in the mid-market, so that opportunity extends beyond just the QuickBooks for us across the entire platform, including Mailchimp.
Brad Reback: Excellent. Thank you.
Sasan Goodarzi: You're very welcome.
Operator: Our next question will come from Kirk Materne with Evercore ISI.
Kirk Materne: Yeah. Thanks very much and congrats on the quarter. Sasan, I was wondering if you could just talk about the -- I realize you have a vast and sort of wide open TAM in your markets on the small business side. But I was kind of curious if you're seeing any evidence that small businesses are looking to consolidate multiple technologies onto one platform. You all obviously offer a lot both on the front office and as well in the back office. Are you starting to see any of that sort of activity happening now that you're sort of integrating Mailchimp with QuickBooks? I realize it's early days, and you need that to happen to be successful. But I was just wondering if you're seeing any evidence of that yet? Thanks.
Sasan Goodarzi: Yeah, Kirk, the short answer is, it's early, but we're seeing green shoots, and it's primarily because of what I shared just a moment ago, as we're building out our account management team across Mailchimp and QuickBooks platform, as we're talking to our customers, and in fact, I personally spoke to three of them in the last month that are very large mid-market customers, two of them in LA and one of them in Miami. And it actually starts with -- they didn't know even know we have, Payments, Payroll. They didn't even know we're the same company that owns Mailchimp as an example. Some of them will use Mailchimp but they'll use QuickBooks. Some of them use our Payroll, but don't use our Payments and so the thing that we're inspired by and where we believe there's a big opportunity is the fact that we actually have a huge differentiation, which is around data, AI and network of experts and an ecosystem of applications. And the applications are all the things that a small business would want. And our account management team is really discovering for us the fact that our customers just don't know. And so therefore, we engage them, build relationships and talk about the benefits of all of our applications and then what could be done based on all of the capabilities that we have around AI and how that could fuel their success. That's what's really opening up doors for us is just the unknown. And that's what we're excited about as we continue to accelerate building out our talent management team. So I think the long answer to your short question is, yes, customers would prefer to be on one platform. And what we're learning is a lot of customers are not because they just actually don't even know what we do holistically, and that's the mission that we are on.
Kirk Materne: Thank you so much.
Sasan Goodarzi: Yeah, you're very welcome.
Operator: Our next question will come from Mark Murphy with JPMorgan.
Arti Vula: Hi, this is Arti Vula on for Mark Murphy. Congrats on the quarter and thanks for taking the question. I just wanted to touch on QuickBooks Advance. You mentioned at your Investor Day that the success of that product is more about just the go-to-market versus kind of a new product or feature development. So can you kind of discuss progress from your perspective on that front? And then in terms of the mid-market, is that -- can you talk about how that's faring in terms of overall health? And maybe compare that to the lower end of the market? Thanks.
Sasan Goodarzi: Yeah, sure. Thank you for your question. First of all, just to play back what I shared at the Investor Day, I said if I had to pick one that was the most important lever going forward, it's go-to-market. We are continuing feverishly to build out the product capabilities that we need on the platform because we don't plan to stop at 100 employees. Our plan is to serve mid-market customers over time that are far larger than 100. However, in the near term, sort of near and midterm, the biggest needle mover is go-to-market. And I would tell you that it continues to be bringing on the right skill sets of talent in sales and marketing. And so even in the last, I think, couple of quarters, it's been -- we've hired a very strong marketing leader. We're -- we've hired a very strong sales leader. We're hiring a couple of more sales leaders. We're bringing on account managers that have a lot of skill in selling and nurturing customers. Because when we think about mid-market, it's really about a lot of the examples I was using earlier, which is really helping customers understand they can run their business in one place on one platform and the benefits of doing so and what it will mean to their cash flow and particularly helping them understand our roadmap as a company and what we are doing with Intuit Assist, which is really creating a feature of done for you with always having a gateway to human expertise. And that's enticing for mid-market customers. So net-net, that's the way I would describe our focus area. But we want you to walk away to be we're continuing to invest in the product and in the platform because that's a big opportunity in the long term as well. In terms of health, I think it really -- it comes down to the sector, if you just use US as an example, comes down to the state, the sector that you're in. Generally speaking, based on our history looking backwards, larger, more tenured customers can withstand more of economic turmoil versus someone that literally just started out their business and they only have $100,000 in their savings and if that $100,000 is spent, then they're done, right, they go bankrupt. So it really depends on the size of the business, how long that they've been in business and then the segment that their business is in, all those variables play in. I wouldn't say younger ones are more or less healthy and the older ones are healthier. I would just say it depends on the components that I just described a moment ago.
Arti Vula: Perfect. Thank you.
Sasan Goodarzi: Yeah, very welcome.
Operator: Our next question comes from Kartik Mehta with Northcoast Research.
Kartik Mehta: Good afternoon. Sasan, maybe we've talked a lot about the Full Service business. And as you look at that business and all the learnings you've talked about, how will you define success for that business at the end of the tax season? Is it the number of returns of process? Is it -- I guess, what are the metrics that you will use to figure if you had success or not?
Sasan Goodarzi: Yeah. Thanks for your question. First of all, I'll start with something that's really, really important, and that is the investments that we've made over the years where TurboTax is now one platform, and that platform is built on an incredible rich sort of data layer, AI layer and expert network. and now an ecosystem of apps, which is consumer app and business taxes. And the reason I start there is because now we have the ability in one place for you to do your taxes yourself, get help with an expert that's matched specifically to your needs and we can do your taxes for you. And in fact, you can request the same person to do your taxes for you year in and year out and provide advice along the way. The reason I started with that foundational element that we are one platform is as we go to market and start talking to customers about the notion of that choice with us, and we can do everything for you, it actually creates a halo effect. And so what we will look at are metrics around number of customers, conversion, retention, ARPC across the entire franchise. And we also look at it by area. So very specifically, Full Service plays a very important halo effect because it's an element of confidence. It's actually knowing that if I want to hand everything off to someone that Intuit can now do it for me, whether it's virtually or now locally, if I want to connect to an expert. But ultimately, the metric that will matter the most for Full Service is going to be ARPC because it's not just the numbers game. It's the value of these customers. We, of course, will measure a number of customers and ARPC, but ARPC will have the largest impact to our outcomes this year and in the future because now we do your taxes for you as a consumer and as a business.
Kartik Mehta: Perfect. And Sandeep just one quick question. You talked about not wanting to focus on one quarter for margins. But I'm wondering, as you look at the year, any differentiation or movement in marketing especially as the tax season unfolds?
Sandeep Aujla: Kartik, we are continuing to invest across our product, across the Big Bet, across GenAI, across marketing and particularly as we go to Full Service, we want to make sure that we are expanding our brand's equity beyond the DIY category to the Full Service. But I would not expect any meaningful shift in the seasonality of our marketing spend, which I think is the question that you're asking. So -- and I feel pretty good about the campaigns and the investments we've been making across the go-to-market motion across tax as well as the other segments.
Kartik Mehta: Thank you. Yes. That was the question I was asking. I just did a poor job of it. So thank you.
Sasan Goodarzi: Thank you.
Operator: Our next question will come from Brad Sills with Bank of America.
Brad Sills: Great. Thank you so much. Another question here on TurboTax as you're kind of heading into the next tax season here. Now that the focus is more on full service and TurboTax Live, is there something different about the end user, the end consumer filer that you're targeting now, say, going after that CPA segment that's different from traditionally, where you've gone after that tax store, you've had tremendous success there against tax stores. Now that CPA segment. Is there some difference there? And is there some learning from last year in go-to-market that you can apply this year to gain more traction there at that end of the market? Thanks, again.
Sasan Goodarzi: Yeah, Brad, thank you for your question. And it's actually spot on the way you asked it, and that is we view our opportunity as nearly 100 million customers that are either consumers, which is about 88 million of the 100 million and the rest are our business customers, small businesses. We view our opportunity going after them, which is a combination of small pros, mom-and-pop shops, stores is actually a smaller part of the whole pie. And in the last, I would say, 18 months, we've experimented a lot with how do we go after these customers, how do we raise awareness, how do we get them to consider and ultimately, how do we ensure that when they come to our front door, front door is a service front or not a software front door because of the behaviors that they have. And a lot of those both go-to-market and platform insights and learnings is what has informed a number of things that I touched on earlier that we experimented with and ran test in the tax extension season and what we feel good about going into this coming season. So it was a long answer to your question, but yeah, a lot of those insights have informed our game plan because we're not just the software platform, we're a software and service platform, given who we're focused on serving. And by the way, while I have the floor, the same thing applies to small businesses as we think about what we're doing to embed QuickBooks Live in our offering.
Brad Sills: Wonderful. Thank you, Sasan.
Sasan Goodarzi: Yeah. Very welcome.
Operator: Our last question will come from Scott Schneeberger with Oppenheimer.
Scott Schneeberger: Thanks very much. I have a follow-up for Sandeep and then one for you, Sasan. Sandeep, on the margins in the quarter, you cited marketing, which I assume was predominantly that. Was there anything else in the quarter that was beneficial? Or was that the lion's share? And then you mentioned spread over the balance of the year and in Kartik’s answer, I felt you kind of were speaking to TurboTax but it looks like you're expecting a bit of a down quarter on margin in the second quarter. So we'll -- and it seemed like it was mostly in small business, the real benefit in the first quarter. So will that end as of second quarter? Is that truly something that is going to tail off in the second half as well? And then I'll come back to the follow-up. Thanks.
Sandeep Aujla: Sure. Thanks for the question, Scott. The way I would think about the Q1, we had multiple expenses that moved out of the quarter into later parts of the year, and marketing was one of those expense lines, and I would not say that marketing was the lion's share of it. There were several things that we expected will hit us in October that got pushed out, but I would definitely not take away as marketing being the lion's share of items that got pushed out. And you're right, some of those will get caught up, and we'll have those expenses in Q2 and so once you look at Q1 and Q2 spent together, those things will start normalizing out. Again, I'll bring you and the team back to the fact that you should all be focusing on our margins on a full year basis. In any given year, we could have different expense trend lines. So again, we remain confident in our guidance for the full year across the margins for the company.
Scott Schneeberger: Thanks. Appreciate that. And Sasan, we're pretty well along now into Karma Guarantee. Would love just to get an update on that and Credit Karma was a bit stronger than we had anticipated in the quarter. Is it something that could potentially inflect a positive year-over-year growth in the fiscal first half? Or is that something that you'd expect more in the back half? Thanks.
Sasan Goodarzi: Yeah. Thank you for your question. First of all, I'll start with, based on our insights and learnings from last year, we really took an approach to be intentional and prudent about the guidance that we provide, which means taking into account not only a macro environment, but also not just banking, a bunch of initiatives in the back half of the year. We're aggressive in the initiatives that we're working on, but we did not make them into our guidance because we just wanted to be thoughtful and prudent. With that as context, I would -- I love your question about Karma Guarantee because we haven't explicitly been talking about it and it's not because it's not important anymore. It's because of the way we are now thinking about it and incorporating it into several areas. One is you've heard us talk about the entire app redesign, which is far more focused on putting the right benefits in front of the customers at the right time, which we talked about at Investor Day, that coupled with Intuit Assist. And the example I used in earlier was the fact that prime customers spend literally four or five hours doing comparison shopping between credit cards because they can get whatever credit card they want, but they're looking for the perps. Now we can automatically do that for them based on all of the data and everything that we know about them. So you combine the app redesign with Intuit Assist and our focus on prime customers. Karma Guarantee plays an important role helping customers, particularly those that have a hard time getting access to financial products, guarantee them that if they choose what's in front of them that they're going to be approved for it or we'll put $50 in their bank account. So the combination of those things is what the set of initiatives are that we are focused on that we expect will drive engagement, higher frequency and monetization. And we've not included that in our guidance, but it's very important for the future growth of the business. Not only that, and I'll end with this, tax is an enormous part of it. We've now spent several years thinking about how does every interaction and move a customer mix in the Credit Karma platform? How does that inform what that will mean to their taxes. So that when it's tax time, it's a much more seamless experience along with compelling offers. So taxes now, as we look ahead, such an important part of the life of the member and our focus area within Credit Karma. And all of those combined is what we have high hopes for in the future. Again, not in our guidance but important for the future.
Scott Schneeberger: Excellent. Thanks for all that.
Sasan Goodarzi: You're very welcome.
Operator: All right. Thank you. Ladies and gentlemen, there are no -- go ahead, sir.
Sasan Goodarzi: Sorry, go ahead.
Operator: There no further questions, so you may proceed with any additional or closing remarks.
Sasan Goodarzi: Sorry to have interrupted you. I was just going to say thank you for all the questions, and we look forward to hearing from everyone next quarter. Until then, be safe. Bye, everybody.
Operator: Ladies and gentlemen, thank you for participating. This does conclude today's conference call, and you may disconnect at this time. |
NVDA | 3 | 2,024 | 2023-11-21 21:33:06 | Operator: Good afternoon. My name is JL, and I will be your conference operator today. At this time, I would like to welcome everyone to NVIDIA's Third Quarter 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] Simona Jankowski, you may now begin your conference.
Simona Jankowski: Thank you. Good afternoon, everyone, and welcome to NVIDIA's conference call for the third quarter of fiscal 2024. With me today from NVIDIA are Jensen Huang, President and Chief Executive Officer; and Colette Kress, Executive Vice President and Chief Financial Officer. I'd like to remind you that our call is being webcast live on NVIDIA's Investor Relations website. The webcast will be available for replay until the conference call to discuss our financial results for the fourth quarter and fiscal 2024. The content of today's call is NVIDIA's property. It can't be reproduced or transcribed without our prior written consent. During this call, we may make forward-looking statements based on current expectations. These are subject to a number of significant risks and uncertainties and our actual results may differ materially. For a discussion of factors that could affect our future financial results and business, please refer to the disclosure in today's earnings release, our most recent forms 10-K and 10-Q, and the reports that we may file on Form 8-K with the Securities and Exchange Commission. All statements are made as of today, November 21, 2023, based on information currently available to us. Except as required by law, we assume no obligation to update any such statements. During this call, we will discuss non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our CFO commentary, which is posted on our website. With that, let me turn the call over to Colette.
Colette Kress: Thanks, Simona. Q3 was another record quarter. Revenue of $18.1 billion was up 34% sequentially and up more than 200% year-on-year and well above our outlook for $16 billion. Starting with Data Center. The continued ramp of the NVIDIA HGX platform based on our Hopper Tensor Core GPU architecture, along with InfiniBand end-to-end networking, drove record revenue of $14.5 billion, up 41% sequentially and up 279% year-on-year. NVIDIA HGX with InfiniBand together are essentially the reference architecture for AI supercomputers and data center infrastructures. Some of the most exciting generative AI applications are built and run on NVIDIA, including Adobe Firefly, ChatGPT, Microsoft 365 Copilot, CoAssist, now assist with ServiceNow and Zoom AI Companion. Our Data Center compute revenue quadrupled from last year and networking revenue nearly tripled. Investments in infrastructure for training and inferencing large language models, deep learning, recommender systems and generative AI applications is fueling strong broad-based demand for NVIDIA accelerated computing. Inferencing is now a major workload for NVIDIA AI computing. Consumer Internet companies and enterprises drove exceptional sequential growth in Q3, comprising approximately half of our Data Center revenue and outpacing total growth. Companies like Meta are in full production with deep learning, recommender systems and also investing in generative AI to help advertisers optimize images and text. Most major consumer Internet companies are racing to ramp up generative AI deployment. The enterprise wave of AI adoption is now beginning. Enterprise software companies such as Adobe, Databricks, Snowflake and ServiceNow are adding AI copilots and the systems to their platforms. And broader enterprises are developing custom AI for vertical industry applications such as Tesla in autonomous driving. Cloud service providers drove roughly the other half of our Data Center revenue in the quarter. Demand was strong from all hyperscale CSPs, as well as from a broadening set of GPU-specialized CSPs globally that are rapidly growing to address the new market opportunities in AI. NVIDIA H100 Tensor Core GPU instances are now generally available in virtually every cloud with instances in high demand. We have significantly increased supply every quarter this year to meet strong demand and expect to continue to do so next year. We will also have a broader and faster product launch cadence to meet the growing and diverse set of AI opportunities. Towards the end of the quarter, the U.S. government announced a new set of export control regulations for China and other markets, including Vietnam and certain countries in the Middle East. These regulations require licenses for the export of a number of our products, including our Hopper and Ampere 100 and 800 series and several others. Our sales to China and other affected destinations derived from products that are now subject to licensing requirements have consistently contributed approximately 20% to 25% of Data Center revenue over the past few quarters. We expect that our sales to these destinations will decline significantly in the fourth quarter. So we believe will be more than offset by strong growth in other regions. The U.S. government designed the regulation to allow the U.S. industry to provide data center compute products to markets worldwide, including China. Continuing to compete worldwide as the regulations encourage, promotes U.S. technology leadership, spurs economic growth and supports U.S. jobs. For the highest performance levels, the government requires licenses. For lower performance levels, the government requires a streamlined prior notification process. And for products even lower performance levels, the government does not require any notice at all. Following the government's clear guidelines, we are working to expand our Data Center product portfolio to offer compliance solutions for each regulatory category, including products for which the U.S. government does not wish to have advance notice before each shipment. We are working with some customers in China and the Middle East to pursue licenses from the U.S. government. It is too early to know whether these will be granted for any significant amount of revenue. Many countries are awakening to the need to invest in sovereign AI infrastructure to support economic growth and industrial innovation. With investments in domestic compute capacity, nations can use their own data to train LLMs and support their local generative AI ecosystems. For example, we are working with India's government and largest tech companies including Infosys, Reliance and Tata to boost their sovereign AI infrastructure. And French private cloud provider, Scaleway, is building a regional AI cloud based on NVIDIA H100 InfiniBand and NVIDIA's AI Enterprise software to fuel advancement across France and Europe. National investment in compute capacity is a new economic imperative and serving the sovereign AI infrastructure market represents a multi-billion dollar opportunity over the next few years. From a product perspective, the vast majority of revenue in Q3 was driven by the NVIDIA HGX platform based on our Hopper GPU architecture with lower contribution from the prior generation Ampere GPU architecture. The new L40S GPU built for industry standard servers began to ship, supporting training and inference workloads across a variety of consumers. This was also the first revenue quarter of our GH200 Grace Hopper Superchip, which combines our ARM-based Grace CPU with a Hopper GPU. Grace and Grace Hopper are ramping into a new multi-billion dollar product line. Grace Hopper instances are now available at GPU specialized cloud providers, and coming soon to Oracle Cloud. Grace Hopper is also getting significant traction with supercomputing customers. Initial shipments to Los Alamos National Lab and the Swiss National Supercomputing Center took place in the third quarter. The UK government announced it will build one of the world's fastest AI supercomputers called Isambard-AI with almost 5,500 Grace Hopper Superchips. German supercomputing center, Julich, also announced that it will build its next-generation AI supercomputer with close to 24,000 Grace Hopper Superchips and Quantum-2 InfiniBand, making it the world's most powerful AI supercomputer with over 90 exaflops of AI performance. All-in, we estimate that the combined AI compute capacity of all the supercomputers built on Grace Hopper across the U.S., Europe and Japan next year will exceed 200 exaflops with more wins to come. Inference is contributing significantly to our data center demand, as AI is now in full production for deep learning, recommenders, chatbots, copilots and text to image generation and this is just the beginning. NVIDIA AI offers the best inference performance and versatility, and thus the lower power and cost of ownership. We are also driving a fast cost reduction curve. With the release of TensorRT-LLM, we now achieved more than 2x the inference performance for half the cost of inferencing LLMs on NVIDIA GPUs. We also announced the latest member of the Hopper family, the H200, which will be the first GPU to offer HBM3e, faster, larger memory to further accelerate generative AI and LLMs. It moves inference speed up to another 2x compared to H100 GPUs for running LLMs like Norma2 (ph). Combined, TensorRT-LLM and H200, increased performance or reduced cost by 4x in just one year. With our customers changing their stack, this is a benefit of CUDA and our architecture compatibility. Compared to the A100, H200 delivers an 18x performance increase for inferencing models like GPT-3, allowing customers to move to larger models and with no increase in latency. Amazon Web Services, Google Cloud, Microsoft Azure and Oracle Cloud will be among the first CSPs to offer H200-based instances starting next year. At last week's Microsoft Ignite, we deepened and expanded our collaboration with Microsoft across the entire stock. We introduced an AI foundry service for the development and tuning of custom generative AI enterprise applications running on Azure. Customers can bring their domain knowledge and proprietary data and we help them build their AI models using our AI expertise and software stock in our DGX cloud, all with enterprise grade security and support. SAP and Amdocs are the first customers of the NVIDIA AI foundry service on Microsoft Azure. In addition, Microsoft will launch new confidential computing instances based on the H100. The H100 remains the top performing and most versatile platform for AI training and by a wide margin, as shown in the latest MLPerf industry benchmark results. Our training cluster included more than 10,000 H100 GPUs or 3x more than in June, reflecting very efficient scaling. Efficient scaling is a key requirement in generative AI, because LLMs are growing by an order of magnitude every year. Microsoft Azure achieved similar results on a nearly identical cluster, demonstrating the efficiency of NVIDIA AI in public cloud deployments. Networking now exceeds a $10 billion annualized revenue run rate. Strong growth was driven by exceptional demand for InfiniBand, which grew fivefold year-on-year. InfiniBand is critical to gaining the scale and performance needed for training LLMs. Microsoft made this very point last week, highlighting that Azure uses over 29,000 miles of InfiniBand cabling, enough to circle the globe. We are expanding NVIDIA networking into the Ethernet space. Our new Spectrum-X end-to-end Ethernet offering with technologies, purpose built for AI, will be available in Q1 next year. With support from leading OEMs, including Dell, HPE and Lenovo. Spectrum-X can achieve 1.6x higher networking performance for AI communication compared to traditional Ethernet offerings. Let me also provide an update on our software and services offerings, where we are starting to see excellent adoption. We are on track to exit the year at an annualized revenue run rate of $1 billion for our recurring software, support and services offerings. We see two primary opportunities for growth over the intermediate term with our DGX cloud service and with our NVIDIA AI Enterprise software, each reflects the growth of enterprise AI training and enterprise AI inference, respectively. Our latest DGX cloud customer announcement was this morning as part of an AI research collaboration with Gentech, the biotechnology pioneer also plans to use our BioNeMo LLM framework to help accelerate and optimize their AI drug discovery platform. We now have enterprise AI partnership with Adobe, Dropbox, Getty, SAP, ServiceNow, Snowflake and others to come. Okay. Moving to Gaming. Gaming revenue of $2.86 billion was up 15% sequentially and up more than 80% year-on-year with strong demand in the important back-to-school shopping season with NVIDIA RTX ray tracing and AI technology now available at price points as low as $299. We entered the holidays with the best-ever line-up for gamers and creators. Gaming has doubled relative to pre-COVID levels even against the backdrop of lackluster PC market performance. This reflects the significant value we've brought to the gaming ecosystem with innovations like RTX and DLSS. The number of games and applications supporting these technologies has exploded in that period, driving upgrades and attracting new buyers. The RTX ecosystem continues to grow. There are now over 475 RTX-enabled games and applications. Generative AI is quickly emerging as the new pillar app for high performance PCs. NVIDIA RTX GPUs to find the most performance AI PCs and workstations. We just released TensorRT-LLM for Windows, which speeds on-device LLM inference up by 4x. With an installed base of over 100 million, NVIDIA RTX is the natural platform for AI application developers. Finally, our GeForce NOW cloud gaming service continues to build momentum. Its library of PC games surpassed 1,700 titles, including the launches of Alan Wake 2, Baldur's Gate 3, Cyberpunk 2077: Phantom Liberty and Starfield. Moving to the Pro Vis. Revenue of $416 million was up 10% sequentially and up 108% year-on year. NVIDIA RTX is the workstation platform of choice for professional design, engineering and simulation use cases and AI is emerging as a powerful demand driver. Early applications include inference for AI imaging in healthcare and edge AI in smart spaces and the public sector. We launched a new line of desktop workstations based on NVIDIA RTX Ada Lovelace generation GPUs and ConnectX, SmartNICs offering up to 2x the AI processing ray tracing and graphics performance of the previous generations. These powerful new workstations are optimized for AI workloads such as fine tune AI models, training smaller models and running inference locally. We continue to make progress on Omniverse, our software platform for designing, building and operating 3D virtual worlds. Mercedes-Benz is using Omniverse powered digital twins to plan, design, build and operate its manufacturing and assembly facilities, helping it increase efficiency and reduce defects. Oxxon (ph) is also incorporating Omniverse into its manufacturing process, including end-to-end simulation for the entire robotics and automation pipeline, saving time and cost. We announced two new Omniverse Cloud services for automotive digitalization available on Microsoft Azure, a virtual factory simulation engine and autonomous vehicle simulation engine. Moving to Automotive. Revenue was $261 million, up 3% sequentially and up 4% year-on year, primarily driven by continued growth in self-driving platforms based on NVIDIA DRIVE Orin SOC and the ramp of AI cockpit solutions with global OEM customers. We extended our automotive partnership of Foxconn to include NVIDIA DRIVE for our next-generation automotive SOC. Foxconn has become the ODM for EVs. Our partnership provides Foxconn with a standard AV sensor and computing platform for their customers to easily build a state-of-an-art safe and secure software defined car. Now we're going to move to the rest of the P&L. GAAP gross margin expanded to 74% and non-GAAP gross margin to 75%, driven by higher Data Center sales and lower net inventory reserve, including a 1 percentage point benefit from the release of previously reserved inventory related to the Ampere GPU architecture products. Sequentially, GAAP operating expenses were up 12% and non-GAAP operating expenses were up 10%, primarily reflecting increased compensation and benefits. Let me turn to the fourth quarter of fiscal 2024. Total revenue is expected to be $20 billion, plus or minus 2%. We expect strong sequential growth to be driven by Data Center, with continued strong demand for both compute and networking. Gaming will likely decline sequentially as it is now more aligned with notebook seasonality. GAAP and non-GAAP gross margins are expected to be 74.5% and 75.5%, respectively, plus or minus 50 basis points. GAAP and non-GAAP operating expenses are expected to be approximately $3.17 billion and $2.2 billion, respectively. GAAP and non-GAAP other income and expenses are expected to be an income of approximately $200 million, excluding gains and losses from non-affiliated investments. GAAP and non-GAAP tax rates are expected to be 15%, plus or minus 1% excluding any discrete items. Further financial information are included in the CFO commentary and other information available on our IR website. In closing, let me highlight some upcoming events for the financial community. We will attend the UBS Global Technology Conference in Scottsdale, Arizona, on November 28; the Wells Fargo TMT Summit in Rancho Palos Verdes, California on November 29; the Arete Virtual Tech Conference on December 7; and the J.P. Morgan Health Care Conference in San Francisco on January 8. Our earnings call to discuss the results of our fourth quarter and fiscal 2024 is scheduled for Wednesday, February 21. We will now open the call for questions. Operator, will you please poll for questions.
Operator: [Operator Instructions] Your first question comes from the line of Vivek Arya of Bank of America. Your line is open.
Vivek Arya: Thanks for taking my question. Just, Colette, wanted to clarify what China contributions are you expecting in Q4. And then, Jensen, the main question is for you, where do you think we are in the adoption curve in terms of your shipments into the generative AI market? Because when I just look at the trajectory of your data center, is growth -- it will be close to nearly 30% of all the spending in data center next year. So what metrics are you keeping an eye on to inform you that you can continue to grow? Just where are we in the adoption curve of your products into the generative AI market? Thank you.
Colette Kress: So, first let me start with your question, Vivek, on export controls and the impacts that we are seeing in our Q4 outlook and guidance that we provided. We had seen historically over the last several quarters that China and some of the other impacted destinations to be about 20% to 25% of our Data Center revenue. We are expecting in our guidance for that to decrease substantially as we move into Q4. The export controls will have a negative effect on our China business. And we do not have good visibility into the magnitude of that impact even over the long-term. We are though working to expand our Data Center product portfolio to possibly offer new regulation compliance solutions that do not require a license, these products, they may become available in the next coming months. However, we don't expect their contribution to be material or meaningful as a percentage of the revenue in Q4.
Jensen Huang: Generative AI is the largest TAM expansion of software and hardware that we've seen in several decades. At the core of it, what's really exciting is that, what was largely a retrieval based computing approach, almost everything that you do is retrieved off of storage somewhere, has been augmented now, added with a generative method. And it's changed almost everything. You could see that text-to-text, text-to-image, text-to-video, text-to-3D, text-to-protein, text-to-chemicals, these were things that were processed and typed in by humans in the past. And these are now generative approaches. The way that we access data is changed. It used to be based on explicit queries. It is now based on natural language queries, intention queries, semantic queries. And so, we're excited about the work that we're doing with SAP and Dropbox and many others that you're going to hear about. And one of the areas that is really impactful is the software industry, which is about $1 trillion or so, has been building tools that are manually used over the last couple of decades. And now there's a whole new segment of software called copilots and assistants. Instead of manually used, these tools will have copilots to help you use it. And so, instead of licensing software, we will continue to do that, of course, but we will also hire copilots and assistants to help us use these -- use the software. We'll connect all of these copilots and assistants into teams of AIs, which is going to be the modern version of software, modern version of enterprise business software. And so the transformation of software and the way that software has done is driving the hardware underneath. And you can see that it's transforming hardware in two ways. One is something that's largely independent of generative AI. There's two trends: one is related to accelerated computing, general purpose computing is too wasteful of energy and cost. And now that we have much, much better approaches, call it, accelerated computing, you could save an order of magnitude of energy, you can save an order of magnitude of time or you can save an order of magnitudes of cost by using acceleration. And so, accelerated computing is transitioning, if you will, general purpose computing into this new approach. And that's been augmented by a new class of data centers. This is the traditional data centers that you were just talking about where we represent about a third of that. But there is a new class of data centers and this new class of data centers, unlike the data centers of the past, where you have a lot of applications running used by a great many people that are different tenants that are using the same infrastructure and that data center stores a lot of files. These new data centers are very few applications, if not one application, used by basically one tenant and it processes data, it trains models and then generates tokens and generates AI. And we call these new data centers AI factories. We're seeing AI factories being built out everywhere, and just by every country. And so if you look at the way where we are in the expansion, the transition into this new computing approach, the first wave you saw with large language model start-ups, generative AI start-ups and consumer Internet companies, and weren't in the process of ramping that. Meanwhile, while that's being ramped, you see that we're starting to partner with enterprise software companies who would like to build chatbots and copilots and assistants to augment the tools that they have on their platforms. You're seeing GPU specialized CSPs cropping up all over the world and they are dedicated to do really one thing, which is processing AI. You're seeing sovereign AI infrastructures, people -- countries that now recognize that they have to utilize their own data, keep their own data, keep their own culture, process that data and develop their own AI. You see that in India. Several -- about a year ago in Sweden, you are seeing in Japan. Last week, a big announcement in France. But the number of sovereign AI clouds that are being built is really quite significant. And my guess is that almost every major region will have and surely every major country will have their own AI clouds. And so I think you're seeing just new developments as the generative AI wave propagates through every industry, every company, every region. And so we're at the beginning of this inflection, this computing transition.
Operator: Your next question comes from the line of Aaron Rakers of Wells Fargo. Your line is open.
Aaron Rakers: Yeah. Thanks for taking the question. I wanted to ask about kind of the networking side of the business. Given the growth rates that you've now cited, I think, it's 155% year-over-year and strong growth sequentially, it looks like that business is like almost approaching $2.5 billion to $3 billion quarterly level. I'm curious of how you see Ethernet involved evolving and maybe how you would characterize your differentiation of Spectrum-X relative to the traditional Ethernet stack as we start to think about that becoming part of the networking narrative above and maybe beyond just InfiniBand as we look into next year? Thank you.
Jensen Huang: Yeah. Thanks for the question. Our networking business is already on a $10 billion plus run rate and it's going to get much larger. And as you mentioned, we added a new networking platform to our networking business recently. The vast majority of the dedicated large scale AI factories standardize on InfiniBand. And the reason for that is not only because of its data rate and not only just the latency, but the way that it moves traffic around the network is really important. The way that you process AI and a multi-tenant hyperscale Ethernet environment, the traffic pattern is just radically different. And with InfiniBand and with software defined networks, we could do congestion control, adaptive routing, performance isolation and noise isolation, not to mention, of course, the day rate and the low latency that -- and a very low overhead of InfiniBand that's natural part of InfiniBand. And so, InfiniBand is not so much just the network, it's also a computing fabric. We've put a lot of software-defined capabilities into the fabric including computation. We will do 40-point calculations and computation right on the switch, and right in the fabric itself. And so that's the reason why that difference in Ethernet versus InfiniBand or InfiniBand versus Ethernet for AI factories is so dramatic. And the difference is profound. And the reason for that is because you've just invested in a $2 billion infrastructure for AI factories. A 20%, 25%, 30% difference in overall effectiveness, especially as you scale up is measured in hundreds of millions of dollars of value. And if you will, renting that infrastructure over the course of four to five years, it really, really adds up. And so InfiniBand's value proposition is undeniable for AI factories. However, as we move AI into enterprise. This is enterprise computing what we'd like to enable every company to be able to build their own custom AIs. We're building customer AIs in our company based on our proprietary data, our proprietary type of skills. For example, recently we spoke about one of the models that we're creating, it's called ChipNeMo; we're building many others. There'll be tens, hundreds of custom AI models that we create inside our company. And our company is -- for all of our employee use, doesn't have to be as high performance as the AI factories we used to train the models. And so we would like the AI to be able to run in Ethernet environment. And so what we've done is we invented this new platform that extends Ethernet; doesn't replace Ethernet, it's 100% compliant with Ethernet. And it's optimized for East-West traffic, which is where the computing fabric is. It adds to Ethernet with an end-to-end solution with Bluefield, as well as our Spectrum switch that allows us to perform some of the capabilities that we have in InfiniBand, not all but some. And we achieved excellent results. And the way we go to market is we go to market with our large enterprise partners who already offer our computing solution. And so, HP, Dell and Lenovo has the NVIDIA AI stack, the NVIDIA AI Enterprise software stack and now they integrate with Bluefield, as well as bundle -- take a market there, Spectrum switch, and they'll be able to offer enterprise customers all over the world with their vast sales force and vast network of resellers a fully integrated, if you will, fully optimized, at least end-to-end AI solution. And so that's basically it, bringing AI to Ethernet for the world's enterprise.
Operator: Thank you. Your next question comes from the line of Joe Moore of Morgan Stanley. Your line is open.
Joseph Moore: Great. Thank you. I'm wondering if you could talk a little bit more about Grace Hopper and how you see the ability to leverage kind of the microprocessor, how you see that as a TAM expander. And what applications do you see using Grace Hopper versus more traditional H100 applications?
Jensen Huang: Yeah. Thanks for the question. Grace Hopper is in production -- in high volume production now. We're expecting next year just with all of the design wins that we have in high performance computing and AI infrastructures, we are on a very, very fast ramp with our first data center CPU to a multi-billion dollar product line. This is going to be a very large product line for us. The capability of Grace Hopper is really quite spectacular. It has the ability to create computing nodes that simultaneously has very fast memory, as well as very large memory. In the areas of vector databases or semantic surge, what is called RAG, retrieval augmented generation. So that you could have a generative AI model be able to refer to proprietary data or a factual data before it generates a response, that data is quite large. And you can also have applications or generative models where the context length is very high. You basically store it in entire book into end-to-end system memory before you ask your questions. And so the context length can be quite large this way. The generative models has the ability to still be able to naturally interact with you on one hand. On the other hand, be able to refer to factual data, proprietary data or domain-specific data, you data and be contextually relevant and reduce hallucination. And so that particular use case for example is really quite fantastic for Grace Hopper. It also serves the customers that really care to have a different CPU than x86. Maybe it's a European supercomputing centers or European companies who would like to build up their own ARM ecosystem and like to build up a full stack or CSPs that have decided that they would like to pivot to ARM, because their own custom CPUs are based on ARM. There are variety of different reasons that drives the success of Grace Hopper, but we're off to a just an extraordinary start. This is a home run product.
Operator: Your next question comes from the line of Tim Arcuri of UBS. Your line is open.
Tim Arcuri: Hi. Thanks. I wanted to ask a little bit about the visibility that you have on revenue. I know there's a few moving parts. I guess, on one hand, the purchase commitments went up a lot again. But on the other hand, China bans would arguably pull in when you can fill the demand beyond China. So I know we're not even into 2024 yet and it doesn't sound like, Jensen, you think that next year would be a peak in your Data Center revenue, but I just wanted to sort of explicitly ask you that. Do you think that Data Center can grow even in 2025? Thanks.
Jensen Huang: Absolutely believe the Data Center can grow through 2025. And there are, of course, several reasons for that. We are expanding our supply quite significantly. We have already one of the broadest and largest and most capable supply chain in the world. Now, remember, people think that the GPU is a chip. But the HGX H100, the Hopper HGX has 35,000 parts, it weighs 70 pounds. Eight of the chips are Hopper. The other 35,000 are not. It is -- even its passive components are incredible. High voltage parts. High frequency parts. High current parts. It is a supercomputer, and therefore, the only way to test a supercomputer is with another supercomputer. Even the manufacturing of it is complicated, the testing of it is complicated, the shipping of it complicated and installation is complicated. And so, every aspect of our HGX supply chain is complicated. And the remarkable team that we have here has really scaled out the supply chain incredibly. Not to mention, all of our HGXs are connected with NVIDIA networking. And the networking, the transceivers, the mix, the cables, the switches, the amount of complexity there is just incredible. And so, I'm just -- first of all, I'm just super proud of the team for scaling up this incredible supply chain. We are absolutely world class. But meanwhile, we're adding new customers and new products. So we have new supply. We have new customers, as I was mentioning earlier. Different regions are standing up GPU specialist clouds, sovereign AI clouds coming out from all over the world, as people realize that they can't afford to export their country's knowledge, their country's culture for somebody else to then resell AI back to them, they have to -- they should, they have the skills and surely with us in combination, we can help them to do that build up their national AI. And so, the first thing that they have to do is, create their AI cloud, national AI cloud. You're also seeing us now growing into enterprise. The enterprise market has two paths. One path -- or if I could say three paths. The first path, of course, just off-the-shelf AI. And there are of course Chat GPT, a fabulous off-the-shelf AI, there'll be others. There's also a proprietary AI, because software companies like ServiceNow and SAP, there are many, many others that can't afford to have their company's intelligence be outsourced to somebody else. And they are about building tools and on top of their tools they should build custom and proprietary and domain-specific copilots and assistants that they can then rent to their customer base. This is -- they're sitting on a goldmine, almost every major tools company in the world is sitting on a goldmine, and they recognize that they have to go build their own custom AIs. We have a new service called an AI foundry, where we leverage NVS (ph) capabilities to be able to serve them in that. And then the next one is enterprises building their own custom AIs, their own custom chatbots, their own custom RAGs. And this capability is spreading all over the world. And the way that we're going to serve that marketplace is with the entire stacks of systems, which includes our compute, our networking and our switches, running our software stack called NVIDIA AI Enterprise, taking it through our market partners, HP, Dell, Lenovo, so on and so forth. And so we're just -- we're seeing the waves of generative AI starting from the start-ups and CSPs, moving to consumer Internet companies, moving to enterprise software platforms, moving to enterprise companies. And then ultimately, one of the areas that you guys have seen us spend a lot of energy on has to do with industrial generative AI. This is where NVIDIA AI and NVIDIA Omniverse comes together and that is a really, really exciting work. And so I think the -- we're at the beginning of a basically across-the-board industrial transition to generative AI to accelerated computing. This is going to affect every company, every industry, every country.
Operator: Your next question comes from the line of Toshiya Hari of Goldman Sachs. Your line is open.
Toshiya Hari: Hi. Thank you. I wanted to clarify something with Colette real quick, and then I had a question for Jensen as well. Colette, you mentioned that you'll be introducing regulation-compliant products over the next couple of months. Yet, the contribution to Q4 revenue should be relatively limited. Is that a timing issue and could it be a source of reacceleration in growth for Data Center in April and beyond or are the price points such that the contribution to revenue going forward should be relatively limited? And then the question for Jensen, the AI foundry service announcement from last week. I just wanted to ask about that, and hopefully, have you expand on it. How is the monetization model going to work? Is it primarily services and software revenue? How should we think about the long term opportunity set? And is this going to be exclusive to Microsoft or do you have plans to expand to other partners as well? Thank you.
Colette Kress: Thanks, Toshiya. On the question regarding potentially new products that we could provide to our China customers. It's a significant process to both design and develop these new products. As we discussed, we're going to make sure that we are in full discussions with the U.S. government of our intent to move products as well. Given our state about where we are in the quarter, we're already several weeks into the quarter. So it's just going to take some time for us to go through and discussing with our customers the needs and desires of these new products that we have. And moving forward, whether that's medium-term or long-term, it's just hard to say both the [Technical Difficulty] of what we can produce with the U.S. government and what the interest of our China customers in this. So we stay still focused on finding that right balance for our China customers, but it's hard to say at this time.
Jensen Huang: Toshiya, thanks for the question. There is a glaring opportunity in the world for AI foundry, and it makes so much sense. First, every company has its core intelligence. It makes up our company. Our data, our domain expertise, in the case of many companies, we create tools, and most of the software companies in the world are tool platforms, and those tools are used by people today. And in the future, it's going to be used by people augmented with a whole bunch of AIs that we hire. And these platforms just got to go across the world and you'll see and we've only announced a few; SAP, ServiceNow, Dropbox, Getty, many others are coming. And the reason for that is because they have their own proprietary AI. They want their own proprietary AI. They can't afford to outsource their intelligence and handout their data, and handout their flywheel for other companies to build the AI for them. And so, they come to us. We have several things that are really essential in a foundry. Just as TSMC as a foundry, you have to have AI technology. And as you know, we have just an incredible depth of AI capability -- AI technology capability. And then second, you have to have the best practice known practice, the skills of processing data through the invention of AI models to create AIs that are guardrails, fine-tuned, so on and so forth, that are safe, so on and so forth. And the third thing is you need factories. And that's what DGX Cloud is. Our AI models are called AI Foundations. Our process, if you will, our CAD system for creating AIs are called NeMo and they run on NVIDIA's factories we call DGX Cloud. Our monetization model is that with each one of our partners they rent a sandbox on DGX Cloud, where we work together, they bring their data, they bring their domain expertise, we bring our researchers and engineers, we help them build their custom AI. We help them make that custom AI incredible. Then that custom AI becomes theirs. And they deploy it on the runtime that is enterprise grade, enterprise optimized or outperformance optimized, runs across everything NVIDIA. We have a giant installed base in the cloud, on-prem, anywhere. And it's secure, securely patched, constantly patched and optimized and supported. And we call that NVIDIA AI Enterprise. NVIDIA AI Enterprise is $4,500 per GP per year, that's our business model. Our business model is basically a license. Our customers then with that basic license can build their monetization model on top of. In a lot of ways we're wholesale, they become retail. They could have a per -- they could have subscription license base, they could per instance or they could do per usage, there is a lot of different ways that they could take a -- create their own business model, but ours is basically like a software license, like an operating system. And so our business model is help you create your custom models, you run those custom models on NVIDIA AI Enterprise. And it's off to a great start. NVIDIA AI Enterprise is going to be a very large business for us.
Operator: Your next question comes from the line of Stacy Rasgon of Bernstein Research. Your line is open.
Stacy Rasgon: Hi, guys. Thanks for taking my questions. Colette, I wanted to know if it weren't for the China restrictions would the Q4 guide has been higher or are you supply-constrained in just reshipping stuff that would have gone to China elsewhere? And I guess along those lines you give us a feeling for where your lead times are right now in data center and just the China redirection such as-is, is it lowering those lead times, because you've got parts that are sort of immediately available to ship?
Colette Kress: Yeah. Stacy, let me see if I can help you understand. Yes, there are still situations where we are working on both improving our supply each and every quarter. We've done a really solid job of ramping every quarter, which has defined our revenue. But with the absence of China for our outlook for Q4, sure, there could have been some things that we are not supply-constrained that we could have sold, but kind of we would no longer can. So could our guidance had been a little higher in our Q4? Yes. We are still working on improving our supply on plan, on continuing growing all throughout next year as well towards that.
Operator: Your next question comes from the line of Matt Ramsay of TD Cowen. Your line is open.
Matt Ramsay: Thank you very much. Congrats, everybody, on the results. Jensen, I had a two-part question for you, and it comes off of sort of one premise. And the premise is, I still get a lot of questions from investors thinking about AI training as being NVIDIA's dominant domain and somehow inference, even large model inference takes more and more of the TAM that the market will become more competitive. You'll be less differentiated et cetera., et cetera. So I guess the two parts of the question are: number one, maybe you could spend a little bit of time talking about the evolution of the inference workload as we move to LLMs and how your company is positioned for that rather than smaller model inference. And second, up until a month or two ago, I never really got any questions at all about the data processing piece of the AI workloads. So the pieces of manipulating the data before training, between training and inference, after inference and I think that's a large part of the workload now. Maybe you could talk about how CUDA is enabling acceleration of those pieces of the workload. Thanks.
Jensen Huang: Sure. Inference is complicated. It's actually incredibly complicated. If you -- we this quarter announced one of the most exciting new engines, optimizing compilers called TensorRT-LLM. The reception has been incredible. You got to GitHub, it's been downloaded a ton, a whole lot of stars, integrated into stacks and frameworks all over the world, almost instantaneously. And there are several reasons for that, obviously. We could create TensorRT-LLM, because CUDA is programmable. If CUDA and our GPUs were not so programmable, it would really be hard for us to improve software stacks at the pace that we do. TensorRT-LLM, on the same GPU, without anybody touching anything, improves the performance by a factor of two. And then on top of that, of course, the pace of our innovation is so high. H200 increases it by another factor of two. And so, our inference performance, another way of saying inference cost, just reduced by a factor of four within about a year's time. And so, that's really, really hard to keep up with. The reason why everybody likes our inference engine is because our installed base. We've been dedicated to our installed base for 20 years, 20-plus years. We have an installed base that is not only largest in every single cloud, it's in every available from every enterprise system maker, it's used by companies of just about every industry. And every -- anytime you see a NVIDIA GPU, it runs our stack. It's architecturally compatible, something we've been dedicated to for a very long time. We're very disciplined about it. We make it our, if you will, architecture compatibility is job one. And that has conveyed to the world, the certainty of our platform stability. NVIDIA's platform stability certainty is the reason why everybody builds on us first and the reason why everybody optimizes on us first. All the engineering and all the work that you do, all the invention of technologies that you build on top of NVIDIA accrues to the -- and benefits everybody that uses our GPUs. And we have such a large installed base, large -- millions and millions of GPUs in cloud, 100 million GPUs from people’s PCs just about every workstation in the world, and they all architecturally compatible. And so, if you are an inference platform and you're deploying an inference application, you are basically an application provider. And as a software application provider, you're looking for large installed base. Data processing, before you could train a model, you have to curate the data, you have to dedupe the data, maybe you have to augment the data with synthetic data. So, process the data, clean the data, align the data, normalize the data, all of that data is measured not in bytes or megabytes, it's measured in terabytes and petabytes. And the amount of data processing that you do before data engineering, before that you do training is quite significant. It could represent 30%, 40%, 50% of the amount of work that you ultimately do. And what you -- and ultimately creating a data driven machine learning service. And so data processing is just a massive part. We accelerate Spark, we accelerate Python. One of the coolest things that we just did is called cuDF Pandas. Without one line of code, Pandas, which is the single most successful data science framework in the world. Pandas now is accelerated by NVIDIA CUDA. And just out-of-the box, without the line of code and so the acceleration is really quite terrific and people are just incredibly excited about it. And Pandas was designed for one purpose and one purpose only, really data processing, it's for data science. And so NVIDIA CUDA gives you all of that.
Operator: Your final question comes from the line of Harlan Sur of J.P. Morgan. Your line is open.
Harlan Sur: Good afternoon. Thanks for taking my question. If you look at the history of the tech industry like those companies that have been successful have always been focused on ecosystem; silicon, hardware, software, strong partnerships and just as importantly, right, an aggressive cadence of new products, more segmentation over time. The team recently announced a more aggressive new product cadence in data center from two years to now every year with higher levels of segmentation, training, optimization in printing CPU, GPU, DPU networking. How do we think about your R&D OpEx growth outlook to support a more aggressive and expanding forward roadmap, but more importantly, what is the team doing to manage and drive execution through all of this complexity?
Jensen Huang: Gosh. Boy, that's just really excellent. You just wrote NVIDIA's business plan, and so you described our strategy. First of all, there is a fundamental reason why we accelerate our execution. And the reason for that is because it fundamentally drives down cost. When the combination of TensorRT-LLM and H200 reduce the cost for our customers for large model inference by a factor of four, and so that includes, of course, our speeds and feeds, but mostly it's because of our software, mostly the software benefits because of the architecture. And so we want to accelerate our roadmap for that reason. The second reason is to expand the reach of generative AI, the world's number of data center configurations -- this is kind of the amazing thing. NVIDIA is in every cloud, but not one cloud is the same. NVIDIA is working with every single cloud service provider and not one of the networking control plane, security posture is the same. Everybody's platform is different and yet we're integrated into all of their stacks, all of their data centers and we work incredibly well with all of them. And not to mention, we then take the whole thing and we create AI factories that are standalone. We take our platform, we can put them into supercomputers, we can put them into enterprise. Bringing AI to enterprise is something generative AI Enterprise something nobody's ever done before. And we're right now in the process of going to market with all of that. And so the complexity includes, of course, all the technologies and segments and the pace. It includes the fact that we are architecturally compatible across every single one of those. It includes all of the domain specific libraries that we create. The reason why every computer company, without thinking, can integrate NVIDIA into their roadmap and take it to market. And the reason for that is, because there is market demand for it. There is market demand in healthcare, there is market demand in manufacturing, there is market demand, of course, in AI, including financial services, in supercomputing and quantum computing. The list of markets and segments that we have domain specific libraries is incredibly broaden. And then finally, we have an end-to-end solution for data centers; InfiniBand networking, Ethernet networking, x86, ARM, just about every permutation combination of solutions -- technology solutions and software stacks provided. And that translates to having the largest number of ecosystem software developers; the largest ecosystem of system makers; the largest and broadest distribution partnership network; and ultimately, the greatest reach. And that takes -- surely that takes a lot of energy. But the thing that really holds it together, and this is a great decision that we made decades ago, which is everything is architecturally compatible. When we develop a domain specific language that runs on one GPU, it runs on every GPU. When we optimize TensorRT for the cloud, we optimized it for enterprise. When we do something that brings in a new feature, a new library, a new feature or a new developer, they instantly get the benefit of all of our reach. And so that discipline, that architecture compatible discipline that has lasted more than a couple of decades now, is one of the reasons why NVIDIA is still really, really efficient. I mean, we're 28,000 people large and serving just about every single company, every single industry, every single market around the world.
Operator: Thank you. I will now turn the call back over to Jensen Huang for closing remarks.
Jensen Huang: Our strong growth reflects the broad industry platform transition from general purpose to accelerated computing and generative AI. Large language models start-ups consumer Internet companies and global cloud service providers are the first movers. The next waves are starting to build. Nations and regional CSPs are building AI clouds to serve local demand. Enterprise software companies like Adobe and Dropbox, SAP and ServiceNow are adding AI copilots and assistants to their platforms. Enterprises in the world's largest industries are creating custom AIs to automate and boost productivity. The generative AI era is in full steam and has created the need for a new type of data center, an AI factory; optimized for refining data and training, and inference, and generating AI. AI factory workloads are different and incremental to legacy data center workloads supporting IT tasks. AI factories run copilots and AI assistants, which are significant software TAM expansion and are driving significant new investment. Expanding the $1 trillion traditional data center infrastructure installed base, empowering the AI Industrial Revolution. NVIDIA H100 HGX with InfiniBand and the NVIDIA AI software stack define an AI factory today. As we expand our supply chain to meet the world's demand, we are also building new growth drivers for the next wave of AI. We highlighted three elements to our new growth strategy that are hitting their stride: CPU, networking, and software and services. Grace is NVIDIA's first data center CPU. Grace and Grace Hopper are in full production and ramping into a new multi-billion dollar product line next year. Irrespective of the CPU choice, we can help customers build an AI factory. NVIDIA networking now exceeds $10 billion annualized revenue run rate. InfiniBand grew five-fold year-over-year, and is positioned for excellent growth ahead as the networking of AI factories. Enterprises are also racing to adopt AI and Ethernet is the standard networking. This week we announced an Ethernet for AI platform for enterprises. NVIDIA Spectrum-X is an end-to-end solution of Bluefield SuperNIC, Spectrum-4 Ethernet switch and software that boosts Ethernet performance by up to 1.6x for AI workloads. Dell, HPE and Lenovo have joined us to bring a full generative AI solution of NVIDIA AI computing, networking and software to the world's enterprises. NVIDIA software and services is on track to exit the year at an annualized run rate of $1 billion. Enterprise software platforms like ServiceNow and SAP need to build and operate proprietary AI. Enterprises need to build and deploy custom AI copilots. We have the AI technology, expertise and scale to help customers build custom models with their proprietary data on NVIDIA DGX Cloud and deploy the AI applications on enterprise grade NVIDIA AI Enterprise. NVIDIA is essentially an AI foundry. NVIDIA's GPUs, CPUs, networking, AI foundry services and NVIDIA AI Enterprise software are all growth engines in full throttle. Thanks for joining us today. We look forward to updating you on our progress next quarter.
Operator: This concludes today's conference call. You may now disconnect. |
GILD | 3 | 2,023 | 2023-11-07 20:42:03 | Operator: Hello everyone and welcome to the Third Quarter 2023 Gilead Sciences' Earnings Conference Call. My name is Nadia and I'll be coordinating the call today. [Operator Instructions] I will now hand over to your host, Jacquie Ross, Vice President of Investor Relations to begin. Jacquie please go ahead.
Jacquie Ross: Thank you and good afternoon everyone. Just after market close today, we issued a press release with earnings results for the third quarter of 2023. The press release, slides, and supplementary data are available on the Investors section of our website at gilead.com. The speakers on today's call will be our Chairman and Chief Executive Officer, Daniel O'Day; our Chief Commercial Officer, Johanna Mercier; our Chief Medical Officer, Merdad Parsey; and our Chief Financial Officer, Andrew Dickinson. After that, we'll open the call to Q&A, where the team will be joined by Cindy Perettie, the Executive Vice President of Kite. Before we get started, let me remind you that we will be making forward-looking statements, including those related to Gilead's business, financial condition, and results of operations, plans and expectations with respect to products, product candidates, corporate strategy, business and operations, financial projections and the use of capital, and 2023 financial guidance, all of which involve certain assumptions, risks, and uncertainties that are beyond our control and could cause actual results to differ materially from these statements. A description of these risks can be found in the earnings press release and our latest SEC disclosure documents. All forward-looking statements are based on information currently available to Gilead and Gilead assumes no obligation to update any such forward-looking statements. Non-GAAP financial measures will be used to help you understand the Company's underlying business performance. The GAAP to non-GAAP reconciliations are provided in the earnings press release, in our supplemental data sheet, as well as on the Gilead website. With that I'll turn the call over to Dan.
Daniel O'Day: Thank you, Jacquie, and good afternoon, everyone. I'm pleased to share that Gilead teams have delivered another strong quarter that rounds out two years of continuous growth for our base business. Our track record of commercial execution continued in the third quarter with our base business up 5% compared to the third quarter of 2022 and up 10% year-over-year for the first nine months of 2023. In the third quarter, our growth was driven by our leading therapies across virology and oncology. Biktarvy had another very strong quarter, up 12% from the same quarter in 2022 and contributing to 9% growth overall in HIV in the first nine months of 2023. Oncology is also driving growth and was up 33% in the third quarter compared to last year. Revenue is now annualizing at more than $3 billion with growing adoption of Trodelvy, the only approved Trop-2 directed ADC and our industry leading cell therapies.
HER2-: Our Phase 2 EVOKE-02 trial showed a strong objective response rate in the PD-L1 high cohort which supports proof of concept for our ongoing Phase 3 EVOKE-03 trial. Important new data at ESMO for Trodelvy's Phase 2 TROPiCS-03 basket trial in our small cell lung cancer and head and neck squamous cell carcinoma cohorts. All of these milestones reinforced our conviction in Trodelvy as our cornerstone oncology asset with pan tumor potential.
EDGE:
Gastric trial:
CART:
ddBCMA:
Arcellx:
GS-1720: In HIV prevention, we completed enrollment ahead of schedule in our Phase 3 PURPOSE-1 trial investigating once every six months lenacapavir subcutaneous injection and announced plans to initiate the Phase 2 PURPOSE-5 trial in 2024 to support access in Europe.
ARTISTRY: In HIV prevention, we completed enrollment ahead of schedule in our Phase 3 PURPOSE-1 trial investigating once every six months lenacapavir subcutaneous injection and announced plans to initiate the Phase 2 PURPOSE-5 trial in 2024 to support access in Europe.
1: In HIV prevention, we completed enrollment ahead of schedule in our Phase 3 PURPOSE-1 trial investigating once every six months lenacapavir subcutaneous injection and announced plans to initiate the Phase 2 PURPOSE-5 trial in 2024 to support access in Europe.
OAKTREE: Veklury remains an important therapeutic options for hospitalized patients with COVID-19. We recently received approvals from both the FDA and the European Commission to extend use of Veklury in patients with mild- to-severe hepatic impairment. Looking at our pipeline overall, our aggregate progress in 2023 is such that we have already completed most of the milestone events as shown on Slide 6. Our clinical pipeline now includes 27 programs in Phase 2 and 19 in Phase 3. We are looking forward to a busy period of updates from many of these studies in 2024, including those evaluating lenacapavir, Trodelvy and obeldesivir. In summary, it's been another strong quarter of commercial and clinical execution, resulting in important progress for Gilead and the people and communities we aim to serve. With that, I'll hand the call over to Johanna to cover our commercial results. Johanna?
Johanna Mercier: Thanks, Dan, and good afternoon, everyone. I'm pleased to share the details of another strong quarter for Gilead and would like to thank the teams that have delivered 10% growth in our base business in the first nine months of 2023. Our third quarter results represent the eight consecutive quarter of year-over-year growth in our base business, illustrated strong commercial execution and revenue growth as our virology and oncology products impact more patient lives. In the third quarter of 2023, total product sales excluding Veklury were up 5% to $6.4 billion as shown on Slide 8, with notable growth in our oncology and HIV businesses partially offset our lower HCV sales. Total product sales including Veklury were $7 billion with a solid base business performance contributing $305 million of growth, offset as we expected by lower Veklury sales compared to the same quarter last year. Moving to HIV on Slide 9, the treatment market continued to grow in line with our expectations of 2% to 3% annually. And as we've discussed previously, a favorable pricing dynamics in recent quarters have begun to normalize with HIV sales growth more closely mirroring market and demand growth. This was evident in the third quarter where HIV sales were up 4% year-over-year to $4.7 billion, driven by higher treatment and prevention demand and higher channel inventory, partially offset by lower average realized price due to a shift in channel mix. Sequentially, sales were up 1%. Looking to the full year, we continue to expect HIV product sales to grow slightly more than the 5% reported in 2022. Turning to Slide 10, third quarter Biktarvy sales were $3.1 billion, up 12% year-over-year, driven by higher demand as well as higher channel inventory. Sequentially, sales were up 4%. Once again, Biktarvy gained market share up over 2% year-over-year in the U.S. to over 47% share in the third quarter. Thanks to its robust clinical profile, Biktarvy remains the number one prescribed regimen for new starts and number one in treatment switches across most major markets, including the U.S. Descovy sales in the third quarter were $511 million, up 2% year-over-year with strong year-over-year growth in demand for Descovy for PrEP offset by less favorable pricing dynamics to ensure broad access ahead of the potential launch of lenacapavir as early as late 2025. The U.S. PrEP market grew about 15% year-over-year and Descovy for PrEP continued to maintain more than 40% market share due to its strong clinical profile and despite the availability of other regimens including generics. Moving to the liver disease portfolio on Slide 11, sales were down 10% year-over-year to $706 million, primarily due to the resolution of a rebate claim in HCV recognized in the third quarter of 2022, as well as other pricing dynamics. From a demand perspective, HCV new starts increased compared to the third quarter of 2022 in both the U.S. and Europe, driven by our continued efforts to link HCV patients to care. Given the curative nature of our treatment, we expect HCV new starts to trend down overtime, but are pleased that we are maintaining 50% to 60% market shares in the U.S. and Europe and that our labor portfolio more broadly has stabilized from a revenue perspective. On to Slide 12, Veklury sales continued to be highly variable and declined 31% year-over-year in the third quarter to $636 million. On a quarter-over-quarter basis, sales were up 149%, driven by an uptick in hospitalizations during the third quarter. And over the last few weeks, we have seen a slowdown in COVID related hospitalization. Veklury's strong clinical profile continues to be recognized most recently by the FDA and the European Commission for use in patients with mild-to-severe hepatic impairment. While the COVID environment remains ever changing, Veklury's performance in the third quarter further reinforces its established role as a key part of the standard of care for patients hospitalized with COVID-19. Moving to Slide 13, our oncology business achieved another strong quarter with sales up 33% year-over-year to $769 million, representing an annual run rate that now exceeds $3 billion. With clear momentum and a solid infrastructure in place, in addition to our compelling clinical pipeline, we look forward to providing more patients with potentially new and effective options. Looking at Trodelvy on Slide 14, sales were up 58% year-over-year and 9% sequentially to $283 million. As a reminder, Trodelvy is the only approved TROP2-directed antibody drug conjugate and to date, we have delivered this therapy to more than 20,000 patients, reinforcing the clinically meaningful benefit Trodelvy can provide across multiple tumor types.
IHC 0: Turning to Slide 15 and on behalf of Cindy and the Kite team, cell therapy sales in the third quarter were $486 million, up 22% year-over-year and 4% quarter-over-quarter, reflecting strong demand with particular strength outside the U.S. in the third quarter. Yescarta sales grew 23% year-over-year to $391 million primarily driven by strong growth ex-U.S. in second and third line relapsed or refractory large B cell lymphoma. Tecartus sales were $96 million, up 18% year-over-year, reflecting increased demand in both the U.S. and Europe for relapsed or refractory mantle cell lymphoma as well as adult acute lymphoblastic leukemia. Given the strong clinical data, it's surprising that only about 10% of eligible second line large B cell lymphoma patients in the U.S. are treated with cell therapy and it is clear that there is still a significant opportunity to drive adoption. As cell therapies are offered and delivered to more and more patients, we are confident that Kite remains well positioned to benefit from this expansion with its differentiated overall survival data for Yescarta and industry-leading manufacturing capabilities. We understand the importance of delivering these potentially curative medicines as quickly as possible to patients with severe and challenging diseases. And to that end, we continue to identify opportunities to bring our therapies to patients faster and are actively working on initiatives to shorten even further our industry-leading 16-day medium turnaround time in the US. Wrapping up the third quarter, I'd like to recognize the strong execution of commercial teams and our cross functional partners across Gilead and Kite. Thanks to their efforts, our therapies are positively impacting more and more people, driven by growing market share and expanding reach, as we bring our therapies to new geographies around the world. And with that, I'll hand the call over to Merdad for an update on our pipeline.
Merdad Parsey: Thank you, Johanna. The clinical highlight of our third quarter was the release of our promising Phase 2 data for Trodelvy in combination with pembrolizumab in first line metastatic non-small cell lung cancer, highlighting Trodelvy's potential to bring a much needed treatment alternative for patients. More broadly, we continue to progress our increasingly diverse pipeline of 60 ongoing clinical programs spanning virology, oncology and inflammation. Starting with our virology programs on Slide 17, we have 10 clinical programs with our long-acting capsid inhibitor lenacapavir including two Phase 3 studies underway in PrEP. I'm pleased to share that we have completed enrollment earlier than anticipated for our Phase 3 PURPOSE-1 trial evaluating lenacapavir for prevention in adolescent girls and young women. Our Phase 3 PURPOSE-2 trial insists [ph] men and trans women and men and non-binary people continues to enroll well and we could have an opportunity to share data from one or both PURPOSE trials in late 2024 ahead of schedule. We are targeting our first approval for lenacapavir in production in late 2025, potentially making lenacapavir the first six-monthly dosing regimen available for PrEP. Turning to treatment, we continue to make strong progress on evaluating nine candidate partners for lenacapavir. Of the remaining candidates, six are already in Phase 1 or 2. We expect to share updates on at least four of these in 2024, including data from our Phase 1 trial of GS-1720, our once weekly long-acting oral integration inhibitor to be combined with lenacapavir and from our Phase 2 ARTISTRY-1 trial evaluating once daily oral combination of lenacapavir and bictegravir for virologically suppressed treatment experienced people living with HIV. We plan to share results from both trials at a conference in early 2024 and we look forward to advancing these programs into the next phase of development. We're also pleased to share that enrollment for our Phase 2 program evaluating our lenacapavir plus bNAbs combination dosed every six months is progressing very well and is another program we expect to update you on next year. Putting this all together, our data continues to support our confidence that lenacapavir has the potential to transform HIV treatment and prevention globally. Turning to oncology on Slide 18. To date, Trodelvy has been delivered to more than 20,000 patients across three approved indications since our launch three years ago. Trodelvy remains the first and only marketed TROP2-directed antibody drug conjugate to achieve meaningful overall survival benefit in two of its indications. With that said, we're seeing both growing real world evidence and clinical trial data supporting not only the approach we're taking for Trodelvy's clinical development across tumor types, but also Trodelvy's unique ADC construct. In particular, trodelvy is the only ADC to have a high 7 to 8 drug to antibody ratio that's able to deliver a highly potent SN-38 payload directly into the tumor microenvironment through its hydrolyzable linker. As a result, in our studies to date, Trodelvy has shown a potentially differentiated safety profile with regards to ILD and stomatitis. We look forward to sharing more emerging Trodelvy data in 2024 as we continue to expand Trodelvy across tumor types and lines of therapy.
TROPiCS:
03:
TROPiCS:
03:
KEYNOTE: As a reminder, we are currently enrolling patients with first line PD-L1 high metastatic non-small cell lung cancer in our registrational Phase 3 EVOKE-03 study. Preliminary data from the PD-L1 TPS less than 50% cohort has also been encouraging, demonstrating an ORR of 44% similar to previous trials that evaluated pembro plus chemotherapy. These results inform our plans to expand into broader first line non-small cell lung cancer patient populations across all PD-L1 expression levels. We're looking forward to sharing further analysis from EVOKE-02 that will highlight the efficacy of Trodelvy and pembro across both squamous and non-squamous histologies in first line metastatic non-small cell lung cancer patients.
024: As a reminder, we are currently enrolling patients with first line PD-L1 high metastatic non-small cell lung cancer in our registrational Phase 3 EVOKE-03 study. Preliminary data from the PD-L1 TPS less than 50% cohort has also been encouraging, demonstrating an ORR of 44% similar to previous trials that evaluated pembro plus chemotherapy. These results inform our plans to expand into broader first line non-small cell lung cancer patient populations across all PD-L1 expression levels. We're looking forward to sharing further analysis from EVOKE-02 that will highlight the efficacy of Trodelvy and pembro across both squamous and non-squamous histologies in first line metastatic non-small cell lung cancer patients.
KEYNOTE: As a reminder, we are currently enrolling patients with first line PD-L1 high metastatic non-small cell lung cancer in our registrational Phase 3 EVOKE-03 study. Preliminary data from the PD-L1 TPS less than 50% cohort has also been encouraging, demonstrating an ORR of 44% similar to previous trials that evaluated pembro plus chemotherapy. These results inform our plans to expand into broader first line non-small cell lung cancer patient populations across all PD-L1 expression levels. We're looking forward to sharing further analysis from EVOKE-02 that will highlight the efficacy of Trodelvy and pembro across both squamous and non-squamous histologies in first line metastatic non-small cell lung cancer patients.
042: As a reminder, we are currently enrolling patients with first line PD-L1 high metastatic non-small cell lung cancer in our registrational Phase 3 EVOKE-03 study. Preliminary data from the PD-L1 TPS less than 50% cohort has also been encouraging, demonstrating an ORR of 44% similar to previous trials that evaluated pembro plus chemotherapy. These results inform our plans to expand into broader first line non-small cell lung cancer patient populations across all PD-L1 expression levels. We're looking forward to sharing further analysis from EVOKE-02 that will highlight the efficacy of Trodelvy and pembro across both squamous and non-squamous histologies in first line metastatic non-small cell lung cancer patients.
EDGE:
Gastric:
FOLFOX:
FOLFOX: Although anti-TIGIT will not work in every tumor type, we're excited to see that DOM has shown encouraging efficacy and tolerability in the tumor types we have advanced into Phase 3 studies including first line non-small cell lung cancer and upper GI cancer. Turning to cell therapy on Slide 21, we are continuing to work to expand the benefits of cell therapy to even more patients with eight ongoing trials in earlier lines, new indications or new settings. We also have an extensive early stage pipeline where we are exploring allergenic CAR-Ts including healthy donor and IPSC derived cell therapies as well as natural killer and invariant natural killer T cell therapies.
CART:
ddBCMA:
CART:
ddBCMA:
CART: Finally, and before I hand over to Andy, the teams progress on key 2023 clinical milestones is shown on Slide 22. As is expected with the diverse and large clinical portfolio, not all our programs will benefit patients the way we hope they will and the ENHANCE and ENHANCE-2 programs evaluating magrolimab have both been discontinued based on futility analyses. The ENHANCE-3 study remains under partial clinical hold in frontline unfit AML and we continue to evaluate the progress of this and other Phase 2 solid tumor trials for magrolimab. With regards to some of the remaining milestones for 2023 as referenced previously, we look forward to sharing data from ARTISTRY-1 at a medical conference in 2024. For our HIV prevention studies, we continue to expect to have our first patient in for the PURPOSE-3 and PURPOSE-4 clinical trials by the end of this year. Additionally, we remain on track to initiate our Phase 2 PALEKONA trial evaluating our potential first in class 222 inhibitor for ulcerative colitis later this year. Our 222 inhibitor represents one of our many oral agents for inflammation. Looking beyond 2023, we will share our target 2024 milestones in due course, but it's already clear that it will be a rich year for data updates for Gilead, including potential updates or regulatory filings for Obeldesivir, lenacapavir, Trodelvy and CAR-T ddBCMA. With that, I'll hand the call over to Andy. Andy?
ddBCMA's: Finally, and before I hand over to Andy, the teams progress on key 2023 clinical milestones is shown on Slide 22. As is expected with the diverse and large clinical portfolio, not all our programs will benefit patients the way we hope they will and the ENHANCE and ENHANCE-2 programs evaluating magrolimab have both been discontinued based on futility analyses. The ENHANCE-3 study remains under partial clinical hold in frontline unfit AML and we continue to evaluate the progress of this and other Phase 2 solid tumor trials for magrolimab. With regards to some of the remaining milestones for 2023 as referenced previously, we look forward to sharing data from ARTISTRY-1 at a medical conference in 2024. For our HIV prevention studies, we continue to expect to have our first patient in for the PURPOSE-3 and PURPOSE-4 clinical trials by the end of this year. Additionally, we remain on track to initiate our Phase 2 PALEKONA trial evaluating our potential first in class 222 inhibitor for ulcerative colitis later this year. Our 222 inhibitor represents one of our many oral agents for inflammation. Looking beyond 2023, we will share our target 2024 milestones in due course, but it's already clear that it will be a rich year for data updates for Gilead, including potential updates or regulatory filings for Obeldesivir, lenacapavir, Trodelvy and CAR-T ddBCMA. With that, I'll hand the call over to Andy. Andy?
Andrew Dickinson: Thank you, Merdad, and good afternoon, everyone. We had another solid quarter as shown on Slide 24, with total product sales excluding Veklury up 5% year-over-year, driven by growth across oncology and HIV, partially offset by lower HCV sales. Total product sales were $7 billion, flat year-over-year, with lower Veklury sales offsetting more than $300 million of growth in our base business. Our non-GAAP results are shown on Slide 25. Product gross margin was 86%, down 85 basis points from last year. R&D was $1.5 billion, up 24% year-over-year, reflecting ongoing clinical trial activities. Third quarter R&D expenses also reflected some sizable wind down costs related to the discontinuation of two Phase 3 magrolimab ENHANCE studies and faster than anticipated enrollment in our Phase 3 PURPOSE-1 and OAKTREE studies, both of which have recently completed enrollment and could accelerate timelines for data readouts in due course. Acquired IPR&D was $91 million, reflecting the Tentarix collaboration announced in August, in addition to other payments associated with ongoing partnerships. SG&A was $1.3 billion, up 7% year-over-year, primarily driven by increased commercial investments, namely in oncology. Moving to tax, our effective tax rate in the third quarter was 7% primarily reflecting a decrease in tax reserves as a result of reaching an agreement with a tax authority on certain tax position. Excluding the settlement, our non-GAAP effective tax rate would have been approximately 16%. Our non-GAAP diluted earnings per share were $2.29 compared to $1.90 for the same period last year. This was primarily driven by growth in our base business, lower tax and lower acquired IP R&D expenses compared to the third quarter of 2022 partially offset by lower Veklury sales and higher R&D and commercial investments. Moving to Slide 26, year-to-date base business revenue has grown 10% year-over-year, highlighting strong performance across virology and oncology. From an OpEx perspective, the investment we have made this year in R&D is notable with a robust and diverse clinical pipeline and with our commercial sales and marketing organization scaled to meet growing demand for our on market oncology portfolio, we continue to expect a moderation of expense growth in 2024 and beyond. Moving to Slide 27, we are updating many of our guidance ranges to reflect our year-to-date performance and our expectations for the rest of the year. Total product sales is now expected to be in the range of $26.7 billion to $26.9 billion, up from $26.3 billion to $26.7 billion previously. We are increasing total product sales excluding Veklury at the midpoint. We now expect the range to be between $24.8 billion to $25 billion, up from $24.6 billion to $25 billion previously. This range represents growth of 7% to 8% for our base business year-over-year and an increase of $650 million at the midpoint from the initial guidance we issued in February. On Veklury, based on our results year-to-date, we now expect full year Veklury sales of approximately $1.9 billion. As always, this remains highly variable and correlated with COVID related hospitalizations. Moving to the rest of the P&L, we continue to expect non-GAAP gross margin to be approximately 86%. On R&D, reflecting the accelerated enrollments and magrolimab discontinuation expenses, our full year non-GAAP R&D expense is now expected to grow approximately 15% in 2023 compared to 2022. Excluding these items, our full year R&D expense is consistent with our prior guidance in the low double digits. Reflecting the Tentarix collaboration closed in the third quarter as well as previously committed acquired IPR&D amounts and known milestone payments from existing collaborations, we now expect non-GAAP acquired IPR&D of approximately $1 billion in 2023. Similar to prior quarters, we will update expected acquired IPR&D expenses if they are incurred during the fourth quarter. We continue to expect non-GAAP SG&A expenses to increase by a high single digit percentage compared to 2022. As a reminder, this includes the one-time legal settlement accrual of $525 million in the second quarter. Excluding this, we continue to expect non-GAAP SG&A expense for 2023 to be down a low single digit percentage compared to 2022. Non-GAAP operating income is expected to be $10.5 billion to $10.8 billion as compared to $10.4 billion to $10.9 billion previously, driven by higher R&D expenses offset by higher product sales. Given certain one- time tax benefits in 2023, we now expect our non-GAAP effective tax rate to be approximately 16% for the full year. Altogether, we now expect our non-GAAP diluted EPS to be between $6.65 and $6.85 per share as compared to $6.45 and $6.80 per share previously. As shown on Slide 28, the chart highlights the continued strength of our business with higher total product sales guidance flowing into the bottom line, which together with the lower expected tax rate more than offsets the higher R&D expenses in the third quarter. On a GAAP basis, our diluted EPS is expected to be in the range of $4.55 and $4.75 per share. Moving to Slide 29, our capital allocation priorities remain focused and unchanged. In the third quarter, we returned $1.3 billion to shareholders through our dividend and repurchase of shares totaling $3.7 billion year-to-date. In the third quarter, we repaid $2.25 billion of senior notes and issued $2 billion in senior notes maturing in 2033 and 2053. Overall, the third quarter was another solid quarter of commercial and clinical execution in an extremely strong 2023 for Gilead so far. Our planning for 2024 is well underway and we've taken steps in the third quarter to continue to evolve our business model and expense structure to set us up for strong execution next year. 2023 has been a year of considerable investment, notably in R&D and we are excited to finally be at the point where many of our key programs will start reading out data. With that in mind, we are preparing for a catalyst rich 2024 and we look forward to sharing more early next year. With that, I'll invite the operator to open the Q&A.
Operator: Thank you. [Operator Instructions] Our first question today goes to Geoff Meacham of Bank of America. Geoff, please go ahead, your line is open.
Geoff Meacham: Okay, great. Hi everyone. Thanks for the question. I guess this is for maybe Johanna or for Merdad. Just on lenacapavir, your competitor has highlighted some of the [derm path] (ph) and I wanted to get your perspective on what you've seen in clinical studies, really as well as the early commercial experience. I wasn't sure if you guys view that as a non-issue or something to navigate as you develop lenacapavir for PrEP or various doublets and HIV treatment. Thank you.
Merdad Parsey: Sure. Hey, Geoff, this is Merdad. Thanks for the question. I would say that our DDI profile has been pretty well characterized and is in our label and laid out. As you noted lenacapavir is metabolized by CYP3A and like many other drugs in the class and we -- that's been available and labeled for quite some time. We don't anticipate any changes to our programs based on that. There are no adaptations that we are making in our clinical development program based on that. As you know, we're well on our way in our PURPOSE 1/2 lenacapavir for PrEP studies and have the approval and highly treatment experienced people and have not made any modifications based on any DDI concerns in those trials. And I'd encourage folks to take a look at the label. You can see what's laid out fairly clearly there.
Johanna Mercier: Yes. And maybe just to add to what Merdad said, so we launched Sunlenca, lenacapavir for heavily treatment experience earlier this year. As per Merdad's comments, the label has no contraindication specific to what you were referring to, to opioids or ED drugs and the launch thus far is well underway and access is increasing every day across the U.S., but also other markets including Japan and Europe and we're excited to have an option for these patients that unfortunately have really no other option at this point in time. So very small market opportunity today with the potential for lenacapavir for PrEP as early as late 2025, so very excited as we continue our plans for that.
Jacquie Ross: Nadia, may we have our next question, please?
Operator: Our next question goes to Michael Yee of Jefferies. Michael, please go ahead. Your line is open.
Michael Yee: Thanks, great. And appreciate the question. Maybe from Merdad coming away from ESMO and some of the recent conferences, obviously a ton of Trop-2 data, and there's a lot of talk around the benefit, particularly in lung, for non-squamous versus squamous. And some of your competitors have modified their studies to be more focused on non-squamous. Can you maybe just talk about how you see the benefits here in the different populations and whether you would consider emphasizing or modifying to be a non-squamous as well to improve probability success? Thank you.
Merdad Parsey: Thanks, Michael, for the question. Yes, look, we had a really interesting ESMO, I think, for all concerned, and I think something that we've been saying for quite some time, is that not all Trop-2 ADCs are equivalent. Right? It's really important to note that there are differences between Trodelvy and the other Trop-2 ADCs in all three components. The affinity of the antibody is two orders of magnitude better. We have a different linker and we have a different payload. That has played out in many ways along the safety spectrum, where we have different adverse event profiles of the two drugs that have clearly emerged. And it's possible now that we're starting to see divergence on the efficacy side as well. Recall that we have shared our EVOKE-02 data, which comprise both squam and non-squamous patients. We have enrolled both squamous and non-squamous patients in our trials, and as one would expect, we do stratify those patients in the studies and we’ll continue to do so. But we're very confident in our approach and with what we've seen so far, and really look forward to being able to share more data from EVOKE-01 next year.
Jacquie Ross: Nadia, next question please?
Operator: Our next question goes to Daina Graybosch of Leerink Partners. Diana, please go ahead. Your line is open.
Daina Graybosch: Thank you. A question about Kite. I wonder if you can talk through the specific barriers that are limiting uptake of CAR-T and the second-line large B cell lymphoma indication. And what do you think will be required to upshift the earlier line demand for cell therapy in a large B cell lymphoma, and maybe even a multiple myeloma as well?
Johanna Mercier: Thank you very much for the question, Diana. I think some of the specific barriers that we're observing are more in the U.S. So I might first talk about what we're observing in Europe where we have socialized medicine. We're seeing uptake as soon as we are granted access and reimbursement. And it goes very quickly into the system, because it's a non-fragmented healthcare system. In the U.S., things look a little bit different given the fragmentation of the healthcare system. So the barriers that we're observing in the U.S. are really our ability to treat patients where they are so moving into community oncology. Today, 80% of oncology patients are seen in the community. Most of our authorized treatment centers exist in large academic hospitals. And so what we're doing for the future, and what we think is going to be very important, is that we're able to have authorized treatment centers in the community closer to patients. So that's one important piece. And we continue to open up new treatment centers in the United States. And in fact, this year we should end with somewhere around 140 treatment centers in the U.S., and that will continue to grow in 2024. I think the second piece for barriers is converting stem cell transplants. So physicians who are transplanting patients, they will have a better outcome via the data if they have CAR-T. And so we're working with transplanters on education and really making sure those patients have access to CAR-T in the earlier lines. I think those are two of the larger barriers that we're observing today. And the last piece, I would say, is the excitement with multiple myeloma therapies coming forward. You can imagine the ATCs now we're seeing both lymphoma patients as well as multiple myeloma patients, and that's causing a crunch within those authorized treatment centers. And that's why it's important in the academic medical centers that we're able to expand the number of beds, and secondly, open new authorized treatment centers that can serve both lymphoma and multiple myeloma.
Jacquie Ross: Nadia, may we have our next question, please?
Operator: Our next question goes to Chris Schott of JPMorgan. Chris, please go ahead. Your line is open.
Chris Schott: Great. Thanks so much for the question. Can you elaborate a little bit more on HIV channel mix dynamics this quarter and how you're thinking about that for 4Q and beyond? I know channel has been a bit of a tailwind over the past year or two. Seems like we're now may be starting to see some headwinds, at least sequentially. And I just was wondering how you think about that progressing from here? Thanks so much.
Johanna Mercier: Sure, Chris, thanks for the question. So you're right, as expected. We've seen some of those favorable pricing dynamics that we'd seen in the last couple of quarters, including in 2022, due to the channel mix, kind of begin to normalize, and you should expect to see kind of the same play from Q3 into Q4. One of the reasons for that had to do with some of the channel – specifically around the channel mix to what you referenced, having to do with some of our government channels being less utilized, where we have higher rebates, and therefore we had pricing [favorability] (ph). We believe a lot of that had to do just stabilization post-COVID around employment rates, inflation, et cetera. So we had benefits that we saw over that probably, I would say four quarters to six quarters or so. And as we kind of shared with you in Q2, we are seeing that normalize out for the second half of this year. And I think you should expect that not only for the next quarter, but then as we go into 2024. And therefore, because of all that, we believe that our HIV sales growth is closely mirroring now more of the market and the demand growth, where we're seeing real strength, both from a market standpoint in treatment and prevention, we're seeing about two points to three points growth in the market when you look at retail and non-retail market, and then, of course, 15% growth in the PrEP market. And then from a demand standpoint, I think obviously with BIKTARVY growing at 12 points year-on-year and DESCOVY continuing to hold on to a very strong share over 40% or so in a competitive market with generics and, of course, new formulations. So more to come as we go into Q4, but hopefully that gives you a better picture of some of the mix of channels.
Jacquie Ross: Thank you. Maybe I have our next caller, please.
Operator: Our next question goes to Tim Anderson of Wolfe Research. Tim, please go ahead. Your line is open.
Unidentified Analyst: Hi. Thanks for taking our question. This is Adam on for Tim Anderson at Wolfe Research. Also on TROP2, just in light of competitor data, can you provide some more color on just latest thoughts on the competitive dynamics within the class? For example, if AstraZeneca gets a label for HR+ breast cancer in the second-line, and Trodelvy only has a label for the third-line, won't that displace Trodelvy? Thanks.
Johanna Mercier: Yes, good question, Adam. So I'm assuming you're referring to some of the data we saw at ESMO with data DXD. We don't believe there is material impact for now anyway, or even in the future for Trodelvy. And the reason for that really has to do with the data itself and the lines of therapy, to your point, I think we've proven very clearly with Trodelvy in second-line TNBC and beyond around the overall survival data that we've shown. And then, of course, showing OS again in HR+/HER2-, although in later lines. I think what we're seeing today in the marketplace is not only are we the leaders in TNBC, we're also leading from an IHC 0 population. And then, of course, looking at sequencing of ADCs posts in HER2, as expected in the HR+/HER2- populations, so quite pleased with our positioning and we don't believe the data that we've seen thus far is going to have a direct impact there.
Daniel O'Day: Yes, I would just add that we continue to expand our programs and continue to want to generate additional data for Trodelvy. So we are very comfortable with where we are. I think our ability to interact with our caregivers and patients now having been on the market for quite some time, is really helping us make sure that we get Trodelvy to as many patients who could benefit from it as possible.
Jacquie Ross: Nadia, may we have our next question, please?
Operator: Of course, our next question goes to Salveen Richter of Goldman Sachs. Salveen, please go ahead. Your line is open.
Salveen Richter: Good afternoon. Thanks for taking my question. Just a question here on the pipeline, just given two data releases that came out. So on the TIGIT gastric data that was presented today, how do we think – or how do you think about the terms, the opportunity, the competitiveness versus standard of care combos and next steps? And then with regard to the multiple myeloma for Arcellx that was presented, it looks to be tracking a Carvykti like profile in relapse refractory multiple myeloma. Could you just walk us through next steps path to market competitive positioning here? Thank you.
Daniel O'Day: Sure. Maybe I'll start with TIGIT and I'll hand it off to Cindy for the multiple myeloma discussion. Yes, I think, look, we find the data that we presented today at the ASCO plenary to really be promising for continued momentum for TIGIT. The data from an ORR standpoint, and I think importantly, the landmark PFS analysis are very promising. It's early data, it's single-arm data, and I think those are all caveats that are appropriate when looking at these. But when you think about the context around what the standard of care PFS and OS are, we think there's certainly promising signals that we could do better than that. So, obviously, what we need to do next is allow these data to mature in ARC-21. And then, of course, we have the 221 study. That is our Phase 3 study, where we will be comparing to standard of care in a randomized Phase 3 trial. We think the data shown today really will help us with momentum in accruing that trial and hopefully demonstrating the promise of TIGIT added onto standard of care, a standard of care like regimen with zim and FOLFOX. We're excited about that Phase 3 outcome, and it really gives us the opportunity to be, we think ahead on that indication compared to the competition in TIGIT. And Cindy, do you want to.
Cindy Perettie: Yes. Happy to. Thank you. So, this is early days, obviously, for the ddBCMA molecule. We have 38 patients worth of data. If I compare it to Carvykti, the population looks more like the LEGEND-2 population. We have 34% extramedillary disease, which is a high risk prognosis patient. And if you look at the LEGEND-2 data, they had 30%. Our overall response rate to date in those 38 patients at 22 months is 100%, and in the LEGEND-2 data is 88% at 25 months. So I do think there is a potential to differentiate on efficacy. We're seeing a differentiation as it relates to the safety profile around the Parkinson syndrome. We are not observing that in any of our patients to date. Obviously, we're going to continue to watch that as we enroll the IMAGINE 1 study and move into our next studies as well. Multiple myeloma is a large market. There is enough room in multiple myeloma to have multiple competitors. But we also feel like we will have a differentiated molecule with Arcellx. So we're looking forward to generating more data and talking to folks about it at ASH.
Jacquie Ross: Thank you, Nadia. We're ready for our next question.
Operator: Our next question goes to Tyler Van Buren of TD Cowen. Tyler, please go ahead. Your line is open.
Tyler Van Buren: Hey, guys, thanks for the presentation. I have another question, actually on the myeloma program. So assuming that Arcellx's CAR-T ddBCMA data continue to look great at ASH, and the IMAGINE-1 trial does later next year and leads to approval, how prepared have you guys gotten on the manufacturing front in the past year? And do you expect the launch to have a similar trajectory to Yescarta in terms of supply or be significantly better.
Johanna Mercier: Hey there's a number of things that we have learned over the course of the years with Yescarta and around manufacturing, all of which we're applying that knowledge to the manufacturing of the ddBCMA CAR-T. So we plan to launch that out of our facilities at Kite and expect to have a strong launch again. We will be applying Yescarta learnings. So our goal is to be significantly better than we were at the launch of Yescarta.
Jacquie Ross: Thank you, Nadia. We're ready for our next question.
Operator: Thank you. Our next question goes to Brian Abrahams of RBC Capital Markets. Brian, please go ahead. Your line is open.
Brian Abrahams: Hi there. Thanks for taking my question. It seems like the long acting HIV combos are moving ahead really well. I was wondering if you could talk a little bit more about the strategic role that the Lenacapavir, Bictegravir daily oral or the weekly 17/20 based combo could play in the HIV competitive landscape. Do you think these could move beyond treatment experienced patients on complex regimens into the earlier lines? Thanks.
Daniel O'Day: Sure, maybe. Johanna, do you want to talk about weekly oral? And I'll do the weekly?
Johanna Mercier: Sure. Thanks for the question, Brian. I think the way we're looking at lenacapavir, bictegravir in the virologically suppressed really has to do with. We've set the standard of care with Biktarvy, and the opportunity now is to ensure that if for some reason there was a reason to switch Biktarvy from a tolerability profile or anything else that they have an option to go to that has a really interesting combination. Right. When you think about a capsid inhibitor as well as an integrase inhibitor. So for us, it's really about the optionality for patients and making sure that this could offer something a little bit different in the daily oral market. And I do think that this will also be a longer term strategy for us as we think about beyond Biktarvy's LOE in 2033. So I would go there and on the weekly just to start, and then I'll kick it over to Merdad to share with you our plans there. On the weekly oral, it's clear from the patient research that we've done in treatment that we really do see benefit not only the daily oral market, but also in the oral weekly, or even potentially even a little bit longer, as we think about what patients are asking for today. So as much as we're very interested in the long actings that are every three months or every six months. We are also making sure that we meet the needs of patients and their requests as they're looking at for some really don't like any injectables or sub Q, and really looking at that weekly oral as potentially expending a little bit the time they don't think about the fact that they have HIV.
Merdad Parsey: Yes, just minor things to add, I would say. We have been focusing our development on what people living with HIV and people who are looking for PrEP options have told us that they're interested in, and that's longer acting oral options and injectable options that are every three months, every six months. And that's what we've been focusing our development program on. And we want to make sure that we provide that optionality to different folks. The other thing about the [indiscernible] to Remember is remember that Lena is a new class of antiretroviral, and that provides caregivers the option to leverage that new class for the appropriate people living with HIV. So our goal as the leader in HIV is to continue to provide as many of the relevant options to people living with HIV and people looking for prevention options as we think are going to be reasonable and valuable. And remember that we think the weekly oral is important enough that we have two programs. So you mentioned 1720. Remember, we also have the program with his islatravir, lenacapavir. So we're very happy with the progress we've made, as you noted, and really on track to provide better options.
Jacquie Ross: Nadia, may we have our next question, please?
Operator: Our next question goes to Terrence Flynn of Morgan Stanley. Terrence, please go ahead. Your line is open.
Terrence Flynn: Thanks for taking the question. I was just wondering if you can provide any preliminary thoughts on 2024 spend or margins. Andy, thanks so much.
Andrew Dickinson: Hey, Terrence, thanks for the question. Happy to take that. Obviously, in late January or early February, as we customarily do, we'll provide very specific guidance in 2024. What we've said, and I would continue to reiterate, is that as you've seen, our expenses increase over the last couple of years as our portfolio has increased, and again, from our perspective, a very necessary and appropriate increase as we developed what we feel is one of the best and broadest pipelines in the industry, both in virology, oncology, across cell therapy, and at Gilead. We're finally at the level where we're spending on par with our peers, especially on the R&D side. You saw that in the third quarter. So as you think about expenses, going forward, we expect that you will see more moderate growth in expenses over time. We're doing a lot to manage our expenses, as you heard on the last couple of quarters. Maybe the best evidence of that, Terrence, is if you look at our first quarter R&D expenses, our third quarter R&D expenses are essentially flat. So you saw a little bit of a step down from the first quarter. In the second quarter, in the third quarter, we're flat. So you already see that we're kind of, as we said, we're approaching kind of the peak spend, recognizing that we have 60 different clinical programs. If I remember correctly, we have 27 programs in phase, 219 programs in Phase 3. That is very different than the Gilead of prior years that you remember. And it's part of what makes it so excited about where we're going as a company. And the final thing I'd say is you're already seeing the benefits of those investments and the commercial performance that we've talked about for the last two years. So we expect that you will continue to see those benefits in our commercial performance across the entire business, and you're going to see a moderation of expense growth. And again, we'll provide much more specific detail early next year and look forward to talking about this further. Thank you.
Jacquie Ross: Nadia. Our next caller, please?
Operator: Our next question goes to Evan Seigerman of BMO Capital Markets. Evan, please go ahead. Your line is open.
Evan Seigerman: Hi, guys. Thank you so much for taking my question. I want one on kind of capital allocation as a function of competitiveness in your respective markets. For example, you have a great moat in virology. How do you think about investment there, say versus oncology, where it's a more competitive marketplace and where we're seeing incremental kind of benefit over time? Maybe some thoughts there. Thank you so much.
Andrew Dickinson: Hey, Evan, it's Andy. I'll start. And others may want to jump in as. Look I mean, what we've said historically, and I'd reiterate, is we're always going to follow the science. So we are completely committed to virology, not just HIV, but virology broadly. You see that, for instance, with our progress with oral DESCOVY [ph] as well as other programs, we've also said in virology that a lot of what happens in virology happens in our internal research and that there are less opportunities externally to invest in. That doesn't mean that we won't continue to look for them. And we're going to continue to invest in oncology. We have a much larger oncology organization today, we've increased our internal research and development, and we're still very focused as the third pillar on inflammation. So I would remind people that we have a number of early inflammation programs, including a number in Phase 2 that we're excited about. Merdad highlighted the TROP2 program in his remarks earlier, but that's just one of the programs that we expect to build out over time. So we'll follow the science. We're going to apply capital to each of those areas. If you look back, our capital investment has risen and fallen over time in each of those areas as we've looked at different opportunities. And of course, we're going to continue to invest in cell therapy as part of oncology and more broadly. I should have highlighted that earlier. So the short summary is, we'll follow the science, but all of the areas will receive additional capital over time. Merdad, you want to add anything?
Merdad Parsey: I would just add that our goal has been to diversify the portfolio. We remain committed and think one of our key competitive advantages is our track record and strength in virology. And I would agree with you, Evan, that's critical to our continued success and growth. And we also believe that having more diversity in our portfolio, whether its oncology or inflammation, is going to be really important to our long term future. So our capital allocation will happen on where the best data are, and we make those tradeoffs virtually every day.
Jacquie Ross: Nadia, I think we have time for one last question, please.
Operator: Our final question goes to Joe Catanzaro of Piper Sandler. Joe, please go ahead. Your line is open.
Joe Catanzaro: Hi everybody. Appreciate you taking my question. I actually had one on Trodelvy within bladder cancer, and appreciate this is a smaller proportion of Trodelvy sales, but just wanted to ask about the potential impact of Padcev's EV-302 data and it moving into the front line and what you could potentially see there with Trodelvy, both maybe in the near term and longer term. Thanks.
Johanna Mercier: So maybe I'll start and then throw it over to Merdad first from a clinical standpoint, what we're thinking from a commercial standpoint, with the data that we saw, I think the standard of care is going to change in first line, clearly, with that data, and we see that as a potential opportunity to actually move up Trodelvy lines of therapy. So right now in the U.S., we do have accelerated approval in the U.S., and we're seeing about 15%, 16% share in bladder cancer, but later lines of therapy. So third line plus, I think with the opportunity to have Padcev kind of move up in the first line setting with Pembro. I think it'll be interesting to see how Trodelvy kind of moves up as we've seen a lot of sequencing from ADCs here as well. So that's in the here and now and maybe Merdad, you want to comment on the clinical development?
Merdad Parsey: Yes, I think it's great news for patients with the data that's come out and we think it does change the paradigm for bladder cancer. I think the other thing I would add to what Johanna said is that we were looking with interest. We don't have data on sequencing, but we're certainly hearing about sequencing and there were data that were shown at ESMO around combining Padcev and Trodelvy where the tolerability profile looked good and the responses looked good. Small study, but we think there continues to be opportunity there for us and having this clarity will help us design where we're going to go from here after our confirmatory trial in second line completes.
Operator: Thank you. That's all the questions that we have time for today. I'll now hand back to Dan for any closing comments.
Daniel O'Day: Well, just want to thank the team here and all of you for joining and just maybe end with this reflection, which is Gilead. I don't think we could be more excited about as we wrap up 2023 and head into 2024, about the evolution of our commercial and clinical execution. In particular, 2024 will be a year that's full of key clinical catalysts across our portfolio, and that's really been a culmination over the past several years of investing in a robust and diversified portfolio, many of which were Phase 2 studies that led to Phase 3 studies that we'll be reading out over the course of not only next year, but the years to come. We'll provide more details on all of our 2024 clinical milestones early next year, but in the meantime, maybe just a couple to highlight in a busy year. Obviously on Trodelvy, where the clinical data increasingly highlight that all TROP2 ADCs are not alike. We'll be rolling out data across a variety of disease states in oncology, and we're excited to share data on lung cancer in the first half of 2024 and then maybe to highlight one other one. Lenacapavir will have a rich year of data on the treatment combination candidates, and we continue to target being first to market with our six month long acting PrEPs, starting with readouts next year on our Phase 3 trials and a commercial launch as early as late 2025. With that, as always, feel free to reach out to the IR team here at Gilead, if you have any questions or feedback for the team and we’ll look forward to updating you again early in the New Year. Thank you for joining.
Operator: Thank you. This now concludes today’s call. Thank you for joining. You may now disconnect your lines. |
ES | 3 | 2,023 | 2023-11-06 14:34:03 | Operator: Hello, and welcome to the Eversource Energy Q3 2023 Earnings Call. My name is Alex, and I'll be coordinating the call today. [Operator Instructions] I'll now hand over to your host, Bob Becker, Director for Investor Relations. Please go ahead.
Robert Becker: Good morning, and thank you for joining us. I'm Bob Becker, Eversource Energy's Director for Investor Relations. During this call, we'll be referencing slides we posted on our website. And as you can see on Slide 1, some of the statements made during this investor call may be forward-looking. These statements are based on management's current expectations and are subject to risk and uncertainty, which may cause the actual results to differ materially from forecasts and projections. We undertake no obligation to update or revise any of these statements. Additional information about the various factors that may cause actual results to differ, and our explanation of non-GAAP measures and how they reconcile to GAAP results, is contained within our news release, the slides we posted this morning, and in our most recent 10-K and 10-Q. Speaking today will be Joe Nolan, our Chairman, President, and Chief Executive Officer; and John Moreira; our Executive Vice President and CFO. Also joining us today is Jay Buth, our Vice President and Controller. Now I will turn the call over to Joe.
Joseph Nolan: Thank you, Bob, and thank you, everyone, for joining us on this call this morning. I look-forward to our conversation today, and to seeing many of you at the EEI Conference next week. First, let me start with the topic that I'm certain is top of mind to all of you, which is an update on the sale of our Offshore Wind investment. We are very pleased to have closed the sale of our 50% stake in the uncommitted lease area to Orsted in September, along with our South Fork Wind tax equity investment. We are delighted to have these transactions behind us. As for the seal of our interest, in the three projects which are under development, we have substantially completed our contract negotiations with a buyer and continued to make good progress on this front. What remains to be completed is for the buyer and Orsted to finalize several documents, such as their new joint-venture agreement. We expect this process to wrap up shortly, allowing us to execute our sales agreement with the buyer and announce the terms of the sale. As you see on Slide number 3, I'm very happy to report that our South Fork Wind project is expected to fully go into service in early 2024. The onshore construction is complete and connected to our export cable. While offshore construction is significantly advanced with the offshore substation and array cables installed and connected. Currently, the turbine installation is underway and we expect to have seven to nine turbines operationally complete by the end of this year, with the remaining turbines installed in January. This project will spearhead the US offshore wind industry and will be one of the country's first utility-scale offshore wind farms built by Connecticut labor from various unions. On October 31st, our joint venture announced that we have taken our Final Investment Decision or FID on Revolution Wind. This is an important project milestone that allows it to advance to full onshore and offshore construction and installation and have this project in service in late 2025. I'd like to now address the recent events in New York, which I know have been a source of great interest for many of you. On October 12th, the New York Public Service Commission denied petitions for pricing adjustments from several renewable developers, including the petition for our Sunrise Wind Project. The petition sought to address the extraordinary macroeconomic challenges from higher inflation and interest rates, along with supply chain disruptions that developed since our OREC agreement was executed in the fall of 2019. These factors were incorporated by the New York State Energy Research and Development Authority or NYSERDA in their recent offshore wind solicitation. While we are disappointed with the New York PSC's decision, especially given that NYSERDA had publicly advocated for pricing adjustments, we support their commitment to transparent competitive RFP process. We are very encouraged to see that New York is working to establish an accelerated rebidding process, which includes an accelerated track, where winning bids could be announced as early as next year. Together with our JV partner Orsted, we responded to NYSERDA's request for information. Together, we will work towards developing a bid that will reflect the attractive nature of this project. We feel confident that Sunrise Wind will deliver clean and reliable energy to New York, and support economic development in the region, much earlier than many other projects. We will continue to evaluate ways to maximize project economics and to ensure project schedules remain on track. We have begun limited onshore construction for Sunrise Wind and we have also identified solutions for our installation vessel, which many of you have been asking us about to maintain the project schedule for Sunrise Wind and Revolution Wind. We expect both projects to be in service in late-2025. We're excited by the recent actions taken by the six regional governors who asked the Biden administration to clarify tax benefits for current US offshore wind projects and provide relief on federal offshore wind lease costs, as well as, encouraging accelerated permitting process for offshore wind projects. And in October, Connecticut Governor Ned Lamont announced a first-of-its-kind partnership between Connecticut, Massachusetts, and Rhode Island to seek offshore wind proposals that will expand the benefits for the region and help reduce costs. All three states have issued RFPs to procure over 6,000 megawatts with bids due in early 2024. Eversource will play a key role in providing the transmission and distribution infrastructure investment needed to connect these important resources to our grid. Moving over to our core business, as you know, everything we do here at Eversource is done with a focus to continue to enhance our service for customers. As shown at the top of Slide 4, we continue to serve customers well, delivering top-decile electric reliability performance at nearly two years between interruption and our gas emergency response are exceeding our internal target. These high-performance levels are the result of the investment we've made in our electric and gas systems over the past several years. Investments focused on ensuring our system is strong and resilient and ready to adapt to the needs of our customers for years to come. Looking at our Clean Energy focus, we continue to move forward on enabling clean energy in our region, and we continue to make good progress in reaching our carbon neutrality goal by 2030. In Massachusetts, we are investing nearly $2 billion in our electric transmission and distribution system to advance clean energy resources. Moving to the bottom of Slide 4, our customers continued to be burdened by high energy prices, particularly during peak winter months. While this winter's supply prices will be high compared to summer rates, they are expected to be significantly lower than last winter's; a welcome relief for our customers. To-date, Connecticut is fully procured at prices significantly lower than last year. Massachusetts is at 50%, New Hampshire is procured through January. If current market conditions continue, the expectation is that the winter supply rates in all three states will be much lower than last year. Though prices across the region are lower than last winter, we recognize that our customers are feeling the pinch of high cost in many areas, that's why we're doing what we can today to help our customers lower their bills this winter. Along with our industry-leading energy efficiency programs, we also launched a new outreach campaign in Connecticut to encourage customers to sign up with competitive suppliers to save money. We're also educating customers on new energy assistance options. I'm happy to report that Connecticut residential customers have responded. The share of residential customers receiving standard service from Eversource has dropped from over 90% last winter to 70% heading into this winter. To serve our customers and ensure they optimize their energy use, we continue to build out our industry-leading energy efficiency programs. In fact, Eversource ranks number one as the best energy efficiency provider in the country. As you can see on the left side of the slide, we invested over $600 million in these programs last year, avoiding lifetime greenhouse gas emissions of nearly 3 million metric tons. We'll continue to build on this great foundation moving forward. By enabling energy efficiency, encouraging customers to shop for supply, and educating customers on energy assistance options, we're doing what we can to lower customer bills today. Longer-term, we are working with our states to provide the infrastructure investment necessary to access reliable renewable energy like offshore wind and solar generation. Turning to Slide 5. The shift to electric vehicles and zero carbon heating will add tremendous incremental electric demand to our grid. As you can see here, New England electric demand growth is expected to more than double by 2050, and winter peak demand is expected [Technical Difficulty] 2050. This is in stark contrast to a relatively flat electric demand we've seen over the past decade. Along with the rest of the utilities across the country, we are aggressively planning for the clean-energy future here at Eversource. On September 1st, we filed our Electric Sector Modernization Plan or ESMP. This plan is a roadmap for our partnership with Massachusetts to enable the state's clean energy climate plan. Plan details how we'll continue to maintain safe and reliable service for our customers, as we transition to a decarbonized future. In addition to our base investments necessary to increase distribution system capacity, including the implementation of AMI and other technology platforms, Eversource has proposed additional investment that goes beyond the nearly $2 billion of clean energy investment, in Massachusetts through 2027. This investment will go towards improving the resiliency of our system, integrating additional solar generation, and implementing new technology to enable additional distributed energy resources. Our proposed plan is expected to exceed Massachusetts' 2040 goals and achieve 70% of the state's 2050 greenhouse gas emission goals. By requiring electric distribution companies to submit in a fully transparent manner, the long-term grid modernization plans, Massachusetts is taking a leadership role in enabling decarbonization. They're not just setting policies, but tying infrastructure, clean energy, and customer engagement together. We're excited to engage with environmental justice and consumer and business advocates to establish the right framework for all Massachusetts customers to advance towards the clean energy future. We look forward to engaging with all stakeholders as we work towards a final decision from the DPU way next year. Moving on to Connecticut, the regulatory environment remains challenging as evidenced by Aquarion and United Illuminating rate case decisions, which produce returns that are value-destructive for investment, but we are encouraged by the recent actions by Governor Lamont supporting offshore wind investment in the region. We see the governor's support as a realization that investment at a reasonable return is necessary to provide the clean energy future that our region and country are moving toward. In closing, I couldn't be prouder of the effort that the Eversource team puts in every day, providing for our customers' needs. We have the experience and the expertise to guide our customers as we develop a bold bright energy future for New England and the Northeast. Thank you again for your time. I will now turn the call over to John.
John Moreira: Thank you, Joe, and good morning, everyone. This morning, I will review our results for the third quarter of 2023, discuss the status of our offshore wind investments, and review our cash flow position. Let me start with Slide 6. Our GAAP and recurring earnings were both $0.97 per share in the third quarter of 2022 compared with GAAP and recurring earnings of $1 per share and $1.01 per share respectively for the third quarter of 2022. GAAP results for 2022 include transition and transaction costs related to Eversource Gas Company of Massachusetts of approximately $2.2 million. As a reminder, results for the third quarter of 2023 reflect a negative $0.08 per share impact for NSTAR Electric's rate design change, as shown on slide 7, adjusting the earnings for the third quarter of 2023 by this amount would result in both GAAP and recurring earnings of $1.05 per share. As I have previously mentioned, this rate design change does not impact full year results. Moving back to Slide 6 and looking at some additional details on the third quarter earnings by segment, starting with our Electric Transmission segment, which earned $0.46 per share in the third quarter of 2023 as compared with earnings of $0.44 per share in the third quarter of 2022. Improved results were driven by our continued investments in our transmission system. Our third quarter 2023 Electric Distribution earnings were $0.50 per share, compared with earnings of $0.65 per share in the third quarter of last year. The earnings decrease is due primarily to the timing of the rate design change at NSTAR Electric that I mentioned earlier, as well as higher storm-related costs, higher interest costs, depreciation, and property tax expense. These factors were partially offset by higher distribution revenues at NSTAR Electric and from capital trackers that we have in place. Our Natural Gas Distribution segment lost $0.10 per share in the third quarter of 2023 as compared to a loss of $0.07 per share in the third quarter of 2022. The increased losses were due to higher regulatory and operating expenses, depreciation, and interest expense, and were partially offset by higher revenues from the base rate increases at NSTAR Gas and EGMA which took effect November 1 of 2022. Our Water Distribution segment earned $0.05 per share in the third quarter of 2023, which is the same level, we are in the third quarter of last year. Eversource Parent and Other Companies' recurring earnings were $0.06 per share in the third quarter of 2023, as compared to a loss of $0.06 per share in the third quarter of 2022. The improved third quarter results primarily reflect a lower effective tax rate, that was partially offset by higher interest expense. Turning to Slide 8. Based on our financial results to-date and our strong cost discipline, we are narrowing our 2023 recurring earnings projection to between $4.30 to $4.43 per share compared with our previous range of $4.25 to $4.43 per share. Looking at our longer term earnings growth rate expectation, as you saw in our news release and can see on Slide 8, we are reaffirming our long-term EPS growth rate solidly in the upper half of the 5% to 7% range. We are also reaffirming our $21.5 billion five-year regulated capital program, as shown on Slide 9. Current capital expenditures totaled approximately $3.2 billion in the first nine months of 2023. Now, to further expand on what Joe covered, we reached an important milestone in our effort to exit our offshore wind business. On September 7th, Eversource completed the sale of its 50% interest in the lease area that includes approximately 175,000 developable acres to Orsted for $625 million in an all-cash deal. We also closed on our tax equity investment in South Fork Wind with Orsted. We used $528 million of the proceeds from the lease area sale for our tax equity investment. As a current 50% equity partner in South Fork, half of this tax equity investment or $264 million was returned to us in October. We expect to recover the tax equity investment primarily in the form of tax credits once the turbines are placed in service. These tax credits will be utilized to reduce Eversource's federal income tax liability, including refunds from prior years expected over the next 12 to 18 months. As Joe mentioned, we continue to make good progress on advancing the sale of our existing 50% interest in our three offshore wind projects. On our second quarter earnings call, I discussed one of our contingent considerations with the sale of the projects, that we expected a positive outcome from the Sunrise Wind OREC repricing petition, representing approximately $450 million in value to Eversource. Although we were very disappointed by the New York Public Service Commission's rejection of the pricing petition, we are encouraged by NYSERDA's quick reaction in its request to run an accelerated RFP process. As I previously indicated, advancing the sales transaction was not contingent on a resolution of Sunrise's OREC repricing petition. As we assess our options for an OREC rebid for Sunrise, we could potentially see a scenario whereby we move forward with the sale for South Fork and Revolution Wind, followed by a transaction for the sale of Sunrise with the buyer. As we navigate through this accelerated RFP process, we will continue to look at every alternative to keep this sales process moving forward in an efficient and timely manner. Now, I'd like to update you on our expectations for qualification for the two additional 10% investment tax credit adders under the Inflation Reduction Act or IRA. We had previously assumed a positive outcome regarding one additional 10% adder for Sunrise Wind and Revolution Wind that represented approximately $400 million in value to Eversource. Let me start with the Energy Communities. We do believe there is a good path around the prospects for qualifying for the Energy Communities provision of the IRA for both Sunrise and Revolution, which would increase our potential ITCs to 40% of the eligible basis for these projects. Therefore, the Energy Communities' qualification would cover this contingent value that we have recognized. Also, we will continue to explore opportunities to engage with the Treasury Department, as they clarify the rules around the domestic content provisions of the IRA to qualify for an additional 10% investment tax credit. As a reminder, the $400 million in value I just mentioned, is based on achieving a single quantification outcome between either the Energy Communities or the domestic content adders. As assumed in our second quarter offshore wind impairment charge, we only assume one additional 10% ITC adder as a contingent consideration. Should the projects qualify for both the energy communities and the domestic content adders, it would result in upside to Eversource. We will continue to monitor both the RFP process and the ability to qualify for one or more of the ITC adders and evaluate their impacts along with other potential impacts, as part of our continual review of our impairment models. As a part of this evaluation, an important consideration will be the likelihood of success of any future bid award for Sunrise Wind from this accelerated RFP. Turning to cash flows. First, let me say that maintaining strong credit ratings is very important to us. Therefore, we are disappointed with the recent credit rating action taken by Moody's as the timing was a bit unfortunate. Our short-term ratings were not impacted by this action and therefore we should not see any impact on our commercial paper cost. As it relates to future long-term financing cost, we see potentially minimal impact. We expect our cash flows will be enhanced and more specifically, an improvement in our ratio of funds from operation relative to debt or FFO to debt. Although we expect that our 2023 FFO to debt would be a bit weak primarily given the delay in closing the offshore wind sales transaction, however, moving forward, we expect our cash-flow position to increase significantly. There are several factors we expect to contribute to enhancing our FFO to debt ratio well beyond the new threshold of 13% of FFO to debt by 2024 and beyond. A key factor driving an improvement in cash flows are the proceeds from the sale of our offshore wind projects along with eliminating the project funding requirements. You may recall that as of June 30th of 2023, the carrying value of our offshore wind investment was $2.1 billion, net of the $401 million pre-tax impairment charge and the proceeds from the sale of the lease area. We have previously indicated that there are approximately $850 million of contingent considerations as part of the sale that is comprised of the $450 million pricing adjustments or now an RFP rebid for Sunrise OREC. If successful with the RFP award, this cash flow would be received when the transaction closes. In addition, as I previously discussed, a potential $400 million from the energy communities of a 10% ITC adder quantification would be received when the projects reach COD, which we expect in 2025. Cash flows will be further enhanced from our core regulated businesses from electric and gas distribution rate adjustments primarily in Massachusetts and other cost recovery mechanisms. We anticipate additional deferred storm cost recovery of about $400 million to $500 million rolling into rates during 2024, that will be recovered over a five-year period. Also of note, we will fully monetize our $528 million of South Fork tax equity investment through lower tax payments and refunds, which will further contribute to an improvement in our cash flow and provide the ability to pay down debt, including a portion of the $1.4 billion of parent debt maturing in 2024. Lastly, we are committed to completing the $1 billion equity as part of our ATM program. As shown on Slide 10, we have issued no additional equity under this program through October. We also anticipate raising an additional equity through our dividend reinvestment and employee incentive programs through October, and we have issued 900,000 shares under that program. Thank you for joining us this morning, and I look forward to seeing many of you next week. I will now turn the call back over to Bob for Q&A.
Robert Becker: Thanks, John. I'll turn the call back to the operator to begin Q&A.
Operator: Thank you. [Operator Instructions] Our first question for today comes from Shar Pourreza of Guggenheim Partners. Your line is now open, please go ahead.
Shahriar Pourreza: Hey, guys. Good morning. Can you hear me?
Joseph Nolan: Good morning, Shar.
Shahriar Pourreza: Good morning. Sorry, we just saw, obviously, your partner Orsted taking a total impairment of around $900 million for the three projects. Can you just talk a little more about why you didn't take an additional impairment this quarter? And maybe just provide more clarity regarding Sunrise and that accelerated RFP process in New York with the buyer? I guess, John, what alternatives were you referencing? Thanks.
Joseph Nolan: Great. Well, thanks, Shar. Let me start with the RFP. While the merits of our repricing petition were in line with the recent NYSERDA RFPs and the resulting price ask from our petition was lower than the average price of a recent New York awards, our repricing petition was denied, unfortunately by the New York PSC. The primary reason, Shar, they cited was the pricing adjustments would have been done administratively rather than through competitive procurement, which is what they did not want to do. However, you'll see that NYSERDA then issued an RFP right after the denial for a future RFP for additional offshore wind. We have responded to that recent New York RFI and we'll evaluate the RFP terms. Given the maturity of Sunrise, in terms of the citing, permitting and early construction, this project is probably best positioned to win this RFP. John, you can hit on the impairment question for Shar, please.
John Moreira: Sure. Good morning, Shar. So it's pretty -- if you look at the impairment charge that our partner took last week and what happened to us in Q2, the impairment charge that we took, the pre-tax $401 million, which was reflective of the gain on the lease area, it's pretty comparable. So I would portray it this way that I think there is alignment between what has happened to us on these projects and what is -- and what we saw just last week with Orsted. So for that reason, and also the assumptions are very comparable with what they assumed and announced and what we considered back in June. And the last part of that question as to from a structural standpoint, you heard in my formal remarks that it's still very, very early in the process, but there could be a scenario where we move forward with the buyer on South Fork and Rev and kind of have a second transaction with this buyer to wrap up Sunrise. Obviously, it should be no surprise to anyone on the call from a project financing standpoint, you need to be locked in on the revenue agreement. So if there's an ability for us to enhance the revenue agreement and that takes four or five months, we are very supportive of that project delay in closing.
Shahriar Pourreza: Got it. And then, John, you mentioned that the sale process could be split with Sunrise later, which is kind of helpful, I guess. What could that look like? How should we think about the implications for investing in the project and timing? Basically, will you be on the hook for it? And any contingencies? Thanks, guys.
John Moreira: Sure, sure. Yes, we'll continue to have a funding requirement, but the negotiations that we already have with the buyer, we would be reimbursed for that extra funding at the time that we close. And, Shar, I think it's important to realize that based on what we have heard come out of NYSERDA, this is a very expedited RFP process. There's actually two. And so we could actually see a decision in advance of us closing the transaction on South Fork and Revolution. So I don't want to lose sight of that. But in case there's a further delay by NYSERDA in clarifying the win -- the bidders of those RFP processes, there is a scenario where we would still move forward on the path that we have in front of us for those two projects followed by Sunrise.
Shahriar Pourreza: Got it. Perfect. I appreciate, guys. I'll jump back in the queue. I know there's others that want to ask. Thanks.
John Moreira: Thank you.
Operator: Thank you. Our next question comes from Steve Fleishman of Wolfe Research. Your line is now open, please go ahead.
Steve Fleishman: Yeah. Hey, good morning.
Joseph Nolan: Good morning, Steve.
Steve Fleishman: So just -- hey, good morning, Joe, John. So the -- I guess on the comment on the Moody's action, the timing unfortunate. Can you just maybe give a little more color on kind of like your thoughts on that comment? And just from a corporate standpoint, ignoring the rating agencies, how should we think about the FFO-to-debt, you're overall expecting and targeting going forward?
John Moreira: Sure, sure. As I said in my formal remarks, we pride ourselves in having very strong credit ratings, and that's important to us. And my remark on the unfortunality of it is that the fact that we do see a significant enhancement in 2024 that would get us well above the 13%, and quite honestly, probably exceeding the 15% threshold. But we fully understand the predicament that Moody's they've been in with a negative outlook for quite some time. Storm activity, as I've mentioned, in the past three years, have been -- have created a headwind for us from a cash flow perspective, but we do see that enhancing in the years to come.
Steve Fleishman: Okay. And then the -- you mentioned that you maybe could have gotten to the 15% in 2024, just like what -- do you have a sense, John, of kind of what you're targeting going forward now for the FFO to debt as you're -- as we're thinking about your overall financing plan?
John Moreira: Well, Steve, let me start by saying that having -- being at the 13% right now does give us a little bit more flexibility where we can be opportunistic from an equity standpoint. But as I've said, I don't want to lose sight of the fact that we strive on maintaining a very strong credit rating. And right now, based on our plan, I do see -- everything else being equal, I do see us getting to 15% by the end of 2024.
Steve Fleishman: Okay. And is -- okay. And then -- so from that standpoint, given that, that you don't -- you not see then any need for more equity in the plan beyond what you've already talked about?
John Moreira: That's what I confirmed in my formal remarks. That is correct.
Steve Fleishman: Okay, great. And then just could you maybe -- I remember early in the year you talked to about the plan being kind of -- you thought kind of conservative on interest rate exposure and how you judge that. Just could you talk to just -- I know you had a slide going through some of the stuff. But just overall, how to think about the plan in terms of interest rate exposure?
John Moreira: Yeah, I mean, we've done a great job in managing to the current year exposure, and we will continue to be focused on that. We are very disciplined in our O&M strategy, and we've been very successful, as a matter of fact. As a result of that cost discipline, we've been able to narrow our guidance range, our EPS guidance range. So, yes, I would say to frame it, when I started the year, I didn't think the Feds were going to move as rapidly as they did with increase in rates. So it has put some further pressure on us, and we have a plan that will get us to where we need to be.
Steve Fleishman: And is that true for not just for this year, but for the long-term growth rate? Is that..
John Moreira: That's correct. That is correct.
Steve Fleishman: Okay. I'll let others ask. I appreciate the time. Thank you.
John Moreira: Thank you, Steve.
Joseph Nolan: Thank you, Steve.
Operator: Thank you. Our next question comes from David Arcaro from Morgan Stanley. Your line is now open, please go ahead.
Joseph Nolan: Hi, David, good morning.
David Arcaro: Thanks so much for taking my question. Hey, good morning. Let's see. Maybe just following up on Steve's last question. If rates stay where they are, do you continue to see the ability to hit solidly in the upper half of your guidance range? And maybe could you elaborate on some of the cost-cutting initiatives where the opportunities are that you see going forward?
Joseph Nolan: Sure. Thanks, David. So, yes, I mean, in our longer forecast, based on what consensus had interest rates moving and where the Fed is likely to be, we have factored that into our long-term growth prospects. The question is, when will the Fed start to turn the corner, either stabilize or perhaps even go start reducing rates? So that's what we're looking at in our 2024 plan. But right now, as I've said, the cost-cutting that we have been very successful to implement has compensated for that. From a cost-cutting measure we look at a multitude of things, right? We have done a great job in introducing technology that has lower operational costs. We look at on the shared services side what can we do there? So those are some of the items that we are very focused on.
David Arcaro: Okay, great. That's helpful. And then also just looking out at the FFO to debt trends you've got a couple or I guess I'm thinking of the tax equity payment in 2024, that's a bit of a one-time boost. But then post 2024, is there a trend off of that year where you expect FFO to debt to trend naturally just based on the core business outlook, does it fall below 15% after that or are there ways to maintain it in that rough range? Thanks.
John Moreira: No, no. If you recall my formal remarks, I said, look, right now our prospects is turn the corner in 2024 and beyond. So our core business is going to be a significant contributor to that. And the biggest driver of that will be the rate adjustments that we have in Massachusetts locked in. And while the pathway that we see to start recovering the nearly $1.6 billion of the first storm costs in Massachusetts and New Hampshire, as I've mentioned, we have about $400 million to $500 million kicking in into rates in 2024 that'll be recovered over the five year period. And then, we will be focused on the Connecticut deferred storm costs. And as we've said in the past, we look to file a Prudency, a cost review, and get that filing into PURA later this year.
David Arcaro: Okay, got it. Thanks. Appreciate the color.
Joseph Nolan: Thanks, David.
Operator: Thank you. Our next question comes from Nicholas Campanella from Barclays. Your line is now open, please go ahead.
Nicholas Campanella: Hey, everyone.
Joseph Nolan: Good morning, Nick.
Nicholas Campanella: Thanks for taking my question. Good morning. I just wanted to follow up on Connecticut. I think you started to hit it there, but obviously the governor, you're saying, has been more supportive, but it has been a challenging backdrop from a rate-making standpoint. Just how are you kind of thinking through the timing of a next CL&P rate case? And then secondly, just the strategy for deferred storm balances. I think you said that you're going to file later this year with recovery thereafter, but can you just kind of give us some more detail on what that process looks like? Thank you.
Joseph Nolan: Sure. Thanks, Nick. I'll take I'll take a crack at it and then John can pipe in. Couple of things we're not -- we have no plans of filing a rate case in Connecticut. We actually -- the settlement precludes that until 2025. So that would be the earliest, although not required at that point. Our storm cost filing is in very good shape and the filing is imminent at any time, we can make that filing as well. Again, that's a filing that we need to go through first, a review of it. So it's -- they'll go through all the documents and make sure that everything is in order so that it's something that you want to deal with outside of a rate case. We'll get that behind us, get the amount established, and then that way there it makes for a simpler or less complex rate case. So that's the current thinking right now. John, if you want to add any color, feel free.
John Moreira: Sure. I mean, it's -- as you can very well appreciate, it's a sizable amount that we will seek Prudency review. Right now, it's about $650 million that we're looking to put in front of PURA. So from a time standpoint, I would imagine that that would take quite some time, probably 10 to 12 months. It's a lot of information, a lot of due diligence that the regulator has to go through, Nick.
Nicholas Campanella: That's helpful. And then just one follow up on the assumptions underlying the 5% to 7% EPS CAGR here, like acknowledging that you're continuing to point to the high end of that range. you do have the ATM outstanding and you haven't issued a lot of that, and multiples are lower. So I'm just trying to understand, is this like a true mark to market of if the stock price stays where it is, you still see this as an executable 5% to 7% CAGR? Thanks.
Joseph Nolan: Sure, sure. Yes, we do. Yes, we do. I mean, I'm hoping that the market and the whole sector doesn't stay at this level much longer. Then I'm hoping that things will start to move forward in the right direction for all of us, quite honestly. But yes, when we haven't issued it any equity, it's not a mad dash to issue equity. So we will continue to monitor things and be opportunistic as we can.
Nicholas Campanella: Thank you.
Operator: Thank you. Our next question comes from Durgesh Chopra from Evercore. Your line is now open, please go ahead.
Durgesh Chopra: Hey, good morning, team. Thanks for taking my questions. Hey, first, just can you tell us what's the expected spending on the offshore projects this year? I think you're targeting roughly $1.5 billion per the Q3 slides.
John Moreira: Yeah. Durgesh, I think we will be -- we will come below that significantly. I think you recall that early in the year, we moved $500 million out of 2023 and into 2024 and beyond. And currently we are behind. So when you see our 10-Q, you're going to see a balance for offshore wind at the end of $930 million of about two and a half. But keep in mind that we got in a little bit over $300 million in mid-October, so which puts -- which puts our year to date balance net of the impairment charge at about roughly $2.2 billion, $2.3 billion.
Durgesh Chopra: Okay.
John Moreira: As compared to about a $2 billion dollar balance at the end of the year.
Durgesh Chopra: Got it. Okay. And then just going back to the equity question, just off the remaining amount that you've -- kind of the $1.2 billion, what's the -- any help you can give us on timing of how you might execute on that equity?
John Moreira: We'll have to wait and see where valuations are. But it's not, right now, it'll be over the next several years to put it in the 2 time to 3 time window time frame.
Durgesh Chopra: Okay. So not this year, right obviously?
John Moreira: No, no.
Durgesh Chopra: Okay. Thanks.
Operator: Thank you. Our next question comes from Jeremy Tonet of J.P. Morgan. Jeremy, your line is now open. Please go ahead.
Jeremy Tonet: Hi, good morning.
Joseph Nolan: Good morning, Jeremy.
Jeremy Tonet: Hi. Just starting off here, coming back to the sales process announcement and realize there are elements that are outside of your hands here. But if we're thinking about timing here, is this a matter of, like, days, weeks, or months? And are you able to identify any material gating items at this point or other risks around these negotiations? Just trying to get a sense for how the process could unfold at this point.
Joseph Nolan: Yeah. Well, thanks. Obviously, this is on everyone's mind. It's a process we've been working through. And as we've mentioned we have completed the terms with the buyer. The buyer now is working with our partner, Orsted. As we've mentioned, this buyer is very familiar to Orsted, they've done transactions with them. And we just need to see that play out. So I can't give you a day, a week, or a month, unfortunately. All I can tell you is that all of the terms associated with transaction with Eversource have been completed and that we feel very good about that. The buyer is still very eager on these projects, and we are going to work through it. And John and I will remain focused and disciplined around the execution of our divestiture of the wind business.
Jeremy Tonet: Got it. Very helpful there. Thank you. And then just pivoting back to equity. Just want to clarify a couple of points here to make sure I got it right. The $1.2 billion of external equity needs, is this kind of embedding, I guess, offshore wind sales price to a certain level, and does this assume higher New York price and success on one of the two IPC adders? Just trying to get clarity on what is factored in at that point. And then just to confirm, I guess, what you talked about earlier, the plan reaffirmation is based on current stock price levels, or does that need to be kind of reevaluated later for the 5% to 7% growth?
John Moreira: Sure. Let me take, there's a lot of items in there. So let me start with what we have left on our ATM is not $1.2 billion. We've already executed $200 million, so all we have is $1 billion left. And that assumption, and was reiterated on the call today, does assume that we would prevail on the -- that $850 million contingent consideration that I highlighted. So we've assumed that that would come in and we feel very good about it to the points that we've made on the call. So going out on the stock price, I mean, we haven't issued any equity this year for the simple fact of where values are. So we will continue to monitor that valuation as we move forward. As I've said, we have flexibility. Not looking to issue it all this year or next year, as I said, over time.
Jeremy Tonet: Got it. That's helpful. I'll leave it there. Thanks.
Operator: Thank you. Our next question comes from Anthony Crowdell from Mizuho. Your line is now open, please go ahead.
Anthony Crowdell: Hey, good morning. Just a couple of questions. First, on Sunrise, I think, on -- Orsted last week lowered their probability of being successful on a rebid. I mean, you guys seem very optimistic on a rebid. Just curious if there's any change in your thinking on Sunrise versus maybe last quarter.
Joseph Nolan: Yeah. No, I mean, we still feel very good about Sunrise, given where it is in the gestation process. And the fact of the matter is, the significant demand and appetite for offshore wind. And the pricing that we were seeking in our filing is less than what the average price was for others selected. The project is a great project. It's got so much economic development, benefit, jobs benefits, location, point of interconnection in New York that we feel very, very good about it. So that's our feeling on it. We feel it's a winner.
Anthony Crowdell: Great. And just curious, on the pricing, I don't know if you want to disclose it. But I just said the pricing you submitted to the New York Public Service Commission was attractive. On the rebid, could we assume that that price would exist on the rebid or through the rebid there's a chance that pricing could even go up higher or lower? I mean, could the pricing change?
Joseph Nolan: As you might imagine, this is a highly competitive process. There are other players in there, and that's something that we're not comfortable disclosing.
Anthony Crowdell: Great. And then just lastly, a whole bunch of moving pieces in this story. Big improvement in FFO to debt we should start seeing in 24. Just when we think about when all the dust settles, I mean, does 2024 look like it becomes a transition year and the offshore wind clears up? Or do you think that happens sooner, or does the cleanup to a fully regulated story happen more in 2025?
Joseph Nolan: No, I feel very, very confident that 2024 is our year for a transition to a clean, pure, regulated utility seeking singles and doubles and keeping everybody on this call very comfortable.
Anthony Crowdell: Great. Thanks for taking my questions. I appreciate it.
Joseph Nolan: Thank you.
Operator: Thank you. Our next question comes from Julien Dumoulin-Smith of Bank of America. Your line is now open, please go ahead.
Julien Dumoulin-Smith: Hey, good morning, team. Thank you guys very much for all the details so far. Just to clean up on a couple of things, if you guys don't mind. Just can we talk about capitalized interest year to date, where are we at the end of the day on the offshore wind projects? Can we talk about just what your expectations as you think about that new normal that you talked about singles and doubles? What is that parent level ongoing drag, if you want to call it that, in a kind of post-offshore world, if you will?
John Moreira: Sure, Julian. So the capitalized interest right now is about -- I don't know, I would say $25-ish million. And that's all at the parent company, $25 million, $30 million.
Julien Dumoulin-Smith: Got it. Okay. All right. I capitalized tied to the offshore $25 million, $30 million. And then how do you think about going forward for the kind of -- that new normal, if you will, at the parent here?
John Moreira: Well, with the cash inflows that I've mentioned, including some of the utilization of ITC, we can't lose sight over that, that I feel we would be able to harvest within the next 12 to 18 months, that's close to $500 million coming in the door, plus the proceeds from the offshore wind. We will turn the corner in 2024 and beyond. So, I do as Joe mentioned, 2024 is the pivotal turning period for us.
Julien Dumoulin-Smith: Right. Fair enough. Oh, yeah, go for it.
John Moreira: And Julian, we have, as I mentioned in my formal remarks, is $1.4 billion that will mature at the holding company in 2024. And that's all back end half year, those maturities will take place June and October.
Julien Dumoulin-Smith: Right. Indeed. And just coming back to trying to compare notes between Orsted and yourselves, and I'm sorry to do this. I think they quoted a number like $450 million here for break fees if Sunrise doesn't have a positive ID. Again, I'm not sure what's in or out of that bucket. Where do you guys assess that metric here on your side, as far as you're concerned? What's your understanding? And also maybe what are the offshore proceeds assumed in the plan with the EPS CAGR reaffirm?
John Moreira: Okay, so the breakup fees that Orsted announced on their call, we're 50% partner. So we would be on the hook for that 50% as well.
Julien Dumoulin-Smith: Got it. And the proceeds just in the plan just to kind of think through super quickly?
John Moreira: The proceeds from the sale?
Julien Dumoulin-Smith: Yeah. Well, I mean, what are you reflecting in your plan as a placeholder, if you will? Right. I know you're reaffirming the CAGR here today, and maybe it's too close to a sale to be able to disclose. But how do you broadly think about that as a big piece of the puzzle?
John Moreira: Yeah. I mean, we haven't disclosed that, but I think you can certainly kind of assess that as to where we stand. And the reason is that it's a moving target as to when the transaction closes because we still have this funding commitment. But if you draw the line in the sand, as of [$9.30 million] (ph), I mentioned that our total investment was $2.1 billion, and we have $850 million of contingent consideration that covers that balance. So the balance would kind of be in the range of what you would expect.
Julien Dumoulin-Smith: Okay, excellent, guys. I really appreciate the details. Thank you guys so much. All right. You guys take care.
John Moreira: Take care, Julien.
Joseph Nolan: Thank you, Julien.
Operator: Thank you. Our next question comes from Travis Miller of Morningstar. Your line is now open, please go ahead.
Travis Miller: Good morning, everyone, and thank you.
Joseph Nolan: Hey, Travis. Good morning.
Travis Miller: Jump over to Massachusetts, the ESMP, and then the investments, the clean energy investments you have planned there. What's your thinking around either rate design or rate filing? Do you foresee all of these investments going into just traditional rate cases, like we've done in the past, or are you going to think about some unique rate design where you could wrap these in more timely?
John Moreira: Travis, we're so excited about that plan that we filed because it does differentiate Massachusetts as being very progressive in that regard. And we're working with the key stakeholders, as Joe mentioned in his formal remarks. I would say from a cost recovery mechanism, I think it's far too early for us to speculate as to what that would be. We need this process to continue to kind of play out a bit more. Right now, as per the legislation, it's before this council, this Grid Mod Council that's made up of key stakeholders and policymakers of Massachusetts. So that is still being reviewed by the Council, and we'll file that early 2024 with the DPU. So I think it's a bit premature to start speculating on the recovery mechanisms.
Travis Miller: Okay. And about what's the rough mix in terms of O&M or variable-cost, operating costs, and capital costs in terms of your thinking about that?
John Moreira: I would say 70-30. 30 be in O&M.
Travis Miller: Okay. Yes. Perfect. And then real quick on the dividend, still, that 60% payout ratio kind of target the way you're thinking about going into next year?
John Moreira: Yeah, I mean, consistently we've been at 62%, and our dividend policy supports that payout.
Travis Miller: Okay, perfect. That's all I had. Thanks.
John Moreira: Thank you, Travis.
Operator: Thank you. Our final question for today comes from Paul Patterson of Glenrock Associates. Paul, your line is now open. Please go ahead.
Paul Patterson: Hey, great to hear you guys. Just really..
John Moreira: Hi, Paul.
Paul Patterson: Just really -- I guess really almost -- all my questions have been sort of answered. But I'm sorry to be a little bit slow on the timing here. Sounds like before we may get a final transaction sort of crossed T's dotted I's by the end of the year. And I'm just wondering, you mentioned the NYSERDA rebid process. If you could just go over, again, I apologize for being a little slow on this. The timing you're expecting on that and how that might impact this potential for splitting up this -- the South Fork versus the other projects and what have you?
Joseph Nolan: Sure. I guess a transaction announced by year end would be ideal. And, obviously, we wouldn't close that until 2024. And then with regard to NYSERDA, they're the ones that are asserting that it would be a very quick turnaround. So that is why we have contemplated this idea that we may, in fact, have not even transacted with the buyer when we already have line of sight on pricing around Sunrise, obviously, which would be beneficial for any buyer to understand what we're dealing with here. So it's very near term -- it's the end of this year, we would be optimistic that we could make an announcement and then a closing in 2024 and then some clarity around Sunrise pricing.
Paul Patterson: Okay. And then, I guess the -- okay, you answered it. Thanks so much.
Joseph Nolan: Thank you.
John Moreira: Thanks, Paul.
Operator: Thank you. I'll now hand back to the management team for any further remarks.
Joseph Nolan: Yeah. I want to thank everybody for taking the time to join us this morning on our earnings call. I'm looking forward to seeing many of you next week in the desert at the EI Financial Conference, and we can spend some more time digging into any of the details that are important to you. And also, as you know, our investment relations team is always available to answer any questions that you might have in the interim. So thank you again for your time, and have a wonderful day.
Operator: Thank you for joining today's call. You may now disconnect your lines. |
AAPL | 4 | 2,023 | 2023-11-02 21:32:21 | Operator: Good day, and welcome to the Apple Q4 Fiscal Year 2023 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Suhasini Chandramouli, Director of Investor Relations. Please go ahead.
Suhasini Chandramouli: Thank you. Good afternoon, and thank you for joining us. Speaking first today is Apple's CEO, Tim Cook. And he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed annual report on Form 10-K and the Form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks.
Tim Cook: Thank you, Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $89.5 billion for the September quarter. We achieved an all-time revenue record in India, as well as September quarter records in several countries, including Brazil, Canada, France, Indonesia, Mexico, the Philippines, Saudi Arabia, Turkey, the UAE, Vietnam and more. iPhone revenue came in ahead of our expectations, setting a September quarter record, as well as quarterly records in many markets, including China mainland, Latin America, the Middle-East, South Asia and an all-time record in India. In services, we set an all-time revenue record with double-digit growth and ahead of our expectations. During the September quarter, we continue to face an uneven macroeconomic environment, including foreign exchange headwinds and we've navigated these challenges by following the same principles that have always guided us. We've continued to invest in the future and manage for the long-term. We've adapted continuously to circumstances beyond our control, while being thoughtful and deliberate on spending. And we've carved a path of groundbreaking innovations and delivered with excellence every step of the way. That includes Apple Vision Pro, which has gotten such an amazing response from developers who are currently creating truly incredible apps. We're excited to get this magical product in the hands of customers early next year. Now let me share more about our products, beginning with iPhone. iPhone revenue came in at $43.8 billion, 3% higher than a year ago, and a new record for the September quarter. This fall, we were thrilled to debut the iPhone 15 lineup. The all-new iPhone 15 and iPhone 15 Plus feature a gorgeous design, powerful cameras and the intuitive Dynamic Island. Powered by the industry-leading A17 Pro, our iPhone15 Pro lineup has a beautiful strong and durable titanium design and the best iPhone camera system ever, including a 5X Telephoto lens on iPhone 15 Pro Max. Customers are loving the entire iPhone 15 family and reviews have been off the charts. In Mac, revenue came in at $7.6 billion, down 34% year-over-year from the prior year's record quarter. This was due to challenging market conditions, as well as difficult compares against the supply disruptions and subsequent demand recapture we experienced a year ago. Earlier this week, we were excited to unveil the next generation of Apple silicon with our incredible family of M3 chips, M3; M3 Pro; and M3 Max. We're continuing to innovate at a tremendous pace. And our industry-leading lineup of personal computers just got even better. The new MacBook Pro lineup brings our most advanced technology to our Pro users, while iMac, the world's best-selling all-in-one, just got faster and more capable. And according to the latest data from Student Monitor, nearly two out of three college students chose a Mac. We couldn't be more excited about the future. Turning to iPad. Revenue for the September quarter was $6.4 billion. iPad sets the gold standard for tablets and our competitors are unable to match the iPad experience that is enabled by our seamless integration of hardware and software. iPad is also our most versatile product. In classrooms around the world, it's helping educators bring lessons to life, while giving students a window into the world around them. And in artist workshops, design studios and everywhere else, creative minds come together, iPad supercharges the creative process, helping users take their ideas farther than they ever could before. Across wearables, home and accessories, revenue came in at $9.3 billion. Apple Watch has become essential in our lives and this is our best Apple Watch lineup ever. With Apple Watch Series 9 and Apple Watch Ultra 2, we're giving people even more tools to stay safe and live healthy, active lives. With the new double tap gesture, users can easily control Apple Watch Series 9 and Apple Watch Ultra 2 using just one hand and without touching the display. It feels like magic. Our latest Apple Watch lineup also includes our first-ever carbon-neutral products, a significant achievement of innovation and determination. Apple's unique ecosystem of hardware, software, and services delivers an unparalleled user experience. During the quarter, we also had the chance to introduce a range of exciting new updates to our software that will allow users to get even more out of their devices. Whether it's personalized contact posters and new face time features in iOS 17, new tools for users to make their experience their own in macOS Sonoma and iPadOS 17, or a bold new look in watchOS 10 that lets you see and do more, faster than ever, Apple is delivering an even better, richer experience that users are loving. Services revenue set an all-time record of $22.3 billion, a 16% year-over-year increase. We achieved all-time revenue records across App Store, advertising, AppleCare, iCloud, payment services, and video, as well as the September quarter revenue record in Apple Music. Whether subscribers are waking up to headlines on Apple News+, getting their morning workout in with Fitness+, feeling the beat with Apple Music on their way to work or school, or unwinding at the end of the day with Apple Arcade, we have so many different services to enrich their day. Apple TV+ continues to delight customers as well, with new and returning shows like the Morning Show, Lessons in Chemistry and Monarch. We're telling impactful stories that inspire imagination and stir the soul. Making movies that make a difference is also at the heart of Apple TV+ and we were thrilled to produce Martin Scorsese's Killers of the Flower Moon, a powerful work of cinema that premiered in theaters around the world last month. We're proud to say that since launch, just over four years ago, Apple TV+ has earned nearly 1,600 award nominations and nearly 400 wins. We also offer subscribers an unprecedented live sports experience with MLS Season Pass. We couldn't be more pleased with how our partnership with Major League Soccer has gone in its first year. Subscriptions to MLS Season Pass have exceeded our expectations and we're excited to continue that momentum next year. With the playoffs now underway, we can't wait to see who takes home MLS cup. And nowhere does the magic of Apple come alive more than it does in our stores. Over the past year, we've continued to find ways to connect with even more customers. We welcomed customers to our first-ever retail locations in India. We also opened doors to new stores in Korea, China and the UK and expanded the Apple store online to Vietnam and Chile. And we have another store opening in China this week. In September, I joined our team at Apple Fifth Avenue on launch day and the energy and excitement were unbelievable. Every time we connect with the customer, we're reminded why we do what we do. From simple joys of creating and sharing memories, to lifesaving features like emergency SoS via satellite, we're enriching lives in ways large and small. And whether we're working to safeguard user privacy, ensure technology made by Apple is accessible for everyone, or build an even more inclusive workplace, we're determined to lead with our values. Our environmental efforts are a great example of the intersection of our work and our values. Across Apple, we act on a simple premise, the best products in the world should be the best products for the world. We've made our environmental work a central focus of our innovation, because we feel a responsibility to leave the world better than we found it and because we know that climate change cannot be stopped, unless everyone steps up and does their part. Our first ever carbon-neutral products represent a major milestone and we're going to go even further. We plan to make every product across our lineup carbon neutral by the end of the decade. And we're not doing it alone. Over 300 of our suppliers have committed to using a 100% clean energy for Apple production by 2030. We also continue to invest in entrepreneurs who are lighting the way for a greener, more equitable future. Through our third impact accelerator class, we're proud to support a new class of diverse innovators on the cutting edge of green technology and clean energy. Apple is always looking forward, driven in equal measure by a sense a possibility and a deep belief in our purpose. We're motivated by the meaningful difference we can make for our customers and keenly determined to push the limits of technology even further. And that's why I'm so confident that Apple's future is bright. With that, I'll turn it over to Luca.
Luca Maestri: Thank you, Tim, and good afternoon, everyone. Revenue for the September quarter was $89.5 billion, down less than 1% from last year. Foreign exchange had a negative impact of over 2 percentage points. And on a constant-currency basis, our revenue grew year-over-year in total, and in each geographic segment. We set a September quarter record in the Americas and saw strong performance across our emerging markets, where both iPhone and Services grew double digits. Products revenue was $67.2 billion, down 5% from last year, due to very challenging compares on both Mac and iPad, which I will discuss in more detail later on. At the same time, we reached a September quarter record on iPhone, driven by strength in emerging markets. Our total installed-base of active devices reached an all-time high across all products and all geographic segments, thanks to our high levels of customer satisfaction and many new customers joining our ecosystem. Our Services revenue set an all-time record of $22.3 billion, up 16% year-over-year, with growth accelerating sequentially from the June quarter. Our performance in Services were broad based, as we reached all-time revenue records in the Americas, Europe and rest of Asia-Pacific and a September quarter record in Greater China. We also set new records in every Services category. Company gross margin set a September quarter record at 45.2%, up 70 basis points sequentially, driven by leverage and favorable mix, partially offset by foreign exchange. Products gross margin was 36.6%, up 120 basis points sequentially, also driven by leverage and mix, partially offset by foreign exchange. Services gross margin was 70.9%, up 40 basis points from last quarter due to a different mix. Operating expenses of $13.5 billion were at the low end of the guidance range we provided, up 2% year-over-year. Net income was $23 billion, diluted earnings per share was $1.46, up 13% versus last year and a September quarter record, and operating cash flow was strong at $21.6 billion. Let me now provide more detail for each of our revenue categories. iPhone revenue was $43.8 billion, up 3% year-over-year and a new September quarter record. We had strong performance in several markets, including an all-time record in India as September quarter records in Canada, Latin America, the Middle East, and South Asia . Our iPhone active installed base grew to a new all-time high and fiscal 2023 was another record year for switches. We continue to see extremely high levels of customer satisfaction which 451 Research recently measured at 98% in the U.S. Mac revenue was $7.6 billion, down 34% year-over-year, driven by challenging market conditions and compounded by a difficult compare in our own business, whereby last year we experienced supply disruptions from factory shutdowns in the June quarter and were subsequently able to fulfill significant pent-up demand during the September quarter. We also had a difference in launch timing with the MacBook Air launching earlier this year in the June quarter compared to the September quarter last year. We have great confidence in our Mac lineup and are excited about the recently announced iMac and MacBook Pro powered by our M3 chips. Our installed base is at an all-time high and half of Mac buyers during the quarter were new to the product, driven by MacBook Air. Also, we saw reported customer satisfaction of 97% for Mac in the U.S. iPad generated $6.4 billion in revenue, down 10% year-over-year. Similar to Mac, these results were a function of a difficult compare from the supply disruptions in the June quarter a year ago and the subsequent fulfillment of pent-up demand in the September quarter. iPad continues to attract a large number of new customers to the installed base with over half of the customers who purchase iPads during the quarter being new to the product and the latest reports from 451 Research indicate customer satisfaction of 98% in the U.S. Wearables, Home and Accessories revenue was $9.3 billion, down 3% year-over-year. We had a September quarter record in Europe and we saw strong performance in several emerging markets around the world. Apple Watch continues to expand its reach with nearly two-thirds of customers purchasing Apple Watch during the quarter being new to the product and customer satisfaction for the Watch was recently measured at 97% in the U.S. Services had a great quarter. We reached a new all-time revenue record of $22.3 billion, up 16% year-over-year. And we're happy to see growth coming from all categories and every geographic segment, which is a direct result of the strength of our ecosystem. Our installed base of over 2 billion active devices continues to grow at a nice pace and establishes a solid foundation for the future expansion of the ecosystem. And we continue to see increased customer engagement with our Services. Both transacting accounts and paid accounts grew double-digits year-over-year, each reaching a new all-time high. Also our paid subscriptions showed strong growth. We have well over 1 billion paid subscriptions across the services on our platform, nearly double the number we had only three years ago. And finally, we continue to improve the breadth and quality of our current services from exciting new content on Apple TV+ and Apple Arcade to additional storage tiers on iCloud. We believe our customers will love this new offering. Turning to enterprise. We are excited to see our business customers in both developed and emerging markets expand their deployment of Apple products and technologies to drive business innovation and employee satisfaction. Starbucks continuously invest in Apple technology to bring the best experience to the customers and employees, including tens of thousands of iPads across all retail stores to help their teams streamline order management, operations and training. In addition, Starbucks recently refreshed over 10,000 Macs to the latest M2-powered MacBook Air for all store managers, enabling them to do their best work and improve productivity. And in Indonesia, popular technology company GoTo is offering Mac as a choice, so that employees can have the best tools to be most productive. Today, more than half of its workforce are already choosing Mac for work. Let me now turn to our cash position and capital return program. We ended the quarter with over $162 billion in cash and marketable securities. We increased commercial paper by $2 billion, leaving us with total debt of $111 billion. As a result, net cash was $51 billion at the end of the quarter. And our goal of becoming net cash-neutral over time remains unchanged. During the quarter, we returned nearly $25 billion to shareholders, including $3.8 billion in dividends and equivalents and $15.5 billion through open market repurchases of 85 million Apple shares. We also began a $5 billion accelerated share repurchase program in August, resulting in the initial delivery and retirement of 22 million shares. Taking a step back, as we close our 2023 fiscal year, our annual revenue was $383 billion. While it was down 3% from the prior year, it grew on a constant-currency basis despite the volatile and uneven macroeconomic environment. Our year-over-year revenue performance improved each quarter as we went through the year, and so did our earnings per share performance, as we reported double-digit EPS growth in the September quarter. We are particularly pleased with our performance in emerging markets with revenue reaching an all-time record in fiscal 2023 and double-digit growth in constant currency. We are expanding our direct presence in these markets from new Apple retail stores in India to online stores in Vietnam and Chile. And we continue to work with our partners to offer a wide range of affordability programs so that we can best serve our customers. We're very excited about the momentum we have in these markets and the opportunity ahead of us. As we move ahead into the December quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. Also, on foreign exchange, we expect a negative year-over-year revenue impact of about 1 percentage point. As a reminder, the December quarter this year will last the usual 13 weeks, whereas the December quarter a year ago spanned 14 weeks. For clarity, revenue from the extra week last year added approximately 7 percentage points to the quarter's total revenue. Despite having one less week this year, we expect our December quarter, total company revenue to be similar to last year. We expect iPhone revenue to grow year-over-year on an absolute basis. We also expect to grow after normalizing for both last year's supply disruptions and the one extra week. We expect Mac year-over-year performance to significantly accelerate from the September quarter. We expect the year-over-year revenue performance for both iPad and Wearables, Home and Accessories to decelerate significantly from the September quarter due to a different timing of product launches. On iPad, we launched a new iPad Pro and iPad 10th Generation during the December quarter a year ago. For the Wearable category, last year we had the full December quarter benefit from the launches of the AirPods Pro 2nd Generation, the Watch SE, and the first Watch Ultra. For our Services business, we expect the average revenue per week to grow at a similar strong double-digit rate as it did during the September quarter. We expect gross margin to be between 45% and 46%. We expect OpEx to be between $14.4 billion and $14.6 billion. We expect OI&E to be around negative $200 million, excluding any potential impact from the mark-to-market of minority investments and our tax-rate to be around 16%. Finally, today our Board of Directors has declared a cash dividend of $0.24 per share of common stock, payable on November 16, 2023, to shareholders of record as of November 13, 2023. With that, let's open the call to questions.
Suhasini Chandramouli: Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?
Operator: Certainly. We will go ahead and take our first question from Mike Ng of Goldman Sachs. Please go ahead.
Michael Ng: Hey. Good afternoon, and thank you very much for the questions. I just have a question on iPhone storage and demand versus iCloud. As demand for storage grows, are you seeing a mix-shift towards higher storage iPhone models or are consumers mostly opting for the same because of increased uptake of iCloud+? What are some of the strategic and financial considerations here and trade-offs, as you think about the mix shift towards higher storage models versus iCloud penetration? Thanks.
Tim Cook: Michael, it's Tim. As you probably know, we started the line with the iPhone Pro Max at 256, and so we are seeing a different mix, if you will, this year than last year. Outside of that, not significant changes.
Michael Ng: Great. Thank you. And as a separate follow-up, I was just wondering if you could talk a little bit about the market conditions on notebooks and desktops, and then any color that you can share regarding the timing of the Mac -- M3 MacBook Pros this year versus the M2 earlier in the calendar year? Thank you.
Tim Cook: Yeah. We're thrilled to have announced the M3 lineup and get the new MacBook Pro, the new iMac out there. We couldn't be more excited about it. We -- as Luca said, with the lineup that we've got and the compare issue that we don't have during Q1, we anticipate a significant acceleration in the Mac space for Q1. To just repeat a little bit about the circumstances of the performance last quarter, in the year-ago June quarter, we had a factory disruption that lasted several weeks. The pent-up demand that resulted from that was filled in the September quarter, and that made the September quarter not only a record, but a substantial record. And obviously, we're now comparing against that for '23 and so that, I wouldn't look at the negative 34% as representative of the underlying business performance. It's sort of the net of it.
Michael Ng: Excellent. That's very clear. Thank you, Tim.
Tim Cook: Yeah.
Suhasini Chandramouli: All right. Thanks, Mike. Can we have the next question, please?
Operator: Our next question is from Aaron Rakers with Wells Fargo. Please go ahead.
Aaron Rakers: Yeah. Thanks for taking the question and congratulations on the execution in the quarter. I'm curious, if you could help us characterize what the demand environment you're seeing in China looks like. How has the reception been to the iPhone 15? And kind of similar question to the prior one, how would you characterize the mix within China as you go through this current product cycle? And I have a follow-up.
Tim Cook: Yeah. If you look at how we did in Greater China for the quarter, we came in at, on a revenue basis, minus 2. But one thing to keep in mind here is that the FX impact was nearly 6 points. So we grew in constant currency. And underneath that, if you look at the different -- the categories, iPhone actually set a September quarter record in mainland China. And the -- what pulled down the performance was a combination, largely of Mac and iPad. Services also grew during the quarter and the Mac and iPad suffered from the same issues that the company did with the compare issues to factory disruptions in Q3 that were filled subsequently in Q4 of '22. We had the -- in addition to that, we had the top four selling phones in urban China for last year, and I was -- I just took a trip over there and could not be more excited about the interactions I had with the customers and employees and others.
Aaron Rakers: Yeah. And then, as a quick follow-up, I'm curious as we move towards more of an inflationary component pricing environment. Luca, how do we think about that effect? How you're thinking about the gross margin at the product level, as maybe component pricing starts to turn, what's been clearly very favorable over the last several quarters to more of an inflationary environment? Thank you.
Luca Maestri: Well, as you've seen from our results in Q4 and the guidance for Q1, we're obviously experiencing very strong levels of gross margin. The 45.2% was a record for the September quarter. And then, the guidance for Q1 is obviously strong at 45% to 46%. Our gross margins are affected by multiple factors. Obviously, the commodity environment is one of them, as you mentioned. It's been a good environment in recent quarters. But equally important is the mix of what we sell. And obviously, growth in Services for us is favorable, and that has helped our company gross margin. Foreign exchange, on the other hand, has been a drag for us for several quarters, given the strength of the dollar. We don't provide guidance past the December quarter, which is a very important one for us because it's the beginning of the product cycle for many products. And so we feel very good, very confident about, this coming year, and I think the gross margin guidance reflects that.
Aaron Rakers: Thank you.
Suhasini Chandramouli: Thanks, Aaron. Can we have the next question, please?
Operator: Our next question is from Erik Woodring with Morgan Stanley. Please go ahead.
Erik Woodring: Awesome. Thank you very much for taking my questions. Maybe if I start, Luca, I know that the iPhone 15 Pro and Pro Max are constrained today, but I think some of your comments suggests you should be back to supply demand balance before quarter end. So, I guess, my question is, does your December quarter revenue guidance account for any supply constraints? And if so, is there any way to kind of quantify how much supply would be limiting your December quarter revenue performance? And then, I have a follow-up. Thank you.
Luca Maestri: Yes. It's correct. We are constrained today on iPhone 15 Pro and iPhone 15 Pro Max. We're working very hard to get the product in the hands of all the customers that have ordered it. We expect, as of today, that we're going to be in supply demand balance by the end of the quarter. So the guidance reflects that.
Erik Woodring: Okay, very clear. Thanks. And then, maybe for you and Tim. You guys have been on the leading end of -- edge of innovation across hardware, software, silicon, services. And I'm sure there's plenty of technology in kind of longer-term projects that you're investing in. How should we think about your capital intensity as we look to fiscal year '24, just given over the last few years, CapEx as a percentage of revenue had been relatively low compared to the eight years prior? So should we expect a step-up or kind of similar capital intensity? And what are the more notable moving pieces, if any, that we should be thinking about? Thanks.
Luca Maestri: Well, the big areas of investment for us are tooling and equipment for manufacturing plants. Our investments in data centers and our investments in our own facilities, both corporate facilities and retail stores. And so, both for the tooling in our plants and our data center investments, we tend to have a bit of a hybrid model where we share some of the investments with our partners and suppliers and so maybe that's why you see sometimes a bit of variability. But over the last few years, we've made all the investments that we needed to make. And obviously, we're planning to make all the investments that we believe are needed and appropriate in order to continue to innovate.
Erik Woodring: Great. Thanks so much for the color, guys.
Suhasini Chandramouli: Thanks, Eric. Can we have the next question, please?
Operator: Our next question is from David Vogt with UBS. Please go ahead.
David Vogt: Great. Thanks, guys for taking my question. I know you covered China. I want to pivot to the US for a second. Obviously, iPhone and the business looks like it returned to growth in the quarter. But it's still relatively softer kind of where I thought it would be at this point in the cycle and some of the U.S. carriers obviously haven't been that particularly aggressive in promoting upgrades. So just wanted to kind of get a sense, first, what you're seeing from your partners in the U.S. kind of currently and going forward and what do you expect? And then, second, Luca, on the margins, I mean, is it fair to say that the mix in Q1 from a product versus services dynamic is kind of the key driver of the better gross margin guide as a whole relative to, let's say, the December quarter? Or is there anything else? I know you mentioned there's a lot of moving pieces, but is that the primary driver of the uplift in the margin? Thanks.
Tim Cook: On the U.S. carriers and the U.S. business in general, it's really too early to call the iPhone cycle, particularly with the constraint around the Pro and the Pro Max and the U.S. tends to do quite well with those products. It's really too early to tell what the upgrade rates will be and what the switcher rates will be.
Luca Maestri: On the margin side, if I understood your question correctly about the December quarter guidance, keep in mind that actually December is the quarter where our products business is tends to be very heavy because of the holiday season. And so the services gross margins that are accretive to total company had an impact, but not as meaningful as other quarters during the year and so I think that the main drivers of the guidance that we provided are the fact that we are seeing improved costs, and improved mix on our -- on the product side of the business, partially offset by foreign exchange, which continues to be a drag, both sequentially and on a year-over-year basis.
David Vogt: Got it. So the weakness in iPad and Wearables are less of an impact on sort of the margin trajectory in the December quarter?
Luca Maestri: That's correct.
David Vogt: I guess?
Luca Maestri: That's correct.
David Vogt: Got it. Thanks, Luca.
Suhasini Chandramouli: All right. Thanks, David. We'll take our next question, please.
Operator: Our next question is from Amit Daryanani with Evercore. Please go ahead.
Amit Daryanani: Yeah. Good afternoon. Thanks for taking my question. I have two as well. I guess, first off, just the Services growth rate, there's a tremendous acceleration I think in September quarter, the 16% growth. And it sounds like it’s going to hold there pretty well into December. Can you just talk about what is driving this acceleration? Are there a couple of products that have just stepped up in a very meaningful way? Just maybe flush out like what is driving this acceleration because it's fairly notable compared to what you've been seeing in the last few quarters.
Luca Maestri: We had a really strong quarter across the border, Amit, because both geographically and from a product category standpoint, we saw very significant growth, I mentioned the records on a geographic basis. And from a category standpoint, literally, we set records in each one of the big categories. We had all-time record for App Store, for advertising, for cloud, video, AppleCare, payments and a September quarter record for Music. So it's hard to pick, one in particular because they all did well. And really then, we step back and we think about why is it that our Services business is doing well and it's because we have an installed base of customers that continues to grow at a very nice space and the engagement in our ecosystem continues to grow. We have more transacting accounts, we have more paid accounts, we have more subscriptions on the platform and we continue to add. We continue to add content and features. We're adding a lot of content on TV+, new games on Apple Arcade, new features, new storage plans for iCloud. So it's a combination of all these things and the fact that the engagement in the ecosystem is improving, and therefore, it benefits every service category.
Amit Daryanani: Got it. That's really helpful. And then, maybe if I could ask you about Vision Pro, which I believe is supposed to be launched more broadly sometime in 2024, in the early part of the year. I'm curious how different do you think the launch and the consumer education of this product or a new category will be versus other things like AirPods or Apple Watch that you've done. And then, perhaps any themes I think that's set out to you from the developers that have been able to use this and the developer labs, what feedback have you gotten from them?
Tim Cook: Yeah. That's a great question. There is a tremendous amount of excitement around the Vision Pro and we're -- we've been very happy to share it with developers, and we have developer labs set up in different parts of the world so that they can actually get their hands on it and are working on apps and I've been fortunate enough to see a number of those. And there is some real blow away kinds of things that are coming out, and so that all looks good. To answer your question about is it similar to AirPods or Apple Watch, I would say, no. There's never been a product like the Vision Pro. And so, we're purposely bringing it out in our stores only, so we can really put a great deal of attention on the last mile of it. We'll be offering demos in the stores and it will be very different process than the -- a normal grab-and-go kind of process.
Amit Daryanani: Perfect. Thank you.
Suhasini Chandramouli: Thanks, Amit. We'll take the next question, please.
Operator: Our next question is from Harsh Kumar with Piper Sandler. Please go ahead.
Harsh Kumar: Yeah. Hey, thanks for the question and congratulations on tremendous execution in a very tough macro. Actually, Tim, the last question is a perfect segue here, given what you are doing with your Vision Pro. So lots of companies are experimenting with generative AI. I'm curious about what kind of efforts you have. I'm sure there are segues into Pro Vision that you have, but I was curious about if you can give us a glimpse on how you might be able to monetize some of these efforts of generative AI.
Tim Cook: If you kind of zoom out and look at what we've done on AI and machine learning and how we've used it, we view AI and machine learning as fundamental technologies, and they're integral to virtually every product that we ship. And so just recently, when we shipped iOS 17, it had features like Personal Voice and Live Voicemail. AI is at the heart of these features. And then, you can go all the way to then lifesaving features on the launch end of phone like fall detection, crash detection, ECG on the watch. These would not be possible without AI. And so, we don't label them as such, if you will. We label them as to what their consumer benefit is. But at the fundamental technology behind it is AI and machine learning. In terms of generative AI, we have -- obviously, we have work going on. I'm not going to get into details about what it is, because -- as you know, we don't -- we really don't do that. But you can bet that we're investing, we're investing quite a bit, we're going to do it responsibly and it will -- you will see product advancements over time that where the -- those technologies are at the heart of them.
Harsh Kumar: Thanks, Tim. Very clear. And for my follow-up, I had a philosophical question. So, you guys always try to provide the best experience for consumers. To that end, I think, over the last decade you in-sourced a lot of important chips in your phones, in your Macs, iPads, so on and so forth. And that was, I think, a function that ARM wasn't around in the industry from a merchant angle. But now, we see these the silicon guys, the chip guys moving to ARM architecture. So my question to you is, has the move to internal silicon been economically profitable proposition for Apple? Or is it -- or is it a strategic one, where you simply need to own this and it's vital to your products for the consumer experience or maybe there's a path back to chip vendors at some point in time?
Tim Cook: It's really enabled us to build products that we could not build without doing it ourselves. And as you know, we like to own the primary technologies in the products that we ship and arguably, the silicon is at the heart of the primary technologies, and so, no, I don't see going back. I am happier today than I was yesterday, than I was last week that we made the transition that we've made, and I see that benefit every day of it.
Harsh Kumar: Thanks, Tim.
Tim Cook: Yeah.
Suhasini Chandramouli: Thank you, Harsh. We'll take the next question, please.
Operator: Our next question is from Wamsi Mohan from Bank of America. Please go ahead.
Wamsi Mohan: Yes. Thank you so much. Tim, over the last decade, pretty much you've gained a lot of share in China. As you look, your -- some of the domestic players are starting to re-emerge, especially in the high-end phone space. I know you touched on China. But how would you see Apple's positioning and opportunity for continued share gains, particularly in China? And how was the linearity in China from a demand perspective? And I have a follow-up, please.
Tim Cook: In the September quarter, we set an iPhone record -- revenue record in China and we're very proud of that and we obviously grew. The market predictions that I've seen, we've had the market contracting. And so if that's -- if those are correct, then we gained share last quarter. And so we are very proud of that, I don't know what every quarter will hold. And obviously, we just give a bit of color on the current quarter. But over the long term, I view China as an incredibly important market and I'm very optimistic about it.
Wamsi Mohan: Okay. Thanks, Tim. And as a follow-up, you obviously had a great Services quarter and part of your Services business has these licensing relationships with research partners, where you serve a very important distribution function for them. Can you talk about how you think about these relationships and potentially some of the options maybe Apple has to mitigate some of the risks, given some of the scrutiny on with some of the research partners? Thank you so much.
Luca Maestri: They are important relationships. And as you know, we don't get into our commercial relationships in the call. I see them as important and we make decisions that are in the best interest of our users or what we feel is in the best interest of our users. And that's kind of what we've done in the past and how we've -- how we'll run the show in the future as well.
Wamsi Mohan: Okay. Thank you, Tim.
Suhasini Chandramouli: Thank you, Wamsi. Can we have the next question, please.
Operator: Our next question comes from Krish Sankar with TD Cowen. Please go ahead.
Krish Sankar: Yeah. Hi. Thanks for taking the question. I had two of them too. First one, Luca, thanks for the color on gross margin. And when I look at it over the last four quarters, even if on a year-over-year basis revenue declined, the gross margins have improved. And I understand Services definitely helped. I'm just kind of curious, when you look at on a go forward basis, are most of the big step functions and cost reductions like the Mac Silicon conversion, et cetera, that are done or is there more room for margin expansion from here? And then, I had a follow-up.
Luca Maestri: Well, on the product side, as you know, we -- when we launch new products, the cost structures of those products tend to be higher than the products that they replace. It happens because we are always adding new technologies, new features, and then, we worked through the cost curve over the lifecycle of the product and we tend to get benefits as time goes by. The guidance that we provided for December reflects all that and so we're starting from a better position than a year ago or than, in the past, in general. There are other factors that play a role. For example, the mix of products that we sell. Not every product has the same gross margin profile, and so our guidance, our results are reflective of that. And also, within a specific product category, a lot depends on the kind of models that we sell because they have different margin profiles. I think one of the things that we've done well over the last few years is to offer more affordability solutions to our customers in the form of instalment plans, trading options, and spend -- low-cost financing in general. And what that has accomplished is reduced the affordability threshold for our customers and therefore, they can, buy at the top of our product ranges. That has been a big factor in the reason for our margin expansion. We don't provide guidance or color past the current quarter because there's so many different variables that affect gross margins, but we obviously feel very good about the trajectory that we've had in 2023 and now, the guidance that we provide for the beginning of our fiscal '24. And we need some of these things because, obviously, their foreign exchange environment has been difficult and has been a bit of a drag for us. But net-net, we're very pleased where we are.
Krish Sankar: Got it. Thanks for that, Luca. And then, I have a follow-up for Tim. Obviously, you're seeing amazing momentum in India. I'm just kind of curious how do you look at -- when you look at the India growth opportunity on these hardware units, how to think about ASP relative to that versus like the rest of the geographies? And is there a way to compare or contrast India, growth momentum versus China maybe a decade ago or so at the same point in the rollout of, the share gains in that geography?
Tim Cook: Yeah. It's a great question. We had an all-time revenue record in India. We grew very strong double-digits. It's an incredibly exciting market for us and a major focus of ours. We have low share in a large market, and so it would seem there's a lot of headroom there. The ASPs, I haven't looked at them most recently, but I'm sure that they're lower than the worldwide. But that doesn't bother us at all. It just -- and in terms of the similarity, I would say, each country has its own journey. And I wouldn't want to play the comparison game. But we see an extraordinary market, a lot of people moving into the middle class, distribution is getting better, lots of positives. We put two retail stores there, as you know. They're doing better than we anticipated. It's still early going, but they're off to a good start and I couldn't be happier with how things are going at the moment.
Krish Sankar: Thanks, Tim.
Suhasini Chandramouli: Thank you, Krish. We'll now take our next question, please.
Operator: Our next question is from Ben Reitzes with Melius Research. Please go ahead.
Ben Reitzes: Hey. Thanks a lot. I appreciate the question. Tim, I appreciate all your commentary around China. It was great to kind of hear about the growth potential there, your optimism. I wanted to also ask about the supply chain and where is your priority? Do you have a priority to diversify your supply chain? How do you feel about Apple's supply chain around the world? And in particular, what do you think about further investments in the U.S. as well?
Tim Cook: Our supply chain is truly global, and so we're investing all over the world, including in the United States, we were very focused on advanced manufacturing for the U.S. and have worked on a number of different projects in the U.S., whether that's our venture with Corning on the glass or Face ID module or semiconductors. And so all of these are our advanced manufacturing and I think exactly the kinds of things that the U.S. would be and are very, very good at. We also invested in other regions of the world and we're continually optimizing the chain. And so we -- the moment we learned something that didn't work exactly right, we are tweaking it. And so we're going to continue to do that. But at the end of day, it will still be a global supply chain.
Ben Reitzes: Got it. Thanks.
Tim Cook: Yeah.
Ben Reitzes: Next one for Luca. Just really quick on the extra week dynamic. There was also last year an issue with the iPhone production, where there was the COVID lockdowns in China. Is it possible to give some color around what that -- I guess, having a normalized supply chain somewhat this year, what that benefit is this year and maybe contrast that with the 7 point hit from the extra week? Thanks a lot.
Luca Maestri: Yeah. Thanks for the question, Ben. I mentioned during the prepared remarks the extra week is 7 points of revenue. We did have disruptions, supply disruptions last year on the phone, on the 14 Pro and Pro Max in the December quarter a year ago. And when we normalize for those two factors, and I said it during the call, we still expect to grow on iPhone. So you take into account the, the loss of the extra week, you compare it with the supply disruptions that are not going to repeat, hopefully, this year. And when you normalize for those two things, we still expect to grow on iPhone.
Ben Reitzes: Thanks a lot everybody. Appreciate it, Luca.
Suhasini Chandramouli: Thank you, Ben. And we'll take the last question now.
Operator: Our last question comes from Richard Kramer with Arete Research. Please go ahead.
Richard Kramer: Thank you very much. Tim, first off, if we look over the past two years, Apple sales are about $18 billion higher and R&D is up by about 8% -- $8 billion or over a third higher. Can you give us a sense of some of the main components or drivers behind that increase in innovation spend? Is it Apple Silicon, is it new products like Vision Pro or is it content to support new services? I think that's one of the top questions investors have. Thanks.
Tim Cook: Sure. It's a number of things, Richard. It's the -- some things I can't talk about, its Vision Pro, it's AI and ML, it's the silicon investment that we're making, the transition with the Mac and other silicon. It's sort of all of those things and -- but I think you would find that the R&D expenditure in the aggregate looks very competitive versus others.
Luca Maestri: And I would add, Richard, on this front. Some of the investments that we're making in R&D are also one of the drivers for the gross margin expansion. So I think it's important to think about it that way.
Richard Kramer: That's great. And Luca, you mentioned -- or Tim mentioned college students choosing Mac. Then, you mentioned the record Services revenue. What other metrics do you think you could provide to help investors understand how Apple measures and increases customer lifetime value, especially when we see a lot of users entering the ecosystem with a relatively lower-priced products or even refurbished devices? So you're growing your ecosystem, but how do you think about growing customer lifetime value over the long run?
Luca Maestri: Well, some of the metrics that I mentioned before, obviously, we look at the installed base of active devices. We see, we want to make sure that, the customers that we acquire remain with us and so we have good visibility over that, and we pay a lot of attention to the behavior of the installed base, both by product and by geography. And then, we look at the daily engagement in the ecosystem. So that's why we pay a lot of attention on things like transacting accounts, paid accounts, we want to see if, in fact, we are able to move our customers from a free model to a paid model over time. That's obviously very, very important for us. And so, on this, we keep track of all these things and that's -- and then what we do, because I think it's really important is that over time, we add new services and that, obviously, like, for example, the progress that we've made in payments in recent years, very, very important because we've attracted more and more people that are actually now using additional features on our devices and we are able to monetize that, right. So we take all that into account, we understand what happens when a customer joins us, when they buy a primary device versus a used device, we understand their behavior, in different markets and so on. So we have, I think, pretty good visibility. And I think the progress that we're making in Services, we did $85 billion in the last 12 months. It's -- that's a size of a Fortune 50 and significantly bigger than it was just a couple of years ago.
Richard Kramer: Absolutely. Thanks very much.
Suhasini Chandramouli: Thank you, Richard. A replay of today's call will be available for two weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0106234 followed by the pound sign. These replays will be available by approximately 5 PM Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142 and financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123. Thank you again for joining us today.
Operator: Once again, this does conclude today's conference. We do appreciate your participation. |
BKNG | 3 | 2,023 | 2023-11-02 21:13:09 | Operator: Welcome to Booking Holdings Third Quarter 2023 Conference Call. Booking Holdings would like to remind everyone that this call may contain forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not guarantees of future performance and are not subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed, implied or forecasted in any such forward-looking statements. Expressions of future goals or expectations and similar expressions reflecting something other than historical fact are intended to identify forward-looking statements. For a list of factors that could cause Booking Holdings' actual results to differ materially from those described in the forward-looking statements, please refer to the Safe Harbor statements at the end of Booking Holdings' earnings press release as well as Booking Holdings' most recent filings with the Securities and Exchange Commission. Unless required by law, Booking Holdings undertakes no obligation to undertake publicly any forward-looking statements, whether as a result of new information, future events or otherwise. A copy of Booking Holdings' earnings press release, together with an accompanying financial and statistical supplement, is available in the For Investors section of Booking Holdings' website, www.bookingholdings.com. And now, I'd like to introduce Booking Holdings speakers for this afternoon, Glenn Fogel and David Goulden. Go ahead, gentlemen.
Glenn Fogel: Thank you, and welcome to Booking Holdings' third quarter conference call. I'm joined this afternoon by our CFO, David Goulden. I'm encouraged by the strong results we are reporting today and by the strong leisure travel demand environment that we continue to see. In the third quarter, our traveler customers booked 276 million, or more than a quarter of a billion room nights, which was an increase of 15% year-over-year, and we had gross bookings of $40 billion, which was an increase of 24% year-over-year. Room night growth versus 2019 was 24% in Q3. Both room nights and gross bookings were record quarterly amounts for the company, and both came in ahead of our previous expectations. Third quarter revenue of $7.3 billion grew 21% and adjusted EBITDA of $3.3 billion increased 24%, both versus Q3 last year, and both exceeded our prior expectations. Finally, our non-GAAP earnings per share in the quarter grew 36% year-over-year, and was nearly 60% higher than in the third quarter of 2019. Our earnings per share growth benefited from our improved profit levels, as well as our strong capital return program, which reduced our end-of-quarter share count by 10% versus the third quarter of 2022. Now, turning to October, we estimate that room night growth was about 8% year-over-year and about 20% versus 2019. Excluding Israel, we estimate these growth rates would have been about 9% and 22%, respectively. We saw a significant negative impact on our business in Israel, and there was some impact on travel trends outside of Israel. Nevertheless, we were encouraged to see global room night growth improve towards the end of the month. And David will explain more about October in his remarks. Overall, we continue to see resiliency in global leisure travel demand. And as we take a very early look ahead to 2024, we see strong growth on the books for travel that will take place in the first quarter of next year, though a high percentage of these bookings are cancellable. Given current trends, we expect customers and consumers will continue to prioritize travel over other discretionary spend in 2024. I firmly believe we are well-positioned to continue our work attracting customers and partners to our platform, while making progress on several important initiatives, which will help strengthen our business over the long-term. These initiatives include: one, advancing our connected trip vision. 2, further integrating AI technology into our offerings, 3; continuing to grow alternative accommodations, and four, building more direct relationships with our traveler customers. Starting with the Connected Trip: this is our long-term vision to make booking and experiencing travel easier, more personal, and more enjoyable, while delivering better value to our traveler customers and supplier partners. In the third quarter, we saw an increase in the percentage of transactions which we count as connected trips, meaning two or more travel components within a trip. Though still a small percentage of our total transactions today, it is encouraging to see an increasing number of our travelers booking more elements of their travel with us. Outside of accommodations, one of the most important elements of travel is flights, and we continue to focus on further developing our flight offering on Booking.com. In the third quarter, air tickets booked increased 57% year-over-year, driven by the growth of Booking.com's flight offering. To provide some context on how this has developed over the last few years, the 9 million tickets booked on our platforms during the third quarter were more than 5x the number of air tickets booked through us in Q3 2019. This significant growth of our flight offering at Booking.com over the last 4 years was achieved through our successful partnership with Etraveli. As previously announced, our proposed acquisition of Etraveli was blocked by the European Commission in September, a decision we will appeal. While we strongly disagree with the EC’s decision to block the deal, our commitment to building the flight vertical at Booking.com has not changed. In fact, we have extended our partnership agreement with Etraveli through at least the end of 2028, which means we anticipate continuing to work with them on improving Booking.com's flight offering over the coming years. We believe offering a compelling flight product alongside our accommodation, ground transportation, and attractions offerings, helps to create a better, easier, and more comprehensive travel booking experience for our travelers, and more opportunities for our partners. We will continue to build out our Connected Trip vision, which we believe will ultimately result in increased customer and supplier engagement with our platform. As we discussed last quarter, we have always envisioned AI technology at the center of the Connected Trip, and we have a long history of investing in AI technology and incorporating it in our platforms across our company. I previously spoke about the hard work our teams have been doing to integrate Generative AI into our offerings in innovative ways, including Priceline’s generative AI travel assistant, named Penny, and Booking.com’s AI Trip Planner. It is still very early days, but both teams are gaining valuable insights on booker questions, concerns, and behavior as the tools continue to interact with customers. At Priceline, we are seeing some encouraging signs of lower customer service contact rates, and we are exploring other areas across our business where we believe we can use generative AI tools to increase productivity For example, our brands are running projects using generative AI to enhance the productivity of our software developers with encouraging results so far. And we look forward to using these tools more widely in the future. I remain confident in our company’s ability to benefit from AI developments by improving our products for our customers and operating more efficiently over time. Turning to our supply partners: we strive to be a trusted and valuable partner for all accommodation types on our platform, and we look to add value for our partners by delivering incremental demand and developing products and features to help support their businesses. During the quarter, some of our partners at Booking.com experienced delayed payments due to a planned upgrade to our finance and payment platforms in early July. We have now cleared the backlog of outstanding payment issues related to this system upgrade. We plan to provide compensation to partners who experienced an extended delay, and we recorded this in our Q3 results. We plan to communicate to all partners who were impacted by these payment delays within the next few days We continue to focus on strengthening our alternative accommodations offering at Booking.com by increasing supply and raising awareness among travelers. In the third quarter, alternative accommodation room nights grew at about 24% year-over-year, which was faster than our traditional hotel category. Alternative accommodations represented about 33% of Booking.com's total room nights, which was 3 percentage points higher than in Q3 2022. We are seeing continued momentum in terms of alternative accommodations supply growth both globally and in the U.S., with global listings reaching about 7.2 million by the end of the third quarter, which is about 9% higher than Q3 last year. We aim to build on this progress by continuing to improve the product for our supply partners and travelers, particularly in the U.S. For our travelers, we remain focused on building a better experience that leads to increasing loyalty, frequency, spend, and direct relationships over time. In the third quarter, our mix of customers booking directly on our platforms continued to increase year-over-year. We see a very high level of direct bookings in the mobile app, which is an important platform as it allows us more opportunities to engage directly with travelers. For the first time ever for our company, over 50% of our room nights were booked through our apps in the third quarter, which is about 6 percentage points higher than in Q3 2022. This is a remarkable achievement considering the mix of our mobile app room nights in the third quarter of 2019 was about 18 percentage points lower than it was in the third quarter this year. We will continue our efforts to enhance the app experience to build on the recent success we have seen here. In conclusion, I am encouraged by the strong third quarter results and the continued resilience of leisure travel demand. Our teams continue to execute well against our key strategic priorities, which helps position our business well for the long-term. We continue our work to deliver a better offering and experience for our supply partners and our travelers. We are confident in the long-term growth of travel and in the opportunities ahead for our company. I will now turn the call over to our CFO, David Goulden.
David Goulden: Thank you, Glenn and good afternoon. I'll review our results for the third quarter as well as our thoughts for Q4 and the full year. All growth rates for 2023 are on a year-over-year basis unless otherwise indicated. We will be making some references to the comparable periods in 2019 where we think these are helpful. Information regarding reconciliation of non-GAAP results to GAAP results can be found in our earnings release. We will post our prepared remarks to the Booking Holdings investor relations website after the conclusion of the earnings call. Now onto our third quarter results. We are pleased to report 15% room night growth in Q3, which was a few percentage points better than our expectations. Looking at our year-on-year room night growth by region in the third quarter, Asia was up about 35%, Rest of World was up mid-teens, Europe was up low double digits and the U.S. was up low single digits. Compared to 2019, our Q3 global room night growth was 24%. The average booking window at Booking.com expanded in Q3 versus the same period in both 2022 and 2019, and was a bit more expanded versus the prior year periods than it was in Q2. In Q3, our mobile apps represented over half of our total room nights for the first time ever. The Q3 mobile app mix of about 51% was about six percentage points higher than the third quarter of 2022. We continue to see an increasing mix of total room nights coming to us through the direct channel. The direct channel increased as a percentage of our room nights in the third quarter relative to the third quarter of 2022. The Q3 international mix of our total room nights was over 50%, up from about 45% in the third quarter of 2022. The Q3 international mix was in line with 2019 levels, similar to the second quarter. Our cancellation rates in the third quarter were slightly higher than Q3 2022, but were slightly below Q3 2019. Cancellation rates were the same as in Q2. For our alternative accommodations at Booking.com, our Q3 room night growth was about 24% year-over-year and the global mix of alternative accommodation room nights was about 33%, which was a few points higher than Q3 2022. Q3 gross bookings increased 24% year-over-year, or 21% on a constant currency basis. The 24% increase in gross bookings was 9 percentage points higher than the 15% room night increase due to about 4% higher accommodation constant currency ADRs, plus about 3 percentage points of positive impact from FX movements, and also due to about 2 percentage points from flight bookings. Our year-over-year ADR growth was negatively impacted by regional mix due to a higher mix of room nights from Asia and a lower mix of room nights from the U.S. Excluding regional mix, constant currency ADRs were up about 7 percentage points year-on-year. Despite the higher ADRs in the third quarter, we have not seen a change in the mix of hotel star-rating levels being booked or changes in length of stay that could indicate that consumers are trading down. We continue to watch these dynamics closely. Airline tickets booked in the third quarter were up about 57% year-on-year driven by the continued expansion of Booking.com's flight offering. Revenue for the third quarter exceeded our expectations, increasing 21% year-over-year, or about 18% on a constant currency basis. Although we had a stronger-than-expected Q3 from a room night and gross bookings perspective, the outperformance versus our expectations was mostly driven by mainly bookings that are for travel in future quarters. As a result, we did not see all of the revenue benefit in Q3 from these incremental bookings. Revenue as a percentage of gross bookings in Q3 was 18.4%, which was lower-than-expected due to this timing effect. Our underlying accommodation take rates continue to be in line with 2019 levels. Marketing expense, which is a highly variable expense line, increased 13% year-over-year. Marketing expense as a percentage of gross bookings was about 50 basis points lower than Q3 2022 due to higher ROIs in our paid channels and a higher mix of direct business. Performance marketing ROIs increased year-over-year helped by our ongoing efforts to improve the efficiency of our marketing spend. Marketing and merchandising combined as a percentage of gross bookings in Q3 was about 30 basis points lower than last year, which was a little better than our expectations, driven by the improved performance marketing ROIs. Q3 sales and other expenses as a percentage of gross bookings were up about 10 basis points compared with last year, a bit better than our expectations. About 51% of Booking.com's gross bookings were processed through our payments platform in Q3, up from about 40% in Q3 2022. For the total company, 56% of gross bookings were merchant, up from about 45% in Q3 2022. Our more fixed expenses in aggregate were up 24% year-over-year, which was below our expectation, due to lower personnel and personnel related expenses. We continue to manage our more fixed expenses very carefully. On a GAAP basis, our more fixed expenses were up 33% year-over-year and included a $90 million accrual in G&A expense for the termination fee related to the acquisition agreement for Etraveli, this accrual was excluded from our non-GAAP results Adjusted EBITDA was $3.3 billion in the third quarter, which was up 24% year-over-year, and would have been up 22% on a constant currency basis. This was also ahead of our expectations. Non-GAAP net income of $2.6 billion in the third quarter resulted in non-GAAP EPS of $72.32 per share, which was up 36% year-over-year. Our average share count in the third quarter was 9% below Q3 2022 and 16% below Q3 2019. On a GAAP basis, we had net income of $2.5 billion in the quarter Now on to our cash and liquidity position. Our Q3 ending cash and investments balance of $14.3 billion was down versus our Q2 ending balance of $15.7 billion due to the $2.6 billion in share repurchases we completed in the quarter, partially offset by the $1.3 billion of free cash flow generated in the third quarter. We repurchased $7.7 billion of our shares through the first three quarters, which represents 8% of our year-end 2022 share count. The repurchases so far this year take our combined authorization down to $16 billion from the total of $24 billion we discussed earlier in the year. Our buyback program takes our share price into account and at current share price levels we expect to spend more on buybacks in Q4 than we did in Q3. We remain comfortable with our ability to complete the full $24 billion of share repurchases within 4 years from when we started the program at the beginning of this year, assuming no major downturn in the travel environment. Now onto our thoughts for the fourth quarter of 2023. In October, we estimate year-over-year room night growth was about 8%, down from 15% in Q3 due in part to a tougher year-on-year compare, as well as the war in the Middle East. When comparing versus 2019, October room night growth was about 20%. Excluding Israel, October room nights grew about 9% versus 2022 and about 22% versus 2019. The 22% growth versus October 2019 excluding Israel is a little lower than the 24% growth we saw in Q3 versus 2019. Looking across our major regions, in October we saw Asia year-on-year growth of room nights without 15%, Europe up about 10%, and the U.S. and Rest of World were down slightly. The impact of the Israel-Hamas war is seen most in the Rest of World growth numbers. Israel on a booker plus inbound travel basis is about 1% of our global room nights. The Middle East, including Turkey and Egypt, on a booker basis is about 4% of our global room nights. Globally, we saw a slowdown starting the second week of October due to cancellations and a drop in new bookings after the start of the war in the Middle East. The cancellations we saw that started in the second week of October were concentrated in Israel, but we also saw some impact on travel trends outside of the country as people absorbed the news. We were pleased to see room night growth recover towards the end of the month. Our comments for the fourth quarter make the assumption that room night growth will be up about 9% year-over-year. When comparing versus 2019, this means we expect Q4 room night growth to be about 20%. This outlook assumes that there is no further expansion of the war in the Middle East. We expect Q4 gross bookings to grow about 5% -- points of about 5 points faster than room nights on a year-on-year basis due to a couple points from higher accommodation constant currency ADRs, including some pressure from changes in regional mix, as well as a couple of points from continued flight bookings growth. We expect Q4 revenue as a percentage of gross bookings to be about 15%, which would be higher than Q4 last year due to benefits from timing. We expect Q4 marketing expenses as a percentage of bookings -- gross bookings to be slightly lower than last year. We expect marketing and merchandising combined as a percentage of gross bookings in Q4 to be slightly higher than last year as we continue to look for opportunities to lean in. We expect Q4 sales and other expenses as a percentage of gross bookings to be about in line with last year as the higher merchant gross bookings mix is offset by efficiencies in payments costs. We expect our more fixed expenses in Q4 to grow a couple of points faster year-over-year than it did in the third quarter. Taking all this into account, we’d expect Q4 adjusted EBITDA to be just over $1.4 billion. Our year-to-date results plus our fourth quarter commentary means that for the full year we expect room nights to grow in the mid-to high-teens year-over-year. We currently expect full year gross bookings growth of over 20% year-on-year. We currently expect revenue as a percentage of gross bookings to increase year-on-year by about 10 basis points, down from our previous expectation for a 20 basis point increase due to higher bookings growth and a longer booking window, which reduce the expected benefit from timing. We continue to expect full year marketing and merchandising as a percentage of gross bookings to be slightly below 2022, and for our more fixed expenses to grow around 25% year-over-year. We manage our more fixed costs very carefully and continue to expect our more fixed expenses next year to grow at an appreciably lower rate than this year. We continue to expect that our adjusted EBITDA margins will expand by a couple of percentage points versus 2022. In closing, we are pleased with our Q3 results, the trends we are seeing into Q4 and with the bookings we have already received for early 2024. We are now [technical difficulty].
Operator: Absolutely. [Operator Instructions] Your first question comes from the line of Mark Mahaney with Evercore. Your line is open.
Mark Mahaney: Thanks. I will ask two questions, please. Glenn, I think just at the very beginning you mentioned something about March quarter, a visibility into the March quarter. Is there anything in particular that you were trying to hint at or point to the areas of that, because the bookings went as a little longer than you get. Do you have more visibility into the March quarter than you typically do. And then secondly, the David the room night growth, upside this quarter that came in a little bit faster than your guidance. What would you attribute that to was at a particular region that contributed to that or was that the alternative accommodations that came in a little bit stronger than you thought. Just the sources of room night growth upside in the quarter. Thank you very much.
Glenn Fogel: Hi, Mark. I was not saying that I see more than I normally do. I'm just saying I was very pleased to see this resiliency in global leisure travel demand and saying that we're looking at 2024, we're seeing strong growth on the books for travel. And that's going to happen in the first quarter. So it's just reinforcing my belief that travel is healthy. And we're looking forward to continue healthy travel.
David Goulden: Yes, Mark, to answer your question relates a little bit to what Glenn just said. Our upside in the quarter, our room night growth was driven by travel -- expect by stronger travel demand across the peak season and along the booking window. If you remember, we said that coming into Q3, we have exceeded -- we see the booking lengthening of the booking window in Q1, Q2. And therefore we expected fewer last minute bookings in Q3. Well, the last minute bookings in Q3 were a little lower than we would have expected any year when we didn't have that long booking window. But what we got were more bookings for longer periods of time out there. So the booking window actually expanded in Q3. And that created the situation that Glenn talked about where we now looking into the first quarter of next year, because of the strong demand we saw for bookings, a lot of which are outside of the quarter plus the window means that our Q1 on the books situation is much stronger than it has been prior to the current situation.
Mark Mahaney: Okay. Thank you, Glenn. Thank you, David.
David Goulden: I would also just comment that the over performance we saw versus our expectation was across all different regions, I wouldn't call one region out. We actually did that and we expected in all regions when compared to our guidance, looking at the actual for the quarter for room night growth.
Mark Mahaney: Okay. Thank you, David.
Operator: Your next question comes from the line of Justin Post with Bank of America. Your line is open.
Justin Post: Great. Thanks for taking my question. Maybe one for Glenn and one for David. Glenn, you've been working on Connected Trip for a long time. Obviously, a lot of progress with air and other areas. If this vision really works out, what does it mean for Bookings financials? And do you think you're accelerating the pace of progress there? And then for David, we see the U.S., which reopened first at kind of low single-digit growth. How are you thinking about Europe comps next year? And can you just remind us of your kind of relative exposure by geography? Thank you.
Glenn Fogel: So, Justin, hello. And I have been talking about the Connected Trip for a while, because I do believe that really is a differentiator in the long run, and why someone would come to us and continue to come to us rather than another way to do their travel. So in the long run, of course, if somebody's coming direct, because they really enjoy the way we do it versus an alternative that of course, the lower the marketing cost, you wouldn't have to reacquire that, that customer. It's interesting because the small send small data, but we do see people who book more than one element with us currently, we do see some benefits the person coming back more frequently, and a higher direct. So I like that. And I think we can do a lot more with them. Now, one of the things that we're not the only person doing this, of course, in this competition, because I think a lot of people see this. And now, on top of this, the whole benefits of generative AI, along with all the AI work we've been doing for a long time. And we see the potential to create a much better experience in discovery, planning and executing your travel in a way that if we do this, right, we may be able to greatly accelerate the growth of the company, because it really is transformationally different versus just incrementally different. And that's what we're striving for. Now, that's not going to happen tomorrow, you know that I know that it's not going to happen next week, next quarter. Not going to happen next year. It's going to take time to get all this built out. But what I'm really pleased about is seeing historically, we said what we're going to do, and we've been doing it, and we're showing markers along the way, hitting milestones, hitting a slight growth rate still, 57% of air ticket booking I talked about talking about, that's 5x greater than 2019. We said we're going to do it, and we did it, and we're going forward. In so many of these other areas where I believe that people are frustrated in the way they travel now. We can do it better. We'll achieve great things, both for the traveler, of course. We're going to achieve great opportunities for our partners to give them more opportunities to get more business working with us. And then of course, together those things will end up with a great derivative, which is more value for the shareholders. That's what we're trying to do. And I'm really pleased to where we are.
David Goulden: Yes, thank you, Glenn. And then, Justin, relative to your question. Yes, we were pleased to see room night growth year-over-year in the U.S market. Don't forget, in the U.S., our room nights are over 30% higher than they were in 2019. So we have made significant strides in terms of advancing our overall position in the U.S., if you compare that with market growth rates are probably more likely recovered versus 2019, not up by 30%. When we think about next year, I don't want to get into too much detail. But I will give you a couple of things to think about. I'd say that when you look across all the regions, if you look at where travel as a percentage of GDP is going to wind up in 2023 compared to where it was in 2019, it still has some recovery, before it fully gets back to the percentage of GDP. It used to be in 2019. So I think that provides upside. I'd also say that, as Glenn said in his comments, and as we see, we do see consumers continue to crack and travel of other discretionary expense items, we don't see any reason why that should change based on current trends. And then also just relative to our own view of the business, we're still committed to our milestones we gave you and said we will continue to grow faster post COVID than we were before on the top line and bottom line and consequently basis, that was 8% bookings on revenue, 8% on bookings, 8% on revenue, 15% earnings per share or constant currency growth rates in 2019. And whilst we're not talking about even specific, around 2024, we are still sticking to those overall guidelines and outlooks.
Justin Post: Thank you, Glenn. Thank you, David. Very helpful.
Operator: Your next question comes from the line of Kevin Kopelman with TD Cowen. Your line is open.
Kevin Kopelman: Thanks a lot. Could you comment on the outsized growth in alternative accommodations that you saw in Q3? I think in Q2, the growth was closer to the overall growth. So what were the drivers there any regions and then I have a follow-up. Thanks.
Glenn Fogel: So, Kevin, why don’t I start and David can add on anything I fail to add in. Obviously, very, very pleased with that number. That's a really good growth rate. And when we compare it to some other people in the space, I'm very impressed by what we've been able to accomplish. And I will shout out to the whole team that works on alternative accommodations. But there's some again. I've been talking about for some time about, we need to improve the product, we need to make people aware of it. And by doing that, we'll get more business. And that's what we've been doing. Now I can do all the things I've talked about them in the past, and we continue to do things to make it a better product. And there's still a lot of things that need to be done to make it even better. And that's what we're going to keep on doing. There's no magic bullet. No, no silver bullet and tell, here's how it came about. It comes through a lot of hard work and a lot of different ways of just grinding away, cranking out making it better talking with the suppliers who have these properties, making sure we're marketing appropriately when people want that property, they can find it and they see it. All those things together will enable us to achieve what I think was a very, very good print on the growth rate there. But I'll tell you, we're not there yet. And I mentioned look, I want to increase the supply a lot more look, it's great. 9% increase. So I mentioned in my prepared remarks and the increase up to 7.2 billion listings. That's great. That's good. But I know there are a lot of areas we need to add even more, particularly in the United States, because that's the place that I want to use our product. Because if I look for anything, and I don't see it. Well, to me, that's upside down. We're doing great right now. And I still see so much opportunity ahead because for example, we don't have enough properties in certain areas and other product features that we need to improve upon. All together. I look at this great opportunity. We're going to well, and we will do it even better in the future. I hope and David, anything specific to add to that? Okay.
David Goulden: Nope, nope. Thank you. That was great.
Operator: The next question comes from the line of Brian Nowak with Morgan Stanley. Your line is open.
Brian Nowak: Thanks for taking my questions. The first one, let me just ask about the U.S. a little bit. You've made some really good progress in the U.S. post COVID, but it has decelerated quite a bit, and now it even down in the most recent months. So Glenn, I guess the question is, as you look into 2024, what are the keys to sort of reaccelerating that U.S. growth from here to sort of contribute to your goal of growing faster post-COVID than you were pre-COVID. So what drives U.S. growth from here? And then secondly, any quantifiable metrics or factors you can share with us on progress on Genius and the Loyalty program over the course of the summer into the fall?
Glenn Fogel: Yes, sure. Thank you, Brian. So, the U.S is not that much different than any other geography in terms of the elements that help create growth are providing a better product. Enabling people to be able to find the properties they want, at the right price, and the easiest thing to do and if anything goes wrong, given great customer service. That's the playbook. And yes, I -- some of the numbers look a little funky. And of course, COVID is really create all sorts of things, different geographies come out faster than others. So you're comparing a year-over-year, and maybe it looks like a deceleration and then there's domestic and international events, I think a good way to look those like compare back to 2019. And the fact is, we've achieved, we've accomplished some great things in terms of increasing our share in the U.S. And we keep on doing what we have been doing. And that will continue to increase that share. And I just mentioned in the previous question about our alternative accommodations, which is important part of growing out of the U.S. And another thing is also you mentioned Genius. So I'll switch over to there. -- and that is continue to develop the Genius program in a way that continues to provide not only great value to the traveler, which of course, is an obvious one, but it's providing opportunity for our partners to be able to get incremental demand when they need it, where they need and how they need it. Working that together is a way for us to provide a better opportunity for both sides of this marketplace to achieve greater value for both sides. And I think that we have that great thing, layer on all those other things we talk about with the whole idea of the Connected Trip. Bring in more of the Generative AI stuff. And altogether, I think this is a good playbook to try and continue to grow our share in the U.S. And again, we've been doing it for some time now. So I'm really pleased with where we stand.
Operator: Your next question comes from the line of Lloyd Walmsley with UBS. Your line is open.
Lloyd Walmsley: Thanks. I had a couple, if I can. First, it sounds like you're still talking about holding this lean in posture on marketing with the leverage on I think marketing plus merchandising in 4Q. As growth slows, should we expect to see you all moderate that posture and get more leverage? And I guess looking at markets, like the U.S growing low single digits? Are you still holding that that posture there? Or are you kind of bifurcating the strategy differently as different markets are perhaps more recovered. Anything you could share there would be great. And then the second one would just be sort of related. But as more than half of room nights are now booked through the mobile app, should that also be an increasing driver of marketing leverage? Or do you think just escalating pricing in performance channels offsets that, so it's kind of balance that? How should we think about that? Thanks.
Glenn Fogel: So Lloyd, let me talk a little bit about this and all we do and add other facts that he wants to add in here. And I want to be very careful here. Obviously, the one thing I don't want to do is give away our [indiscernible] ideas and all the things we're going to play with our competitors listening in on this. So you'll understand it, while it'll be a little bit general in this. But one of the things I continue to try and talked to the team about is we need to be nimble. We need to be agile, and we need to be able to be smart and move into markets, where we see opportunities and pull back in other places where we think we're not going to get the right ROIs. Whether that be a geography, whether it be a channel, would that be developing a entire product, whatever it is, I don't look at any of these in a different way. I look at all together holistically. What we're trying to do to achieve growth at the right type of profitability levels. And we're going to continue to do that. Right now, as David said, we have a lean-in position because we see opportunity here. Time can -- these things can change depending on the time. And certainly, the idea is to say I'm going to do this for a long-term period is it's a nice thing to say, but who knows what the world is going to be like, and as we all see, unfortunately, the world can change very, very rapidly. So we'll continue to do this, and this is our profile right now the way David explained those numbers for what we are going to disclose right now. But you should always recognize that we have an overall view of how to do things, but we will be willing to change, depending on circumstances. Regarding the mobile app, I talked about, David, why don't you just take in terms of how that will apply to our numbers going forward.
David Goulden: Yes, Lloyd, I'd add a couple of comments. So first of all, just to kind of pick up on what Glenn lets off on the leading in. We are leading into a recovery marketplace. I said, there's still on one of my other answers, there's so some recovery of travel as a percentage of GDP post-COVID left tap into 2024. We haven't seen it fully recover yet. So there are still opportunities to do that. You'll notice though, that we are in lower spending more on marketing, merchandising, in 2023, than we did in 2019. We are getting leverage relative to what we spent in 2022. As a couple things happen. One as our direct mix increases, and of course mobile is highly correlated to direct mix. The majority, the vast majority of all our mobile -- of all of that mobile app bookings are in fact direct bookings, so that helps as well. So and then you did make a reference, I would just say to Q4, and I wouldn't read too much into Q4. Here's how I would explain why we expect to get some deleverage in marketing in Q4, relative to the other quarter where we've shown leverage. It's really quite simple. We're having a strong year, and we decided to invest in some additional programs in Q4 that will help us finish the year well. And to build on our momentum going into 2024. So that was us. It's very conscious. Again, we are not going to go into the playbook in terms of what they are or where they are, but we recognize that we're doing well this year financially, delivering great EBITDA and results. So we are leaning a little bit in Q4 to position us well, the first year and going to 2024 strong. Again, that's what we are doing. Not driven by any [indiscernible] in the marketplace is our conscious decision. Of course, we'll still create leverage on marketing merchandising for the full year.
Lloyd Walmsley: Thank you.
Operator: Your next question comes from the line of Doug Anmuth with JPMorgan. Your line is open.
Doug Anmuth: Thanks for taking the questions. Glenn, you talked about expecting a strong 2024. Just curious if you have any more color on how you're thinking about the outlook for ADRs next year. I think you said it was a 4% increase in 3Q. Any more thoughts there would be helpful. Thank you.
Glenn Fogel: I will let David talk about what you wants to [indiscernible]. I don't think we talked about 2024. I think we talked first quarter. I will let David, clarify whatever he wants to clarify.
David Goulden: Yes, Doug, I mean, the 2024 conversation, we're going to have that when we get into February next year, I really don't want to have -- how that now. We've told you a little bit about the strength of the on the books in the first quarter given the strength of bookings in the booking window. And we talked a little bit about our framework for growth post-COVID hasn't changed. So I want to keep anything beyond that until we get to see a little bit more. We are talking to you next time, of course, we'll give you much more insight at that point in time. But it's too early to talk about the specifics of line items in the income statement in 2024.
Doug Anmuth: Okay. Thank you, David.
Operator: Your next question comes from the line of Lee Horowitz with Deutsche Bank. Your line is open.
Lee Horowitz: Great, thanks. Maybe following up on some of the comments around sort of the vacation rental industry? Can we talk a bit more about sort of the U.S vacation rental business. Glenn, you talked about growing supply and building product functionality in order to continue to grow that. [Technical difficulty] getting this incremental products rolled out and getting supply to the place where you are competitive relative to some others in the market. So how do we think of sort of the timeline and maybe even the investment dollars needed to get that business to the place where you want to get it to?
Glenn Fogel: Hi, Lee. Well, you won't be surprised, I'm not actually going to give out the details exactly how and what level and what amount of money we're going to put to work out and what the methods are. I will say that the best way to look at this and look at what we've done historically. And where the numbers have been going and how the growth has been going. That's the best indication for you in terms of thinking forward, how -- what we're going to end up in result, and the results going to be. I will say that it's fairly obvious to be looked at our site and tries to find homes in certain properties and in certain parts of the U.S., you can see perhaps you don't have enough of them in those areas. So it would not be illogical to think that's where we'll start going to. As we talked in the past, we think that there is a lower hanging fruit for us in properties that are controlled or managed by larger groups of properties, makes it easier for us to get that. So I'm not giving anything away here. When I say, well, we'll let us go there first, and let's be sure we're doing that. And for example, you may have noticed that recently started doing the request on demand type of thing, where a person doesn't automatically be able to book instantly. And that's a product improvement because some people in, let's say, higher quality or higher value properties. Perhaps the owner or the manager did not want to have an instant booking and want to have a chance to do it on request basis. So that's an improvement thing. So we'll continue to roll out all these different things that we think will make our property -- our product as good as anybody else's, it applies the money to the appropriate marketing to make sure people are aware of it, and that will enable us to continue the growth that we've seen so far, I hope.
Lee Horowitz: Helpful. Thanks. And then maybe one follow-up on perhaps another air of the low hanging fruit. Can you comment at all on anything you're seeing in terms of APAC outbound travel pattern, travel patterns, and how much room there may be in this travel quarter sort of cover back to pre-COVID levels. Should we be thinking -- thinking of this travel pattern as a source of premium growth in the medium term?
Glenn Fogel: I'm not sure the term premium growth, I'll just say, well, we talked a little bit about, look, we talked some time about different geographies coming back faster in other areas. Asia was certainly the one who was last. And of course, it looks good when you're starting to see the, nice growth rate those regions as the other ones start getting more normalized. It's a nice thing to say. It's certainly outbound for example, outbound China still significantly behind, when you look at any of the industry reports, and think how much lift do they have going out bond, et cetera. Although that's a small part of our business, not going to make a huge difference even when it starts to come back. So overall, look, we love to see that Asia is going to get back to where all the other parts of the world are -- and I really do and I understand the term premium that you mentioned, maybe explain that I could give a better explanation.
Lee Horowitz: I guess just faster growth relative to the core.
Glenn Fogel: Oh, faster. Okay. I thought maybe you're talking about more expensive travel or something?
Lee Horowitz: No, no, no, no.
Glenn Fogel: Okay, got it. Sorry. Thank you.
Lee Horowitz: Thank you.
Operator: Your next question comes from the line of Eric Sheridan with Goldman Sachs. Your line is open.
Eric Sheridan: Thank you so much for taking the question. Maybe come back to the topic of Air, where I understood on the comments about appealing Travel decision from the European Commission. If we go beyond that appeal and think about how you plan on building scale in a the supply side. I would love to know how are you thinking about some of the investments that are key to build that as opposed to possibly going down the acquisition route in Air. And where you've already deployed Air, especially markets like North America, can you remind us of what Air has done in terms of growing overall checkout baskets and return on trip side? Thank you so much
Glenn Fogel: I will let David handle that last part. In terms of the appeal, the appeal will take some time. This type of court action is not going to happen overnight. I can't tell you exactly how long it will take, but it's not going to happen anytime soon. So I would not put anything in terms of what that will mean for [indiscernible] in the relative future. However, we do like the fact that we do have this new agreement with Etraveli, going out to 2028. That's really great. Also, as you know, it's not just booked many travel line. That's one area of our air business. We have Priceline. Of course, that's that company started Priceline or as an Air product. That was the first product. We have lots of good relationships with air travel there. I obviously am very disappointed by the European Commission's blocking, what I believe would have been an extremely beneficial transaction for the travelers, good for them, were they good for the partners, good for them. And together, this will create value, which, of course, would have come back to all the people involved in the company, whether they be for higher value for our shareholders, a higher value for our employees working on , et cetera. Very disappointing decision, we moved on. We will continue to develop this product. And by the way, it's been growing very nicely even though we didn't actually have possession of Etraveli, and yet, we still were able to reduce 57% increase in air tickets. David, I'll let you if you want to talk anything about basket size and things around if you do.
David Goulden: I can talk about where we are with some of the customer oriented dynamics around there, Eric, I think will be helpful. So we said this is about Booking.com, which is of course where Air is still relatively new and growing very rapidly. We said previously that over 20% of Air customers are brand new to us. We've never seen them before, that continues to be the case, as the business grows, which is very, very healthy. We also see that those new customers who are booking Air [Indiscernible] who've never booked anything prior to that with us, are doing a healthy attachment rate from into accommodation because these are brand-new customers. So you wouldn't expect that attachment ratio to be all that high, but it's quite healthy. Not quite as high as examples of what we're doing with Priceline where we've been doing that for many years. But it's certainly an encouraging attachment rate. What I would tell you, though, on the other side, of course, by definition, most of the air that we are selling is to existing customers, which you would expect. And there is a very good attach rate on those air tickets to accommodation because these customers know us from an a combination background in the first place. What I would also say is that we still have good data that says that customers who buy multiple things from us, whether they be the new customers or the existing customers buying air and the combination. We have good data that says that, that will drive better frequency, loyalty, future basket size, getting them kind of up that loyalty and frequency curve that we talked about to the higher value customers. So the dynamics around air are still healthy and they haven't changed. We are encouraged about them. And as you can see, they're helping us in multiple different ways.
Eric Sheridan: Thank you so much.
Operator: Your next question comes from the line of Ron Josey with Citi. Your line is open.
Ron Josey: Great. Thanks for taking the question. Glenn, I wanted to ask a little bit more about AI. And just you talked about a little bit in your script as to consumer adoption of the booking tools, a trip planner. Wondering if this adoption is trending as you would have expected, I think we're still relatively early days. And you also mentioned the common around lower customer care costs because of AI. So any insights there would be helpful. And David, we don't hear too much about just the milestones coming out of COVID. I know they're there, we've talked about it, but just remind us a little bit more about the underlying assumptions of maybe the bookings and revenue growth. Thank you.
Glenn Fogel: Okay. AI. We only have so much time because I could go on for a long time on this, so I'll try and concise my thoughts on this. So as in all new technologies, the hype is always great, very beginning or [indiscernible] thing is going to be the greatest thing some slice bread, but then it takes longer than it takes to toast a slice to actually haven't needed. That's the thing about what we are seeing is that it's really exciting. I absolutely believe it's going to be transformative, but it's going to take a long time. And when I said in my prepared remarks about this is very early, it is very, very early. Now some of the stuff that we are seeing and that we have done enough so we see some data to see there are going to be some good benefits. So the example of the customer service example is, for example, you have a customer service agent, who actually is able to use a copilot, let's call it, with AI agent that helps enable that customers or agent answer the question or taking action much faster, than they would have been able to do previously. Particularly in terms of a number of years, the person has been a CS agent and maybe a CS agent has been there forever. They're instant how do everything perfectly is great and all that. But if you're a relatively new CS agent, this is going to be extremely healthy for that person. As you know, the turnover of CS agents is very great because there's a good efficiency productivity game there. Then everybody, I'm sure, has read lots about how coding can be greatly increased in terms of speed and efficiency, using some of these copilots in terms of coating. So there's another area, again, early stages, just seeing it, but we do believe that is going to do something like that. And then you go on into the things that we have for the customer. And the things like Priceline and their Penny product. We're a customer when they're about to buy something, there's a chatbot where they can put in a question because they get not sure they want to buy or not. And instead of having to go all the way back up the funnel to find the information they say, do they want to buy or not, using that chatbot, they can be instantly given an answer that will help convert that person into a buy much faster and actually not losing as much. And questions be everything one of the things that I've noticed is coming a lot is, can I bring my dog to the hotel. And actually, it can become quite a conversational type thing where, yes, you can't bring your dog and so, but my dog is a very big dog. How big is your dog and if you go back [indiscernible] that's using our information that we have -- that's all our current end using an LLM in combination [indiscernible] this type of chat relationship. That's really good. And then you can go to the other things, we're in the Booking.com AI product, which is really trying to create an itinerary, the discovery from the very top and going down. And then when it offers hotels, it integrates with our hotel condos [ph], you can book right data also very good. Now both those things relatively small usage of any of these things compared to the overall size of the amount of inquiries we get a number of bookings, we do in terms of the overall size of the company. But it's very encouraging that this stuff really does matter, and it's going to make a difference. Now the question would be how long until we get sort of that hit that inflection point, where people start saying, "oh, this is so much better. I don't know that yet. But we're going to keep on experimenting on all these things, increasing the efficiencies. So we can do things faster with a lower cost and at the same time, increasing things for the travelers to make sure they want to come and use our products and our services versus anybody else's. That's the plan right now, and I like it. And David, I'm not sure what the second question was.
David Goulden: Yes, I will talk a little bit about a framework for post-COVID recovery because I think that's important. So we've committed that when the dust settles and the market goes back to normal growth rates, whenever that is, we'll be a larger and faster-growing business. Delivering more EPS and faster-growing EPS than we did before. So larger and faster growing on the top line and the bottom line. So why do we think that is the case? Well, we will have made a ton of progress. So the comparison point is 2019. If 2024 is the year that we get to normalized growth rates, it will be 5 years later. If it's 2025, it will be 6 years later. But the business is so fundamentally different in, the business we had in 2019. I think we need just to step back and remind you of that. So, what we've done since 2019 and mainly around Booking.com, but other parts of the business have also contributed as well. Back then, we were mainly, an accommodation mainly hotel, mainly agency business. So since then, we have added a significant alternative accommodation business, which is now very sizable and now we're trying to be for growing quickly. We have -- back then, we did very little in payments. Now over half of our business is transacted through Payment. So we built out our payments platform, which is enabling better service for customers and partners. We have built out air taxi and car capability, we didn't have back in. Back in 2019, we were great at performance marketing. We didn't do much around merchandising. We've now developed a big merchandising arm and capability, but also we've refined our performance marketing tools to the level where we really think we can lean into recurring marketplaces and gain share more aggressively than we did back then. And then, of course, we've added our Genius program and enhanced it significantly. So we believe that we have made huge strides since 2019, which is our comparison point when we grew at 8% on the top line, constant currency bookings and revenue. And of course, this year, we are going to be a lot bigger than we were in 2019. But you add all those capabilities together, and we believe we have a fundamentally different and more competitive business that's providing more value to our customers and partners and is much, much for towards the vision of the Connected Trip than we had back then. And that's why we are confident that we can grow faster and have a bigger business that grows faster on the top line and the bottom line than we had in 2019. That is the framework.
Ron Josey: Super helpful. Thank you both.
Operator: Your next question comes from the line of John Colantuoni with Jefferies. Your line is open.
John Colantuoni: Thanks. Thanks for taking my questions. A couple for me. So as more bookings come through the app, I'm curious how repeat rates have trended among more recent cohorts on the app or whether you're seeing any diminishing returns and stickiness as you move beyond early adopters into the longer tail? And second, are you seeing any patterns in behavior like demand strength in higher priced hotels that's giving you confidence in consumers' continued continuation of prioritizing travel spend over other forms of discretionary spend next year? Thanks.
Glenn Fogel: Let me just take that last one, and then I'll let Dave. I'm not sure what we disclose and what we don't disclose about your first question. Obviously, it's an important one. So we say -- and we've said this several times, several quarters [indiscernible], the same question keeps coming up in different forms of -- do we see any softening? Do we see anything decline? Do we see a decrease in star rating? Do you see a decrease in length of stay and things like that. We say no. And that's what we'll be -- no and no. In terms of why we believe that discretionary spending will continue to travel versus other things, that's obviously a lot of the survey. So I can maybe a whole bunch of things that are independent, third-party actual people are saying they're going to do etcetera. Here's something more important though. And I really try and stress this is how important the long is in terms of how we think about the business and increasing value. So if we agree that over time, GDP for the world will continue to increase and per capita GDP will continue to increase. It's fairly logical that as people get wealthier, they're going to spend more of their money on things that are services or experiences than they are things. Once you going rich enough to have, let's say an apartment, you have one apartment in generally or you have one sofa. You're not going to buy a sofa each year. What you're going to do is you need to get more money is you will travel either more frequently or in a higher level of style travel or you'll do both. And we see that over and over again, when you go look at countries and you see what the amount of the -- ease to look at his international travel, which is a higher I think you know that's going to be a higher level for some people. And you see, as the GDP for a person there goes up. You see the amount of going outbound travel increases, too. So that's why I believe that this is in the long run. We have a great tailwind. The trial will continue to be one of the things that people always are going to want or there's a lot more of it. And thus, provide a great service, our job is get a safer share, a bigger piece of that pie that is going to continue to grow. And you grow a little bit faster than global GDP. That's why I believe we have a great future here. And Steve, I don't know what we talked or do not disclose regarding his question regarding apps.
David Goulden: I'll be really quick because we got over time. But there are multiple ways you can book on our property on our platforms directly. You can book directly through the app, book directly on the mobile web and book directly on a desktop or laptop. The app is by far the stickiest those in terms of repeat rates return rates. And of course, the app is where we're kind of designing to optimize the experience around the Connected Trip, because not only do we want you to be able to book all elements through the app, but also goes with you on the trip, that doesn't usually happen when you book and print something on one of the other platforms. So it's very important for us. It's a big effort. It's where the Connected Trip is moving towards. And then what I would just leave you with as a final sort of course, not all customers are created equally and the higher value customers who do more business, where spend more of their total spend with are higher usage of both app and direct by an appreciable amount, compared to the average customer. So the app is very much at the center of that thinking.
John Colantuoni: Okay. Thanks so much.
Operator: And with that, I will hand the call back over to Glenn Fogel for closing remarks.
Glenn Fogel: Thank you. I want to thank our partners, our customers, our dedicated employees and our shareholders. We appreciate your support as we continue to build on the long-term vision for our company. Thank you, and good night.
Operator: This does conclude the conference call. You may now disconnect. |
MRNA | 3 | 2,023 | 2023-11-02 12:17:08 | Operator: Good morning. My name is Kevin. And welcome to Moderna's Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. Following the formal remarks, we'll open the call up for your questions. [Operator Instructions] Please be advised, today's call is being recorded. At this time, I'd like to turn the call over to Lavina Talukdar, Head of Investor Relations at Moderna. Please proceed.
Lavina Talukdar: Thank you, Kevin. Good morning, everyone, and thank you for joining us on today's call to discuss Moderna's third quarter 2023 financial results and business updates. You can access the press release issued this morning as well as the slides that we'll be reviewing by going to the Investors section of our website. On today's call are Stéphane Bancel, our Chief Executive Officer; Stephen Hoge, our President; Arpa Garay, our Chief Commercial Officer; and Jamey Mock, our Chief Financial Officer. Before we begin, please note that this conference call will include forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please see Slide 2 of the accompanying presentation and our SEC filings for important risk factors that could cause our actual performance and results to differ materially from those expressed or implied in these forward-looking statements. With that, I'll turn it over to Stéphane.
Stéphane Bancel: Thank you, Lavina. Good morning or good afternoon, everyone. Thank you for joining us today. I will start with a quick review of our business for third quarter. Arpa will then give you an update of our commercial progress and plans. Jamey will present our financial results and will explain in detail the one-time charges we announced this morning in our press release. Stephen will then review our clinical programs. And I will share our key priorities for 2024 and 2025 to return Moderna to sales growth and profitability. We delivered $1.8 billion in Spikevax sales of COVID vaccine in the third quarter. Based on trend we are seeing in the U.S. COVID market in recent weeks, we expect our sales for 2023 to be at least $6 billion. We have been preparing for the 2023 fall COVID launch throughout the year, because the U.S. market was pivoting from a pandemic government purchase market to a commercial market. I am very pleased to report that according to IQVIA market data, we have a market share in the U.S. of 45% season to date, compared to 36% for 2022. [And Arpa] (ph) will show you, we even achieved 51% market share last week in the U.S. This commercial performance in the U.S. market shows that Moderna can compete commercially with large established players, [that will prove] (ph) important as we launch RSV 2024 and combo of flu-COVID in 2025. On the cost side of the company, we informed you at R&D Day that it was important for us to resize our manufacturing footprint as the world has moved from a pandemic to an endemic setting. I am pleased that our manufacturing and finance team were able to move fast and resize our manufacturing, so that we can go back to 75% to 80% gross margin levels. This resizing resulted in a charge of $1.6 billion, which Jamey will explain in detail in his section. Now let me turn over to Arpa to walk you through our progress in the U.S. market.
Arpa Garay: Thank you, Stéphane, and good morning or good afternoon to everyone. Today, I will provide an update on our third quarter performance, our U.S. commercial launch progress and our preparation for our RSV launch next year. Our total sales in the third quarter came in at $1.8 billion, which includes approximately $800 million in international sales and $900 million in U.S. sales. Total sales for the first three quarters of the year were $3.9 billion. Turning now to our expectations for the fourth quarter and full year 2023 outlook. In our international business, we expect an additional $1.1 billion in sales. These sales are based on government contracts and once vaccine doses are shipped and accepted by the customer, they are not returnable. More than half of these sales have already shipped in the fourth quarter. In the U.S., we expect at least $1 billion in sales in the fourth quarter, which would bring U.S. sales to approximately $2 billion for the second half of 2023. This assumes approximately 50 million doses administered in the U.S., which would be similar to the fall season of 2022. With $3.9 billion in sales recorded as of the end of the third quarter, expected fourth quarter sales of $1.1 billion internationally and at least $1 billion in the U.S., our updated sales outlook for 2023 is at least $6 billion. Now turning to the U.S. launch. The data shown here are from IQVIA. As a reminder, IQVIA data only captures the retail channel in the U.S., which includes retail pharmacies and long-term care. I'm first going to share what our weekly market share trends look like and then discuss our cumulative share since launch and how it compares to last year. On the fifth week post launch, for the week ending October 20th, what you can see on the slide here is that Moderna's market share is 51%. As we look over the season to date, Moderna's cumulative market share for this season is now 45%, which is higher than the 36% market share we had in 2022. As Stéphane mentioned, this progress demonstrates our ability to compete effectively in the commercial endemic market. Turning now to Slide 8, which shows cumulative vaccinations in the U.S. retail pharmacy channel. This year, COVID vaccines were launched two weeks later than in 2022. As a result, we analyze the data on a launch-adjusted basis as shown in the graph on the slide. To do this, we look at the data based on the number of weeks post launch rather than simply on a calendar basis. This helps us compare vaccines uptake in 2023 versus 2022. On the graph, the blue line represents cumulative vaccinations post launch in '22 and the red line represents cumulative vaccination post launch this year. And on a launch-adjusted basis, the total market is tracking ahead of last year's vaccination levels, both on a weekly basis but also on a cumulative basis. As a reminder, the retail channel is typically the largest segment, so these trends in the first five weeks are encouraging given the later launch and slightly shorter season in 2023. Let's now turn to look at the channel mix in the market on Slide 9. In 2023, we expect retail and non-retail mix to evolve as the season progresses. The non-retail segment includes independent networks, health systems, U.S. government entities, clinics, and other providers. Last year, this non-retail segment made up approximately 16 million doses in the season, or 33% of the total market. The gray line on the graph charts CDC-reported vaccinations, which capture both retail and non-retail channels in 2022. The blue line is vaccinations at retail pharmacies, as reported by IQVIA, in 2022. The difference between these two lines represents the non-retail segment. Looking at the data on the graph, you can see that the retail channel captures the majority of vaccinations early in the season. This can be seen in the narrow spread between the CDC and IQVIA data represented by the gray and blue lines, respectively. Now, if you look in the seventh week of launch in 2022, the current week that we are in, in '23, you can see that the slope of the non-retail channel is increasing. We know that distributors this year have recently increased shipments to the non-retail channel and, as such, we expect non-retail as a percentage of market to grow between now and year-end. Importantly, we expect our market share to be consistent across channels and higher in 2023 than in 2022. We are committed to focus on public health efforts to increase vaccination rates. In the United States, we are taking a multi-pronged approach to educate all stakeholders and increase the urgency to get vaccinated. Across the medical community, pharmacies and clinics, and advocacy groups, we are providing patient education resources to help our partners encourage their patients to get their COVID vaccine this fall. Earlier this week, we also launched our branded direct-to-consumer campaign, both on TV as well as across digital channels. For the remainder of the year, we will be amplifying education on the need for vaccination prior to gatherings, particularly with at-risk populations such as families, and traveling during the holiday season. We are also launching a focused education effort for consumers who are infected with COVID this summer on the importance of getting vaccinated in November and December. To summarize our COVID outlook, we expect at least $6 billion of sales this year based on the U.S. vaccination trends that signal a market of at least 50 million doses. Moderna's share, both in retail and non-retail, is expected to be consistent across channels and higher than in 2022. Vaccine administrations in the retail channel are tracking ahead of last year on a launch-adjusted basis, signaling strong early consumer demand. Last year, only about 55% of COVID vaccinations were given by the end of October, with an additional 23 million vaccinations given in November and December. We expect the non-retail channel to increase as a percentage of the market, which will provide additional sites of vaccination for consumers to allow for a strong November and December. This year, given the later launch of vaccines, the non-retail channels are just now beginning their vaccination campaigns. To continue the momentum from our launch and supplement our customers' efforts, we will be amplifying our marketing campaigns in November and December. Let me now turn to the upcoming RSV launch in 2024. We believe we have a best-in-class product profile that can make a difference both to patients but also to our customers. Our clinical profile shows strong vaccine efficacy. We have a well-established safety and tolerability profile that leverages the same mRNA technology that has been delivered in over 1 billion COVID vaccines. Additionally, we have not seen any cases of GBS in our Phase 3 trials. An important differentiator for our customers is that we will be the only company with ready-to-use pre-filled syringes, which are preferred by pharmacists and by clinicians. We continue to expect a 2024 launch of our RSV vaccine in the U.S., and are also preparing for launches in several international markets. We're encouraged by the recent RSV launches in the market this year, beating expectations due to robust consumer awareness and demand. And we believe that we are well positioned for our launch in 2024. Our strong clinical profile and ready-to-use pre-filled syringes are key competitive differentiators. My team and I are particularly excited about our ready-to-use pre-filled syringes given the robust demand for our COVID pre-filled syringes this fall. The majority of RSV vaccines in the U.S. will be given in the pharmacy setting. And given the ongoing pharmacy labor shortages, our ready-to-use presentation will save time and also reduce administration errors. We will be the only company with a one-step administration compared to competitive products, which require multiple preparation steps by pharmacists and clinicians. We are very excited for the launch of our RSV vaccine given the strong product profile. And the commercial team is well positioned to bring our RSV vaccine, our second respiratory vaccine, to market. I will now turn it over to Jamey to provide an update on our financials.
Jamey Mock: Thanks, Arpa, and hello, everyone. Today, I will review our financial performance for the third quarter and provide an updated framework for our full year 2023 financial outlook. Additionally, given we know it's top of mind for investors, we wanted to provide our early thoughts on 2024 and how we're approaching the next couple years. Starting on Slide 15. Total net product sales for the quarter were $1.8 billion, down 44% year-over-year, driven by lower sales volume, and partially offset by a higher average selling price. Product sales were almost evenly distributed between the U.S. market and the rest of the world. We initiated product shipments to customers in mid-September for the fall booster season, following the authorization of our updated COVID-19 vaccine. Cost of sales for the third quarter of 2023 was $2.2 billion compared to $1.1 billion in the prior year. I will provide detailed commentary on the following slides. Research and development expenses were $1.2 billion, which increased by 41% versus the prior year. This increase was driven by our expanded and maturing development pipeline with six products now in Phase 3 studies or pending approval. Selling, general and administrative expenses were $442 million, reflecting an increase of 59% year-over-year. The growth in spending was primarily driven by the buildout of our commercial activities and, in particular, our launch in the U.S. commercial market. The income tax provision in Q3 was $1.7 billion, as we reported evaluation allowance against deferred tax assets of $1.7 billion. Under GAAP accounting rules, we are required to take a reserve, also referred to as evaluation allowance, for deferred tax assets when the current year and cumulative income projection for the next three years is in a loss position. These losses indicate our deferred tax assets may not be fully realized. It's important to note, future income from products not yet approved by regulators are excluded from these income projections, which restricts us to adjust our COVID vaccine, and it does not include expected future launches. In combination with our updated endemic COVID forecast, we determined it was appropriate to record a valuation allowance for our deferred tax assets. This valuation allowance did not impact cash flows, nor future returns, nor the company's ability to utilize deferred tax assets in future periods. Net loss for the period was $3.6 billion compared to net income of $1 billion last year. Diluted loss per share was $9.53 compared to diluted earnings per share of $2.53 in 2022. Finally, we ended the third quarter with $12.8 billion in cash and investments. The decline versus prior quarter was driven by our operating loss and sales to be collected in Q4. Now, let me come back to cost of sales on Slide 16. We now expect full year cost of sales of $5 billion, driven by $1.5 billion of unit-driven expenses, which also includes royalties, and $3.5 billion of inventory write-downs and charges related to CMO purchase commitments, cancellation fees, and wind-down costs. As Stéphane previously highlighted, in our pursuit to optimize the cost structure of our COVID-19 franchise, we undertook a strategic initiative in the third quarter to restructure our manufacturing footprint, which was built for the pandemic. As part of this initiative, we reduced our capacity and commitments with several third-party vendors, we reevaluated our raw material inventory levels, and cut back on our purchase commitments for raw materials not anticipated to be consumed before expiration. As a result, we are recording charges of $1.6 billion, $1.4 billion of which are in Q3 and an expected $0.2 billion in Q4. The $1.4 billion charge in Q3 consists of inventory write-downs of $0.9 billion and CMO wind-down costs and cancellation fees of $0.5 billion. The Q4 charge is related to CMO wind-down costs. Despite the immediate financial impact, we are confident that this strategic move will improve the efficiency of our manufacturing operations and establish a strong foundation for improved margins going forward. As part of the $1.6 billion in total restructuring charges I just mentioned, only the CMO-related costs and cancellation fees are cash restructuring costs. We project this approximately $0.7 billion charge will have a payback in less than two years and a net cash benefit of approximately $1 billion through 2029. As I mentioned, our full year forecast for cost of sales in 2023 is now $5 billion. Before resizing charges of $1.6 billion, our cost of sales for the full year is expected to be at the low end of our previous guidance of $3.5 billion to $4 billion. So, now coming back to my commentary on Q3. In addition to unit-driven manufacturing costs and the cost from this initiative, we also incurred approximately $0.4 billion of inventory charges for excess and obsolete material, demand-related write-downs of our latest Spikevax product, and unutilized manufacturing capacity charges. Moving to Slide 17. In summary, we made substantial progress to resize our COVID cost structure and accelerated our path towards our longer-term target of 20% to 25% of sales. We expect our cost of sales to not only be at a lower level, but also be more predictable in the future. In recent quarters, our cost of sales were highly impacted by write-offs and charges as we just addressed today and in previous calls. Year-to-date write-offs and charges for inventory CMO and supplier-related commitments are 74% of sales. Starting in 2024, we expect those to be less than 10% of sales on an annualized basis. Our capacity is now better positioned to scale with volume. At a $4 billion sales level, we expect cost of sales of approximately 35%, reducing to approximately 30% at $6 billion of sales, and 20% to 25% at even higher sales levels. In other words, with our resized manufacturing footprint, we now expect to achieve significant volume leverage moving forward. Let's now move to Slide 18. While we intend to continue to focus on GAAP results, we wanted to give you a view of our financial results in Q3 with and without the resizing and tax valuation allowance charges. While our total GAAP net loss in the third quarter was $3.6 billion, our loss excluding these charges would have been $0.5 billion. Now, let's turn to our updated 2023 financial framework on Slide 19. As Arpa mentioned earlier, we now expect product sales for 2023 of at least $6 billion for the full year, which is comprised of $3.9 billion of sales through the third quarter, an additional $1.1 billion of international sales in Q4, and at least $1 billion of Q4 sales from the U.S. As explained earlier, we now expect cost of sales for the full year of approximately $5 billion, which includes resizing charges of $1.6 billion. For R&D and SG&A, we now expect full year expenses to be approximately $6.3 billion, with approximately $4.8 billion in research and development. Our R&D spend is slightly higher than the $4.5 billion previously forecasted, which is mainly driven by business development activities as well as additional investments in our late-stage clinical trials. Our forecast for SG&A expenses remain consistent at approximately $1.5 billion. We now expect a full year tax expense of approximately $0.8 billion to $1 billion, driven by the $1.7 billion increase in the deferred tax allowance I referenced earlier. And finally, we now expect capital expenditures of approximately $0.9 billion, down from our previous guidance of $1 billion. Before I get into the specifics on 2024 and 2025, I wanted to share with you our principles on how we are operating the company today and our plans over the next three years. We are laser-focused on making our COVID franchise profitable in 2024 and beyond. We look at our Spikevax product profitability, excluding research and development costs, for our future pipeline, and we believe our recent resizing efforts will ensure that our COVID franchise is a continuous and increasing source of income and cash generation. At the same time, we also recognize the significant and unique opportunity for organic sales growth ahead of us with our late-stage pipeline. We will be disciplined in our investment approach and adjust R&D and SG&A based upon the sales performance of our product lines, which in 2024 is still mostly COVID, but we expect it to also include RSV. We expect this investment in our late-stage pipeline will result in a loss over the next two years, but help us to breakeven starting in 2026. We believe our current balance sheet is more than sufficient to fund our plans without the need to raise equity. We are also not planning to repurchase shares in the intermediate term. Stepping back, we believe this is an unparalleled opportunity to impact the lives of patients while creating shareholder value at the same time. Moving to Slide 21, let's start with our view on sales over the next couple of years. We're expecting sales to hit a low point in 2024 at approximately $4 billion. The biggest change year-over-year is related to our signed APAs. We currently have $1 billion of COVID-related APAs for delivery in 2024. Recall that our first half sales in 2023 of $2.1 billion were mostly deferrals from our 2022 existing contracts. So, we expect minimal sales in the first half of 2024. For the U.S., we expect 2024 to be at least $2 billion and believe it will grow over time. Lastly, we expect approximately $1 billion from RSV and other international COVID sales. And finally, in 2025, we expect a return to growth. Let me finish by giving you a more fulsome view on 2024 and our thinking on 2025. Starting with 2024, as I just explained, we expect sales to be approximately $4 billion. Cost of sales are expected to be approximately 35% of sales. R&D expenses of approximately $4.5 billion in 2024, would be down 6%. In 2024, the majority of our R&D expenses are for registration trials, which are now mostly committed. I will speak to our view on 2025 R&D expenses in a moment. SG&A expenses of approximately $1.3 billion in 2024 would be down 13%. We expect taxes to be negligible in 2024 and capital expenditures to be similar to 2023 at $0.9 billion. In summary for 2024, Spikevax will generate nearly $1 billion of income. When we combine that with our estimated investments in R&D and capital expenditures, our cash balance is projected to be approximately $9 billion at the end of 2024. Now for our preliminary thoughts on 2025. As mentioned earlier, sales will return to growth. Cost of sales will improve with the increased sales growth. R&D will be flat to down, and we have much greater flexibility for reduction, given that only approximately half of our current R&D spending levels for registrational trials are committed for 2025. SG&A will be flat to down. Taxes will continue to be negligible. And capital expenditures will be materially lower after the completion of our facilities in the UK, Canada and Australia in the first half of 2025. In summary, our COVID operating income will grow and our investments will remain flat or lower, leading us to an estimated ending cash balance of approximately $6 billion to $7 billion in 2025. Finally, during this period, we expect to launch five new products to help us breakeven in 2026. So with that, I'll now turn the call over to Stephen.
Stephen Hoge: Good morning or good afternoon. Today I'll do a quick review of our clinical programs. Many of the details from these programs were shared at our R&D Day in September. I will also review the Phase 3 trial designs for our combination flu and COVID vaccine, mRNA-1083 and the Phase 3 trial design for our INT in non-small cell lung cancer. During R&D Day, we shared the significant progress we've made through the year in advancing our late-stage pipeline, creating the opportunity to have up to 15 product launches in the next five years. Through 2025, and subject to regulatory review and approvals, we anticipate launches for our RSV vaccine, our flu vaccine, a next-generation COVID vaccine, and our combination flu and COVID vaccine. Looking beyond 2025, we have a diverse pipeline of other vaccines, cancer therapies, and rare metabolic disease medicines. We're very excited by the potential benefits these medicines offer across a diverse range of therapeutic areas. Slide 25 is an overview of our respiratory vaccines pipeline. Our leading pipeline includes commercial and Phase 3 programs against COVID, RSV, and flu, as well as earlier-stage next-generation programs in COVID and flu and multiple [combinations] (ph). We recently shared positive topline Phase 1/2 data from our combination flu and COVID vaccine, mRNA-1083. And on the heels of this success, we've started and are rapidly enrolling a Phase 3 study for mRNA-1083 in adults 50 and older. Slide 26 shows the Phase 3 design for mRNA-1083. The Phase 3 study is a randomized, stratified, observer-blind, active-control study evaluating the immunogenicity and safety of 1083 compared to co-administered flu and COVID vaccines. The study will enroll 8,000 participants overall, with two cohorts of 4,000 participants stratified by age 65 years and older and 50 to 64 years of age. Both cohorts will receive mRNA-1083, or in the control arm, an age-recommended licensed quadrivalent flu vaccine plus our approved COVID vaccine. Study participants will be followed for six months. The next, on Slide 27, is an overview of our latent and other vaccines pipeline. As previously announced, our Phase 3 study evaluating vaccine efficacy and safety of our CMV vaccine in women of childbearing age is now fully enrolled, including the adolescent cohort. The study is accruing cases and we look forward to vaccine efficacy data when it becomes available. Earlier-stage clinical programs against EBV, HIV, VZV, HSV, and against the Norovirus and Lyme disease continue to progress. Slide 28 is an overview of our therapeutics pipeline. We're proud of the progress across cancer, rare diseases, and other areas. Many of the details of these programs were highlighted at our recent R&D Day, and I refer you to that presentation on our website. Notable since R&D Day is the continued rapid enrollment of the INT Phase 3 adjuvant melanoma study, which has seen a great deal of interest from investigators and patients since presentation of the Phase 2 data at ASCO earlier this year. As previously announced, before the end of the year, we will conduct another analysis of the Phase 2 study with longer follow-up time at approximately three years, and we are looking forward to sharing that data INT is also moving forward in other types of cancer with the initiation of a second Phase 3 study in adjuvant non-small cell lung cancer. The Phase 3 design for adjuvant non-small cell lung cancer is shown on Slide 29. It is a randomized placebo-blind -- double-blind placebo and active comparator controlled study of a combination of INT plus KEYTRUDA versus placebo plus KEYTRUDA in patients with non-small cell lung cancer. The study will enroll approximately 900 patients with stage II to IIIB tumors who were resected and previously treated with adjuvant chemotherapy. Each patient will receive up to nine doses of INT administered intramuscularly every three weeks with KEYTRUDA administered every six weeks in the active arm, or nine doses of a placebo injection administered every three weeks and KEYTRUDA every six weeks in the comparator arm. The primary endpoint of the study is disease-free survival. Key secondary endpoints include overall survival, distant metastasis-free survival, and patient-reported outcomes. This study marks an important milestone in our collaboration with our partner, Merck, and our shared commitment to rapidly bring INT to patients. With that, I'll turn it over to Stéphane.
Stéphane Bancel: Thank you, Stephen, Jamey and Arpa. Our focus is to return Moderna to sales growth and profitability. To achieve that, we have three priorities. Priority number one, commercial execution. Our market share in the U.S. demonstrates we can compete. We are focused on launching RSV in 2024. We believe we have best-in-class profile for RSV vaccine, high-efficiency, good safety profile, and the easiest to use in pharmacies or doctor's offices. As you all know, pharmacy chains are having challenges given the workload, especially in the fall season. The two other vaccines on the market today are very complicated to prepare before injection; one is nine steps, and one is four steps. Now we launched pre-filled syringe and, as Arpa said, we are very excited about that. And from the discussions I had with the leadership of pharmacies, I believe that this will be an important differentiation. Our COVID plus flu combo vaccine should launch in 2025. And as you know, flu is a higher volume market than COVID. In the U.S., for example, flu is around 3 times the number of doses compared to the COVID market. With these new product launches in '24 and '25, and the combination of COVID sales in the endemic setting, we believe Moderna will be in sales growth again in 2025. Priority number two, discipline investments. We'll be disciplined in our investments and [cycle] (ph) them based on our sales performance. As you saw, we have taken bold actions to resize our manufacturing footprint in the third quarter. The team is not done and there are many continuous improvement projects to drive a reduction in cost of manufacturing. We'll also look at our R&D costs and will consider partnering some programs, if needed, to allow us to be responsible and disciplined about our costs. For SG&A, as Jamey mentioned, we are currently going through our 2024 budget and our goal is to have a lower spend in SG&A in 2024 than we had in 2023. We still plan to keep SG&A flat in 2025 versus 2024. We're launching respiratory products in 2024 and 2025, and we anticipate the same teams [indiscernible] productivity gains as we improve our commercial operations. As Jamey mentioned, we expect to breakeven in 2026. Priority number three, executing on our late-stage pipeline to drive sales growth. As you all know, we have an exciting late-stage pipeline with six Phase 3 assets. For respiratory program, RSV, flu, next-gen COVID, mRNA-1283, and COVID plus flu combo that Stephen just talked about. One latent program, CMV, which is fully enrolled in Phase 3 and accruing cases. One oncology program, INT in melanoma, and as Stephen mentioned, in lung cancer. We look forward to having and sharing three years of INT data from our melanoma study before the end of this year. If the data are strong, we believe it could be the basis for regulatory discussions for potential accelerated approval. We have been investing in building a factory in Marlborough, Massachusetts, which will enable the commercial launch for INT. Thanks to the mRNA platform we built, we have an exciting pipeline, with up to 15 launches in the next five years. We have the largest late-stage pipeline of any mRNA company in the world and will continue to focus to deliver the greatest possible impact to people for mRNA medicine. I've never been more excited about the potential we have to deliver for patients. The actions we are taking help us to execute on that vision. With this, operator, we'll be happy to take questions now.
Operator: Thank you. [Operator Instructions] Our first question comes from Gena Wang with Barclays. Your line is open.
Gena Wang: Thank you for taking my questions. I have two questions regarding the commercial questions. First, you did mention 2026, you're looking to have a breakeven. And when we take a quick look based on your 2024 and 2025 outlook, it seems the total cost could be in the $8 billion to $9 billion, that range. Could you give us a sense what could be the additional sales if we're using 2024 guidance as a base point? And the second very quickly regarding the manufacturing resizing. After resizing, what is the full capacity regarding doses and what percentage of the manufacturing will be internal in 2024 and 2025?
Jamey Mock: Maybe I'll take the first one -- first part of the question. So, in terms of 2026, and thanks for the question, let's talk to you about how we're thinking about it. So, we mentioned $4 billion in 2024, approximately $4 billion. And this is all about our late-stage pipeline coming to fruition. So, in 2024, we'll launch RSV, but it's mostly kind of in the second half year sales, and then we'll have a full year in 2025, so that'll provide growth. We will also come to market with flu in 2025. We'll also come to market with a combination of flu and COVID in 2025. Again, depends on timing, but by 2026, we should have a full portfolio. So, we're not going to say what the exact sales numbers are, but you mentioned $8 billion to $9 billion in costs. I'm not exactly sure where you'd get there unless you're assuming a certain sales line on that, but let me go back to what we tried to lay out here. If you assume, for instance, $6 billion in sales, we should have 30% of cost, or $8 billion in sales, we should have 25% of cost. And then, we've said historically in our R&D Day that we need $25 billion overall to make this investment, which should average $5 billion a year. So, hopefully, we're giving you enough pieces without officially guiding any kind of numbers in 2026. But here's what's also important is, if those sales don't come to fruition, we are telling you that we will adjust our expenditures in our investment. So, that's -- we hope that we are -- they will, we are confident in our pipeline, but should it not happen, then we were prepared to adjust our investment. I missed the second part of the question.
Arpa Garay: Capacity.
Jamey Mock: Hey, Gina, can you maybe repeat the second part of your question? I apologize. I missed it.
Gena Wang: Sure. Basically, after manufacturing resizing, what is the full capacity regarding doses, and what percentage will be internal?
Jamey Mock: Yeah, thank you for the question. So, we -- as we try to lay out here and are showing you, this capacity is built for volume leverage. So, we at least put $10 billion of sales on that page, and it will require no additional capacity. We will complete, of course, over the next year and a half the UK facility, the Canada facility and Australia facility, but for the respiratory framework, we need no more, at least the $10 billion. I won't project beyond that, but that should answer that question. INT is a little bit different and we are building that and getting that ready for commercial purposes, but we're built for volume leverage moving forward.
Gena Wang: Thank you.
Operator: Our next question comes from Salveen Richter with Goldman Sachs. Your line is open.
Salveen Richter: Good morning. Thanks for taking my questions. Two from me here. One is, you provided guidance of about $4 billion between COVID and RSV on the [forward here] (ph) for 2024. Could you just speak to the contribution from each and how you're thinking about flu monotherapy? And the second question is that your financial framework for 2025 includes the ability to flex R&D and SG&A. Are there any parameters you can share on the range of this flexibility and how you would prioritize R&D programs and development? Thank you.
Jamey Mock: Yeah, thanks, Salveen. I appreciate the question. So, on the $4 billion, we're not going to break out the $1 billion that we attributed to RSV and COVID. All we can say is we've talked about our PDUFA date and that we filed in certain amount of countries across the globe. I will also say, as Arpa mentioned in her prepared remarks that we're super confident in the product profile. We are encouraged by the market and how it's already started from an uptake perspective, and we think we will compete very well in 2024 and beyond. As it pertains to the flexing on our spending for 2025, obviously, I don't know, 80% of our expenses or investments are in R&D, so $4.5 billion for R&D and $1.3 billion for S&A. So that, as I mentioned, 50% of the current spending levels is not committed. So, we have time to make decisions and watch the market to be able to say what amount of registrational trials and what amount of R&D are we going to spend in 2025. So, hopefully that gives you a sense for how much is still the ability to flex. We also have other levers that we can pull, et cetera. SG&A, we also have some flexibility, probably not to the same magnitude, but there is still some amount of flexibility to bring that down from a variable expense perspective.
Stéphane Bancel: And Salveen, this is Stéphane. Maybe just to add to Jamey's point on the R&D, as I mentioned in my remarks, if we have to, we will be open, of course, to partnership some of those programs, which is an important way we could flex the R&D number based on where the sales are, as Jamey mentioned, which is if the sales are according to our plan, then we're going to be okay. If the sales are below, we will be very open to partnering. As you know, we've done that in the past. The team knows how to do it. But we will be disciplined about our investments in the business based on where the sales line is.
Operator: Thank you. Our next question comes from Eliana Merle with UBS. Your line is open.
Unidentified Analyst: Hi, this is Sarah on for Ellie. Thanks so much for taking our question. First, I guess, can you talk about in 2024 again on that $1 billion RSV international sales number? Are you expecting any contribution from flu in '24, and maybe how you're thinking about it into '25? And then, on CMV, can you talk about where you are in cases and how they're tracking versus R&D Day where I think you said a fourth of them were currently tracked? That would be great. Thanks so much.
Jamey Mock: So, thanks, Sarah. I'll take the first part and then hand it over to Stephen on CMV. So, there is no flu contribution in our 2024 sales outlook of approximately $4 billion. So, in that $1 billion, that is solely RSV and other COVID international sales. We do, as I mentioned in my -- to answering Salveen's question, we do expect to launch flu in our combination products sometime in 2025, and we'll see what we've projected that time.
Stephen Hoge: And on the CMV question, thanks for that. So yes, we did update that we're about a quarter of the way through the case accrual back in R&D Day. I think the next -- we continue to accrue cases at a steady pace. I do think the next update will provide is likely our Vaccines Day in the spring.
Unidentified Analyst: Okay, thanks.
Operator: Our next question comes from Terence Flynn with Morgan Stanley. Your line is open.
Terence Flynn: Great. Thanks so much for taking the question. I know GSK has provided an estimate in terms of size of the RSV market, about £5 billion, and Pfizer has given some metrics as well. Given what we're seeing now with these early launches, can you provide us with your assessment of total market size here? And then given some of your comments on competing with larger companies, as you're doing in COVID now, where ultimately do you see your market share shaking out in the RSV space? Thank you.
Arpa Garay: Thank you for the question. In terms of the total RSV market, as I mentioned earlier, we're excited by the uptake and the consumer awareness of the market overall. And our projections are similar to what both GSK and Pfizer have already guided. In terms of our market share with RSV, we have not yet provided or are ready to provide any forward-looking projections on share, but we are very excited about our strong product profile, both in terms of efficacy, safety, and, as I mentioned, our ready to use pre-filled syringes. So, we will be leveraging the learnings and the success from our COVID commercial launch this year and applying them to RSV next year.
Stéphane Bancel: Yes. Just to add to Arpa, Terence, it's Stéphane, the point that Arpa and I made about the market share of COVID is what I think is very important. I think some people believe that because we're a new company in commercials we're not able to compete and I think the market share data that Arpa has shared really show that our U.S. team is able to compete and we will continue to improve things that we are doing, because we are not done improving the [indiscernible] culture as you know us. But the share already moving from 36% last year to 45% cumulative so far in the season, I think it's already a demonstration of what the team is able to achieve. And the season is not over, so that's 51%, so let's see where this one finish when the season is over. But basically, the [differential] (ph) we have, as I mentioned, I've been speaking to pharmacist leadership. And they are all, I think, have a very big workload issue, as you know. There's even strikes in some pharmacy chains in the U.S. as we speak. And you think about the season there, [indiscernible] business for the pharmacy for preparations, and then the flu, and then the COVID. And then, as I mentioned, those two other products, if you just download the label of those products from the FDA website and you look at how many steps they have, it's very complicated. And when you talk to a pharmacy leadership, they don't know how they're going to deal with that type of workload. And so, coming with pre-filled syringe is a tremendous differentiator. We have very good efficacy. We have very good safety profile. We really believe that we have the best in-class product in the market. And [indiscernible], it's going to translate, I think, into a very good effect.
Operator: Thank you. Our next question comes from Jessica Fye with JPMorgan. Your line is open.
Jessica Fye: Hey, guys, good morning. Thanks for taking my question. Just a couple coming back around to one that I think some others were trying to get at, but maybe a little differently. When we think about breakeven in 2026, what are you contemplating in that sales number embedded in your assumption? Does it reflect just respiratory vaccines? Or are you considering INT could be on the market then? And then second, I know you said the percentage of non-retail jobs would grow as the season progresses from where it has been so far this season. Do you believe that the proportion of COVID shots running through the retail channel has shifted at all, bigger picture in 2023 relative to 2022, or should we think of that proportion as remaining similar year-over-year? Thank you.
Jamey Mock: Yeah. Thanks, Jess, for the question. Again, without getting into too much detail on 2026 in terms of how we think about it, I mean, the best way to keep going back to that late-stage pipeline that we've been talking to you about, RSV, flu, our combination, our next-gen COVID product as well, will all be very much there for the year 2026. And we are confident in all those product profiles and how we will compete. As I mentioned, at 6%, our cost of sales -- at $6 billion, sorry, our cost of sales would be 30%. At $8 billion, our cost of sales would be 25%. And of course, we'll try to improve on that. And that will give us the envelope for how much we can continue to invest in the future products, which we said we'll launch 15 by 2028. That'll be all of our latent product portfolio, that'll be our INT portfolio, that'll be our rare disease portfolio. So, I think that's as much as we can say right now. I just want everybody to know that we are very committed to breaking even in that year, and we have a lot of flexibility, both from a growth standpoint and a discipline investment standpoint.
Arpa Garay: Great. And I can take the second question on the percentage of non-retail. So, as expected, in 2023, the retailers have been the majority of the market, with more than 90% of the volume during the first few weeks. However, we're now beginning to see a shift towards more non-retail channels, as I had mentioned. We are seeing increased shipments to IDNs, to clinics, to pediatricians, as of the recent weeks. And as I think about full year 2023, I believe the retail mix will be stronger than in 2022 and could land at about 70% to 80% of total vaccinations, whereas in 2022, we saw that the retail channel was only about two-thirds of the mass.
Operator: Thank you. Our next question comes from Luca Issi with RBC Capital. Your line is open.
Luca Issi: Oh, great. Thanks so much for taking my questions. Maybe circling back on the P&L, I appreciate all the effort on resizing manufacturing and the focus on gross margin, but how should we think about OpEx plus CapEx? As COVID numbers continue to come down, we've seen the BioNTech and Pfizer materially realigning OpEx plus CapEx to their top-line. I believe BioNTech lowered by $600 million this year and Pfizer by $1 billion this year and $2.5 billion next year. However, your OpEx plus CapEx is not materially changed this year and you anticipate that the next year it's going to be generally flat to down. So, can you just maybe comment on why you think that's the right strategic decision for the organization? And then maybe second question on RSV. Obviously, impressive initial launch by GSK and Pfizer and appreciate the differentiations of your product. But what's the latest thinking on whether the vaccine is needed every year or less frequently than that? Is there a scenario where Pfizer and GSK penetrate the market pretty aggressively this year and then you face an uphill battle next year as it turns out that we need a vaccine maybe every other year and not every year? Any thoughts there much appreciated. Thanks so much.
Stephen Hoge: Maybe I'll take the first -- the second part of that question and then hand it over to Jamey for the first. So, on RSV and the need for it, obviously, we're continuing to follow the public health situation in terms of the rate of occurrence of the RSV epidemic this year. At this point, I think we don't have data yet on whether or not it will ultimately be an annual or something less than annual, say every two or three year vaccination regime. I think like everybody else, we'll be looking to our data, the other manufacturers' data, as well as the public health, the epidemiologic data to guide that decision. There are plenty of vaccines for which there is an approach, flu as an example, where there's a seasonal vaccination approach, both because of the benefit offered by the vaccine, but also because of the convenience of just making sure that every season, every year, people are reminded to get that vaccine. So, the ultimate decision on whether this is going to be recommended is not ours, the manufacturer, it will fall to public health officials based on a number of factors, which will include the [indiscernible] and the data we provide, but other factors as well. And we'll work to make sure they have the data they need to make that decision.
Jamey Mock: And I'll take the first part. Thanks, Luca, for the question. I think the short answer is the opportunity set ahead of us, and we are acting. So, you referenced some of our competitors, so I just want to break that down. I mean, we are super encouraged by the opportunity for additional growth and our ability to impact patients. And we have this 15 products that we think will launch by 2028 or by 2025. We think that's the right thing to do. We have to grow out of our, we have to grow this company and to be able to afford the investment to be able to capture the unparalleled opportunity for this. And I think we are acting, I believe we are acting, and I mentioned everything that we're doing from a cost of sales perspective. And so I think that's very much in line and sized appropriately to have volume leverage when it comes, because it will come. And we are saying in 2024, we can adjust both R&D and SG&A down to a good level, down 6% R&D, down 13%, so, on SG&A. We are largely committed to our registrational trials for 2024. But as I mentioned, we don't have as much flexibility in that particular year, but by 2025, we have even more flexibility. So we're prepared to take action should we need to, but we're very optimistic about the price line that's coming. And hopefully this will just come through growth, and we'll still be able to afford much of this investment.
Stéphane Bancel: It's Stéphane. Just maybe adding to Jamey, who said it super well. As you know, we have a platform company. And the [indiscernible] success of those programs we feel very good about. If you just look at with COVID and Phase 3 RSV -- sorry, and Phase 3 for RSV and Phase 3 for flu, we have three out of three positive Phase 3. This is not your industry average. So, we think we can create value and create return on capital for shareholders by investing that capital to high-priority projects that are in late-stage pipeline. As I said, we have the largest late-stage pipeline of any mRNA company. We have six programs right now. And as soon as we launch [indiscernible], which is very, very soon, there's going to be seven programs. We believe the best way to create returns for shareholders is to invest that capital to drive sales growth and profitability.
Luca Issi: That's it. Thanks so much.
Operator: Our next question comes from Michael Yee with Jefferies. Your line is open.
Unidentified Analyst: Hi. Thanks for taking our question. This is Dina on for Mike. I just wanted to get a sense of your assumptions for Q4 COVID jabs and what are you seeing in Q4 right now? How much of that is actually jabs and actual injections versus channel fill? And just to follow-up on that. Now that you've seen sort of half of the 2023 fall season play out, what are your assumptions for 2024 and 2025 for COVID? Are you essentially assuming that the same people who got vaccinated this year will continue to get COVID vaccine every year? Thanks so much.
Arpa Garay: Thank you for the question. In terms of the fourth quarter '23 jabs, what we saw in 2022 is there was a significant portion, about 45% of the total COVID vaccinations happening in November and December. This year, we're expecting a similar split, likely larger, given that we launched two weeks later into the season in 2023 than we did last year. And what we are hearing from our different non-retail customers as well as our retail pharmacy partners is they are planning vaccination campaigns and marketing efforts to really capture on the November and December months. So, in total, we do anticipate getting to at least 50 million doses this year, and we do believe that November and December will be strong months for us. In terms of 2024, our assumption is everyone who has gotten their booster in 2023 will at least get their booster also in 2024 and beyond. Now, given the higher burden of disease with COVID, as consumers become more understanding of the annual recommendations and as the convenience of getting both flu and COVID becomes more normalized, we do believe over time we'll start to see some increase in the overall COVID market.
Operator: Our next question comes from Hartaj Singh with Oppenheimer. Your line is open.
Hartaj Singh: Great. Thank you for my question. I just got a question on the combination programs. And just to give a little bit of -- frame the question, in other therapeutic areas, aside from vaccines for infectious diseases, for example, oncology, monotherapy treatments generally tend to be minority of treatments, 10%, 15%, 20%. Currently, monotherapy vaccines dominate the market in COVID-19 flu. So when you get the combination vaccines going, do you imagine -- does your market research tend to suggest that you would -- again, probably a combination approach might dominate that versus a monotherapy approach, singular vaccines going forward? And then secondly, will the cost of goods sold be any different for the combination versus the monotherapy products? Thank you.
Arpa Garay: Great. Thank you for the question. So, we do anticipate that our combination vaccine will take a substantial share of the monotherapy vaccines that are available. We have seen in the pediatric vaccine market that upon availability of combinations, you see very strong uptake and conversion from monos to combinations, and we expect a similar trend in the adult market. From our market research, we have heard consistently from consumers that they prefer one shot over multiple shots. From a customer perspective, we are hearing, as Stéphane had mentioned, just with workload issues, one shot saves a lot of time and also helps them to get more patients protective. And from a broader healthcare system and government and payer perspective, we are hearing an increased need to help get greater uptake and compliance in adult vaccinations. And our healthcare authorities believe that combinations can help actually boost the vaccination rate. So, we are very excited about our combination products in the future and think this could really be an inflection point for our mandatory vaccines.
Stéphane Bancel: Yes, it's Stéphane. Just to add to Arpa's comments, during COVID, we've been discussing to a lot of -- with healthcare ministers, and the topic of vaccination combination has come a lot. And as you think, especially outside the U.S., where you have a lot of [indiscernible] taking care of people from birth to death, basically, we are very, very interested in combinations. Because they know that if a participant of a country got the vaccine, they got protection against several viruses which prevent hospitalization. As you know, we've done partnership with some countries like the UK, Canada, and Australia. And through those negotiations, the concept of combination was critical in their decision-making. Because as they see their population getting older, they worry that the number of hospitalizations will just go up over time and the ability to prevent that when you see shortages of healthcare workers and as you project those shortages in the future is a key determination of a decision. So, I only think in integrated healthcare system, the drive the [good combo] (ph) will move even faster than actually in commercial markets like the U.S. market.
Jamey Mock: And, Hartaj, maybe I'll take the cost of sales question. Thank you for it. So this provides a substantial margin expansion opportunity. So, if you think about it, our cost of sales, the smallest portion is our drug substance, so it's our actual mMRA, and that's a very small portion of our overall cost of sales. Everything from drug product in terms of the cost to finish the product and the presentation type, whether it's PFS or a vial or whatever, that now gets cut in half. So, when we sell two, it's a very limited amount of cost increase versus a single presentation. So, it does provide a significant margin expansion opportunity. So, thank you for the question.
Hartaj Singh: Thank you all.
Operator: Our next question comes from Evan Wang with Guggenheim Securities. Your line is open.
Evan Wang: Hey guys, thanks for taking the question. Appreciate you guys sharing early thoughts on '24 and beyond. For '24 specifically, you talked about some of the contribution from COVID and RSV in terms of split. It sounds like you plan to hit the ground running there in RSV. With international, how are you thinking about the longer-term contribution from COVID as competitor agreements expire? And with flu, with the comments on [marketing] (ph) '25, wondering if you've had any recent conversations with the regulators there in terms of potential approval. Thanks.
Arpa Garay: Thank you for the question. In terms of our expectations in 2024, we have put about $1 billion across international COVID and RSV. We do anticipate a strong launch in the second half of the year with RSV. And on the international side for COVID, we are continuing to pursue multiple options across a number of countries. In Japan, we will be in a fully commercial market, is our expectation, where we will be competing for the Japanese business. In the EU, we continue to work with countries on agreements to secure our COVID-19 vaccine. As publicly disclosed, the EU has renegotiated their contract with Pfizer earlier this year. So, the EU demand has been substantially satisfied in many markets, but we are hearing from individual member states that they are looking for a second supplier for vaccines. And we are in those discussions right now, both at a country level, but also at a European Commission level to see if a joint procurement agreement can be established in 2024.
Stephen Hoge: And thank you for the flu question. So, as you referenced, we had really strong data out of our P303 Phase 3 study for flu that we released at R&D Day. We're excited about that. We are engaging right now with multiple regulators about the pathway to licensure. I don't have an update about all those conversations because they're happening as we speak, but we will, once we have clarity across all markets on the pathway licensure, provide an update.
Operator: Thank you. Ladies and gentlemen, this does conclude the Q&A portion of today's conference -- end of the call itself. You may now disconnect, and have a wonderful day. |
SBUX | 4 | 2,023 | 2023-11-02 11:21:10 | Operator: Hello. My name is Kevin, and I'll be your conference operator today. I'd like to welcome everyone to Starbucks Fourth Quarter and Full Fiscal Year 2023 Conference Call. [Operator Instructions]. I will now turn the call over to Tiffany Willis, Vice President, Investor Relations. Ms. Willis, you may now begin your conference.
Tiffany Willis: Thank you, Kevin. And good morning, everyone, and thank you for joining us today to discuss Starbucks' fourth quarter and full fiscal year 2023 Results. Today's discussion will be led by Laxman Narasimhan, Chief Executive Officer; and Rachel Ruggeri, Executive Vice President and Chief Financial Officer. This conference call will include forward-looking statements, which are subject to various risks and uncertainties that could cause our actual results to differ materially from these statements. Any such statements should be considered in conjunction with cautionary statements in our earnings release and risk factors discussed in our filings with the SEC, including our latest annual report on Form 10-K and quarterly report on Form 10-Q. Starbucks assumes no obligation to update any of these forward-looking statements or information. GAAP results in fourth quarter and full fiscal year 2023 and the comparative period include several items related to strategic actions, including restructuring and impairment charges, transaction and integration costs, and other items. These items are excluded from our non-GAAP results. All numbers referenced on today's call are on a non-GAAP basis, unless otherwise noted or there is no non-GAAP adjustment related to the metric. For non-GAAP financial measures mentioned in today's call, please refer to the earnings release on our website at investor.starbucks.com to find reconciliations of those non-GAAP measures to their corresponding GAAP measures. This conference call is being webcast, and an archive of this webcast will be available on our website until Friday, December 1, 2023. Also, for calendar planning purposes, please note that our first quarter fiscal year 2024 earnings conference call has been tentatively scheduled for Tuesday, January 30, 2024. And with that, I'll now turn the call over to Laxman.
Laxman Narasimhan: Thank you, Tiffany. Good morning, everyone. Welcome to Starbucks' Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. Thank you in advance to those who will join us this afternoon where we will share an update on our long-term strategies and celebrate the launch of a holiday at Starbucks. Before we get started this morning, I'd like to express my deepest gratitude to our Starbucks partners around the world for a very successful fiscal year 2023. I've learned through connecting with so many of you how our reinvention plan has continued to be well executed, giving us great momentum in this age of our transformation at Starbucks. I have discovered how our brand is uniquely delivered in our stores and digitally through our extraordinary partners and the tremendous headroom we see for our global business. Turning now to our business performance. Rachel and I will share details of our strong results delivered in the quarter and fiscal year 2023, and we will also share our confidence in the company's long-term opportunity with guidance for fiscal year 2024. What you will take away from this call today is that we have great momentum, fueled largely by our reinvention plan. We are seeing the work pay off through improved partner and customer experiences, as well as captured improvements in efficiency and margin. We believe this bodes well for this next year and for years beyond. To deliver our long-term sustainable growth, we are focused on five areas. You will hear more on what we call our triple shot reinvention and our continued momentum this afternoon. The discussion will provide a more detailed outlook on our three core and two enabling priority areas. First, we will elevate the brand through our stores. Second, we will strengthen and scale in digital. Third, we will become truly global. Fourth, we will unlock efficiencies, including outside stock. Finally, we will reinvigorate the partner culture at Starbucks. In the fourth quarter, our total company revenue reached a record $9.4 billion, representing an 11% increase year-over-year. Full-year revenue reached a record of $36 billion, representing 12% growth year-over-year for fiscal 2023, or 14% when excluding the 2% impact of foreign currency translation, aligning our revenue growth at the high end of our guidance range. Equally impressive, our global comparable store sales increased 8% year-over-year, both for the quarter and the fiscal year 2023, driven by a healthy mix of ticket and transaction growth. We grew earnings per share by 31% to $1.06 for the quarter and by $0.20 to $3.54 for the fiscal year, again, aligning to the top end of our guidance range. Importantly, we grew margin by 310 basis points for the fourth quarter and 100 basis points on a full-year basis. And we did all this while growing our global store count to over 38,000, in line with our store growth guidance of 7% in fiscal year 2023. Demand for Starbucks remains strong around the world. Here in the U.S., our largest market, we saw momentum sustain throughout the quarter. Revenue for the quarter was up a record 12%, underpinned by 8% comps. We had a remarkable fall launch that led to record-breaking average weekly sales. Our 90-day active Starbucks Rewards members reached a new record this quarter of nearly 33 million 90-day active members, and setting records in spend per member and total member spend. Customers remain loyal to their favorite four menu classics that have stood the test of time, including the Pumpkin Spice Latte, which celebrated its 20th anniversary. In addition to very strong performance in our core offerings, we also have strong performance with new offerings, including our Apple-inspired beverages and food items. The results from the quarter, including the dynamic way we are driving ticket growth, give us great confidence in our menu innovation on both an individual product overall portfolio level. We have proven that complementary yet competing products and flavors can successfully coexist, such as pumpkin and Apple, with the right menu innovation, marketing mix, and strategic pricing strategies. As customer demands have evolved, we've delivered more beverages, food, and personalization and customization across existing and new formats to meet their expectations and grow the business. Our continued investments in our partners, equipment, supply chain, and technology are paying off, evidenced by a margin expansion across North America to 23.2% this past quarter. Timed with our busiest cold foam promotion of the year, the recent rollout of our new portable cold foamers to all U.S. company-operated stores, enhanced productivity in the fourth quarter. and lessened the trade on our partners, while continuing to meet the high cold beverage demand. In support of the continued growth in cold beverages, we delivered over 550 new Nugget ice machines and remained on track with installation prioritized for our most ice-constrained stores in fiscal year 2024. Clover Vertica, our on-demand single-cup brewer, is now installed in over 600 of our stores across the U.S., and we continue the on-schedule rollout of the Siren System cold and food stations, prioritizing new stores and renovation locations. Our portfolio and pipeline management of new equipment design and rollout plans are robust and enabled us to deliver our results. We have created a more stable environment in our stores. Hours per partner increased in the quarter by 5% as we continue filing schedules that fit our partners and customers' needs. Total was down in the fourth quarter by 10%, while barista tenure increased by 16% for the quarter. Customer connection scores also improved in the quarter relative to this time last year. We did all of this by investing over 20% of this year's profits back into our partners and stores through wages, training, equipment, and new store growth. All this is further evidence that our strategy is working. Turning to International. In the fourth quarter, we saw record store growth of nearly 600 stores across the segment, with International store count remaining higher than that of the U.S. We also experienced record double-digit revenue growth internationally in the quarter, with continued growth on every key market around the world. Our comparable same-store sales in our company-operated markets for both the U.K. and Japan remained well above historical averages in fiscal year 2023, with growth attributed to higher profitability and higher productivity store formats, as well as elevated digital and partner experiences. We saw strong customer demand for our beverage and food offerings around the world with record global demand for our pumpkin platform. And in our international license markets, Starbucks Rewards programs grew by 4 million 90-day active members, now contributing to 30% of total sales, up 9 percentage points in just one year, driven by the growth for Starbucks Digital Solutions. Supported by our strong brand globally, outside of China, our International segment is well ahead of the growth pace we indicated at last year's Investor Day, with focused growth in our company-operated markets and motivated business partners powering our licensed stores. Turning to China. We were pleased with our performance in the quarter. delivering revenue growth of 8% from the prior year or up 15% when excluding approximately 6% impact of foreign currency translation. This has further supported by a comp of 5% squarely in line with our expectations. Full-year revenue grew to $3 billion, up 3% from the prior year or up 11% excluding approximately 8% impact foreign currency translation with comp of 2%. Our performance in China improved sequentially quarter-over-quarter, with revenue in the second half of the year 20% higher than the first half, reflecting our growth momentum. These results underscore the strength of beverage and food offerings, the success of our market strategies, and the powerful execution unleashed by our partners in China as we capture the abundant opportunities in front of us. We continue to see strength from coffee-forward innovations, delighting our customers with locally relevant product innovation like the Moose Espresso and the smaller-sized Intenso range, a first in the world. We're also seeing higher food sales with tremendous headroom in this area, driving both transaction and ticket opportunities. In Q4, we saw continued momentum across the omnichannel experiences of Starbucks in China with strength in store through Mobile Order & Pay, Mobile Order Delivery, E-commerce, and in channels. China now has over 21 million active loyalty members, representing 22% year-over-year growth, with many members skewing younger to build our next generation of customers. In the quarter, we opened a record 326 net new purpose-driven stores in China, reaching 13% net new store growth over the prior year to over 6,800 stores at the end of fiscal year 2023. The outstanding financial returns of new stores give us confidence we will reach our goal of 9,000 stores by 2025, opening nearly 1,000 net new stores every year. Finally, the September opening of the China Coffee Innovation Park, designed to be our most energy-efficient and sustainable coffee manufacturing and distribution center in the world, further signaled our commitment to the largest consumer market in the world and the growth of our business in China for China. We look forward to sharing more on the headroom we see in China later today. The momentum against the backdrop of headwinds in China this past year gives us optimism in our position and affirm our distinctive competitive advantages for our business. These advantages include our uplifting partners, including our China leadership team, our distinctive stores, our vertically integrated and highly digitized efficient operations, and our relevant innovation. We will maintain our leading position in the premium market as we continue to grow in scale across our current portfolio and through new tiers of cities in this growing market of coffee drinkers. Finally, our channel business continues to elevate the Starbucks brand around the world at home and on the go, creating Starbucks moments for consumers outside of our retail stores. We're the number one ready-to-drink brand around the world. Notably, in the fourth quarter, we celebrated our five-year partnership with the Global Coffee Alliance with Nestlé. This Nestlé relationship, which includes We Proudly Serve Food service locations as well as additional partnerships, such as our Nova Mera channel partnership with PepsiCo and international partners like Tingyi and Arla have helped us grow our customer touch points, and is now in nearly 90 markets around the world. For fiscal year 2023, we saw notable growth in our leading channel market position as well as accretive brand equity as we continue to be recognized for our innovation. Some notable accolades include awards in China Ready Select, in the Europe, Middle East, Africa multiserve business as well as achieving 1 billion in servings in Korea and selling out of Grab & Go in Japan. In closing, while navigating an environment of unprecedented volatility throughout fiscal year 2023, we finished our fourth quarter and full year strong delivering on our guidance. Our reinvention is moving ahead of schedule, fueling revenue growth, efficiency and margin expansion. Notably, we continue to see the positive impact of our reinvention on our partner and customer experiences, proof points that we can continue to innovate, grow, and strengthen our business while creating value for all. Looking ahead, we remain fully optimistic about our headroom across the U.S. and internationally, and we see limitless possibilities across all areas of the business. While the global business environment remains uncertain, we are confident in our ability to adapt and innovate to meet evolving consumer needs. We will continue to invest in our partners to expand upon our reinvention and to deliver on our sustainability and social impact initiatives, all while driving long-term growth. We feel very good about the business momentum for next year, the continued strength of the brand, and the opportunity for growth in the years ahead. I look forward to sharing greater detail around these strategies for growth with you later this afternoon. Our performance this past year and the plans ahead give us great confidence in the multiple paths we have in front of us to achieve our long-term results. I will now hand the call over to Rachel to walk you through further details of the fourth quarter and fiscal year 2023 results, as well as our fiscal year 2024 guidance. Thank you all for joining us this morning, and we look forward to seeing you this afternoon. Rachel?
Rachel Ruggeri : Thank you, Laxman, and good morning, everyone. I'm very pleased to discuss our strong Q4 and full fiscal year 2023 performance, which delivered on our full-year guidance shared at the 2022 Investor Day. Our fiscal year 2023 double-digit earnings growth was a direct result of both double-digit revenue growth and margin expansion, as our focus and disciplined execution of our reinvention delivered tangible financial results. Our Q4 consolidated revenue reached a record $9.4 billion, up 9% from the prior year or up 12% when excluding a 1% impact of foreign currency translation. As Laxman mentioned, the U.S. business delivered strong performance with record-breaking average weekly sales from an overwhelmingly successful fall launch, and our International business was also strong, with China performing in line with our expectations. Combined, this resulted in our consolidated comparable store sales growth of 8% and net new company-operated store growth of 7% globally over the prior year, as well as sustained momentum in our global licensed markets. Q4 consolidated operating margin expanded 310 basis points from the prior year to 18.2%, exceeding our expectations, primarily driven by increased efficiency throughout our U.S. stores as our strong execution on reinvention amplified results even greater than we anticipated, coupled with sales leverage and pricing. Margin expansion continued to be partially offset by our investments in store partners as well as higher G&A costs and support of reinvention. Q4 EPS was $1.06, up 31% from the prior year, driven by strong performance across our segments, especially the U.S., as its results were bolstered by the amplified success of our reinvention. For fiscal year 2023, our consolidated revenue reached a record $36 billion, up 12% from the prior year or up 14% when excluding approximately two percentage impact of foreign currency translation. Consistent with our guidance, our revenue growth included 8% comparable store growth and 7% net new company-operated store growth over prior year, as well as ongoing contributions from our global licensed store businesses. Our fiscal year 2023 consolidated op margin was 16.1%, up 100 basis points versus prior year. And EPS of $3.54 was up 20% over prior year. above our recent guidance of 16% to 17%. I'll now provide segment highlights for Q4. North America delivered another quarter of record revenue with $6.9 billion in Q4, up 12% from the prior year, driven by a combination of an 8% increase in comparable store sales, consisting of 6% and 2% growth in average ticket and transactions, respectively, as well as net new company-operated store growth of 4% over the prior year and contributions from our licensed store business, which continues to benefit from increased travel. When considering growth from all stores, comp new and licensed, we were pleased to see more than two-thirds of our growth came from transactions, mix, attach, and customization, which we collectively call demand. Our U.S. business delivered 8% comparable store sales growth in Q4, primarily driven by strong ticket performance with 6% comp growth, which benefited from volume, mix, attach, customization, and pricing. Our customers continue to favor more premium beverages, creating a new normal as it relates to mix and customization. To fuel this, we continue to lean in with innovation, offering our Iced Pumpkin Cream Chai Tea Latte, which boosted tea cells; as well as Pumpkin Cream Cold Foam, which become a customization favorite with our customers. In addition to our beverage success, we also had another record quarter of food attached, driven by both our core breakfast sandwiches and promotional items, such as our Baked Apple Croissant. The success we're having in driving incremental spend gives us confidence that we're delivering meaningful value and a differentiated experience to our customers. Transaction comparable sales growth in the quarter was 2%, which, combined with another quarter of a record ticket, drove multiple record average weekly sales, including delivering our sixth-highest sales weeks ever, driven by our successful fall launch. Demand continued outside of our promotion windows, which translates to future opportunities as we leverage targeted offers to our most loyal customers, increasing efficiency as we create a more personalized experience. As it relates to demand, it was another record-breaking quarter for key aspects of our Starbucks Rewards program, active members, spend per member, and total member spend, which all surpassed previous highs. To further illustrate the strength of demand, we saw total customer growth among our occasional customers as well. Collectively, this demand speaks to the stickiness of our business. That, coupled with increased customer connection scores and growth across transactions, mix, customization, and attach, all leads to a durable and growing business. U.S. licensed store revenue remained strong in Q4, up 18% from the prior year, benefiting from consumers adopting pre-COVID routines of summer and business travel and expanded digital offerings, such as MOP and airports and curbside at select retailers, enabling us with more ways to meet our customers where they are, supporting increasing demand. North America's operating margin was 23.2% in Q4, expanding 420 basis points from the prior year, driven by increased efficiency in our stores, largely from reinvention, sales leverage, and favorable impacts of pricing, partially offset by continued investment in our partners. Moving on to International. In the quarter, the segment delivered $2 billion in revenue, up 11% from the prior year or up 15% when excluding approximately 3% impact from foreign currency translation. Our revenue growth momentum continues off of a remarkable prior quarter and stems from double-digit growth in the majority of our international regions demonstrating global strength. The segment delivered a 5% increase in comparable store sales driven by a 6% transaction growth, as store traffic increased and digital engagement continued with an increasing Starbucks Rewards member base. In addition, the International segment delivered 12% net new company-operated store growth year-over-year, with China contributing a significant portion of store growth as they had their highest store openings this year, equating to almost four new store openings daily in Q4, exceeding our expectations. Collectively, the segment surpassed the 20,000-store mark with ample headroom for growth across markets in the years to come. Shifting to China. As Laxman shared, China's revenue in the quarter and on a full-year basis grew by double digits driven by strength in our new stores and comparable store sales growth of 5%. Importantly, China's average weekly sales grew quarter-over-quarter, in line with our guidance of low to mid-single-digit growth. Comparable store sales growth of 5% was driven by strong transaction growth of 8% over the prior year, reflecting the strong brand affinity we create with locally relevant food and beverage and the consistent experience our partners deliver with every visit, differentiating us in the market. We continue to see long-term growth in China with significant opportunities in dayparts, digital offerings, and store format, and accordingly, continue to make investments for the future of our partners, stores, and local community. Notably, in the quarter, as Laxman shared, we opened the Coffee Innovation Park, our largest roasting plant outside of the U.S., demonstrating our unwavering commitment to our business in China. Operating margin for the International segment was 15.2% in Q4, expanding 70 basis points over the prior year, driven by sales leverage partially offset by digital investments. We are pleased with our margin, reflecting the strength of business and enabling us to unlock capital to reinvest back in the business to fuel growth. Shifting to channel development. The segment's revenue was $486 million in Q4, essentially flat over the prior year, in line with our expectations. This was driven largely by at-home coffee, while probably holding the number one share position in the category at 16.1%, as well as the number one position in ready-to-drink achieving our highest share in two years. Our fall launch in conjunction with our North America coffee partnership drove our performance resulting in the segment growing better than overall category. Segment's operating margin was 55.8% in Q4, up an impressive 520 basis points from prior year and exceeding our expectations, driven by ongoing strong performance in the North America coffee partnership. This segment continues to be highly margin accretive to our business and we're excited by the significant profit growth we're seeing in this channel. Shifting to our fiscal year 2024 guidance. Our guidance accounts for the macroeconomic and geopolitical environment as we see it today. Additionally, our guidance does not include any impact from foreign currency translation. First, let me start with the foundation of our growth, comparable sales growth. We expect fiscal year 2024 global comp growth to be 5% to 7%. While this is a change from our prior year global comp guidance of 7% to 9%, our comp range, coupled with our strong new store performance and momentum in our licensed business, drives a broader and more durable growth narrative supporting our attractive consolidated revenue growth. For color, our fiscal year 2024 U.S. comparable store sales are expected to grow in the range of 5% to 7% as our business continues to have substantial headroom spurred by our leading innovation and technology, increasing customer loyalty and strong digital engagement as evidenced by the U.S. finishing fiscal year 2023 with strong performance of 9% comp growth. Another positive driver of our fiscal year 2024, 5% to 7% global comp growth is the performance in China, with comp expected to be in the range of 4% to 6% in Q2 through Q4, with a higher comp in Q1 as we lap prior year mobility restrictions. Such growth is fueled by our increasing digital capability, coupled with the local opportunity we see stemming from our relevant product innovation and purpose-designed stores, which are resonating with customers and driving engagement. Our new store performance, combined with our strong China comp guidance, will give another year of double-digit revenue growth in the market, delivering on our momentum. Next, in thinking of our global new store growth, we expect global new store growth of approximately 7%, with approximately 75% of the growth still coming from outside of the U.S. as we continue to focus on our strategic global expansion, reaching nearly 41,000 stores globally by the end of fiscal year 2024. We -- of the approximate 7% growth, we expect our U.S. store count to grow by approximately 4% in fiscal year 2024, driven by our dynamic portfolio format, expanding our white space opportunity. We anticipate China will continue its rapid growth of approximately 13% in fiscal year 2024, given the attractive unit economics of our new stores. We expect the remainder of our growth will be driven by the robust development in our other markets around the world that are leveraging the strength of our brand internationally and becoming more global. The combination of our global comp growth that I discussed a few minutes ago and our global store growth as well as continued growth in our licensed business, sets the foundation of our consolidated revenue growth. For fiscal year 2024, we expect our consolidated revenue growth to continue in the range of 10% to 12%, albeit at the low end of the range. This does not include any impact from foreign currency translation. We expect the foundational elements of our growth will be partially offset by an expected high single-digit revenue decline in our Channel Development segment largely related to the sale of Seattle's Best Coffee and broad optimization. Absent those impacts, Channel Development revenue is expected to be flat year-over-year. We're proud to reinforce yet another year of double-digit revenue growth at the low end of a 10% to 12% range, building on a very strong fiscal year 2023 performance, all of which reinforces the confidence we have in our business and opportunities we see ahead. Shifting to operating margin. We expect progressive margin expansion in fiscal year 2024 as we continue to deliver efficiency both in and out of our stores, inclusive of approximately $1 billion in incremental high-return, growth-oriented investments balanced across our partners, stores, and customers across wages, new store equipment and enhancements, digital and product innovation, and supply chain modernization. We will also continue our focus and discipline in unlocking strategic efficiencies across our business, and have multiple work streams underway to support approximately $1 billion in incremental leverage opportunity. These efficiencies, paired with sales leverage and strategic pricing, support continued investment in our business even as we expand margin and grow earnings over the long term. We will provide greater detail around our efficiency work streams in our strategy meeting later today. In addition, we expect our Channel Development segment to continue to be accretive to overall operating margin, with operating margin expanding to the high 40% to low 50% range from their favorable portfolio mix. Moving on to capital allocation. Through a very disciplined approach to capital allocation, our return on invested capital in fiscal year 2023 approach 25%, a meaningful improvement from prior year. Equally important, we expect this upward trajectory to continue in fiscal year 2024. We expect our CapEx in fiscal year 2024 to be approximately $3 billion, with over 85% of our CapEx directly invested in our global store portfolio. We also expect to continue our stable dividend approach and remain committed to targeting an approximate 50% dividend payout ratio, displaying our confidence in our long-term growth and attracting a broad investor base, which benefits all stakeholders. As one of the highest dividend payers among high-growth companies, we are proud to have recently commemorated our 13th consecutive annual dividend increase with a CAGR of 20% over such period. Our capital allocation strategy has positioned us well to be able to continue significant business investments while retaining financial flexibility and maintaining our BBB+ investment-grade credit rating. Regarding tax rates in fiscal year 2024, we expect our effective GAAP and non-GAAP tax rates to be in the mid-20% range. This is higher than our fiscal year 2023 GAAP and non-GAAP tax rates of 23.6%, which benefited from certain discrete tax items that are not expected to reoccur in fiscal year 2024. In closing my guidance comments, we continue to expect fiscal year 2024 GAAP and non-GAAP EPS growth to be in the 15% to 20% range. Proudly, we expect our double-digit EPS growth will be a result of a balanced plan, compromised of both revenue growth and margin expansion. Overall, we are pleased with the durability of our business and strong foundation fiscal 2023 has set for fiscal year 2024, and our guidance is a product of our confidence in our continued long-term growth. We look forward to telling you more about our limitless opportunities in our afternoon strategy meeting. Before I close and turn it over to Tiffany, I want to thank the more than 450,000 partners who wear the green apron across the globe for their tireless contributions to create the experience that makes Starbucks such a meaningful place for all of our customers. It's because of you that I have such great confidence in the opportunity ahead. Tiffany?
Tiffany Willis : Thank you, Rachel. At this time, we'll proceed with our normal Q&A session, which will last until the top of the hour. Just for clarification, this Q&A session shall be focused on our fourth quarter and full fiscal year 2023 results and fiscal year 2024 guidance. Questions on topics outside of either of those should be held into our afternoon strategy meeting. Kevin, please open the call for questions.
Operator: [Operator Instructions]. Our first question today is coming from Sara Senatore from Bank of America. Your line is now live.
Sara Senatore : Thank you, very much. I had a question about China, please, which I think we've heard the competitive environment there very intense. And I was just curious if that was perhaps some of what we saw in terms of positive traffic, but perhaps a negative ticket, and then some of the investments you're making, and perhaps that might be gating factors for margin expansion? The positive same-store sales, I think, certainly suggest that your business is executing well. But just trying to get a read on competitive intensity and maybe implications for new unit economics and the margin structure for the business going forward. Thanks.
Laxman Narasimhan: Thank you for the question. Let me start with the answer here. Our brand in China is known as Shing Baka and it uplifts the everyday for millions of customers in China. And as Rachel said, our business is also strong, 5% comp in Q4. If you look at the first half of the year versus the second half of the year, the growth difference in the second half was 20% higher than the first. One thing you should know is that if adjust the morning daypart, the morning daypart for our business in China now is higher than it was pre-COVID. We have very strong local innovation. And to answer your question, if you look at the transactions that Rachel mentioned, we're very comfortable with the food and beverage transactions. And what we see there, including the price realization that we have, the ticket that you mentioned specifically points to merchandise, and what we had in the store, which we are still working through. But we feel very good about the competitive position of beverages, the competitive position of food. We feel very good about the cash returns of the stores that we are opening. They're very strong. The team has done a wonderful job in ensuring that the cost of builds are low, with the productivity that we have been able to accomplish in our stores. We feel good about the overall returns that we are getting there. And I'm heartened by the -- by how the business is coming together despite all the headwinds that have been there for the last couple of years.
Operator: Next question is coming from Jeffrey Bernstein from Barclays. Your line is now live.
Jeffrey Bernstein : Great. I had a question and then just one clarification. The question is on the U.S. comp. Laxman, I think you mentioned momentum sustained through the fourth quarter. Just wondering if you could offer any color on whether there's been any change in consumer behavior in recent months for better or for worse. I know there's some concern about affordability into a slowing macro, I was hoping maybe you could prioritize the greatest levers to reaccelerate the U.S. comp if they were to slow. And my clarification. Just Rachel, you gave fiscal '24 guidance. I appreciate the color. I know you mentioned 5% to 7% worldwide comp and 15% to 20% EPS. That worldwide comp is below the current long-term 7% to 9%, is it fair that those are still the long-term guidance metrics? Or might those be updated later today? Just trying to clarify the guidance you gave for fiscal '24 relative to the long-term guidance. Thank you.
Laxman Narasimhan: I'll take the first question and Rachel for the second. On the first question, clearly, we're reading all these statements about the macro uncertainty, and it's clear that we are navigating the uncertain economies and markets around the world. But rather than talking about the economy in general terms, let me just speak about what we see with the Starbucks customer. Customer demand for us remains strong. We're not really seeing any change in the sentiment in our customer base at this time. And I think what it does is it reflects the strength of the Starbucks brand globally, it reflects the loyalty of our customers, it reflects our position in their routine and it also reflects the long-term durability of this business. Now we, of course, watch all of this extremely carefully. Unlike 2008, which is the number that people have been tattling around, we have a widely more diversified set of channels that we participate in. We have digital relationships worldwide with over 75 million customers in terms of their last 90-day activity. But we can reach a multiple of those digitally. So, it's a much larger universe than what we would traditionally refer to as just our 90-day active users. So, we have the ability to reach our customers, and we have multiple levers in terms of how we deal with any uncertainty that we might see, and that's true as well in the U.S. So, I feel good about the momentum we have. We're obviously extremely watchful and humble about where we are, and we'll do everything we can to exceed the expectations of our partners and our customers. But we do have multiple levers to play. Rachel?
Rachel Ruggeri: Thank you for the question. The way I'd look at the comp guidance is as we look at a very strong fiscal year 2023, and as we move into FY '24, our comp guidance of 5% to 7% on the global comp guidance range as well as for North America, we believe, reflects both a healthy as well as achievable comp guidance that supports not only the strength that we've seen and the momentum, but it supports the confidence we have in the business. I think what's important to think about is we've been talking about a more balanced approach to how we drive our earnings growth. And so, when we look at comp, it's part of a broader growth narrative. Where we look at comp, we're looking at the performance of our new stores and the performance of our licensed stores. And collectively, that's supporting the revenue growth range that I provided. That, coupled with progressive margin expansion, gives us a balanced approach to achieving the 15% to 20% earnings growth guidance, which we believe is attractive but also reflects the confidence that we have in the business and the momentum that we're seeing.
Operator: Next question is coming from David Palmer from Evercore ISI. Your line is now live.
David Palmer: Thanks. Good morning. The Americas operating margin, 23.2%, up over four points, could you provide a bridge or describe the biggest contributors to this? Maybe not just by line item, but also, but what is the color behind that? What is going right operationally, both in the stores and in supply chain that's driving that? And of course, this is a lot higher than where the Street is for fiscal '24. I'm just wondering how we should be thinking about that margin for '24 as part of your guidance. Thanks.
Rachel Ruggeri: David, I would start with saying our guidance on margin for next year is progressive margin expansion. And remember, on a full-year basis -- even with the strength we saw in Q4, on a full-year basis, we achieved 100 basis points of margin expansion, which we're incredibly pleased with. In the quarter, in Q4, we saw very strong margin expansion, particularly in North America, the 420 basis points that we spoke about, that as the benefits of the reinvention have begun to amplify. And so, we expected that would amplify in the back half of the year, and that's what happened. And so, when you look at the drivers of that 420 basis points, the largest driver of it, around 340 basis points or so, is leverage we saw in our store operating expense. And that's really driven by, what I'd say, is the sustained operational efficiencies from our reinvention. So, the investments we made are fueling growth, investments in our partners, in wages, in training, in our new store and equipment, and that's leading to a more stable environment overall, which is supporting that leverage. It's allowing us to be more efficient in how we serve the customer. So that's the biggest driver in the quarter. Next is sales leverage, followed by a strategic pricing. And that sales leverage really comes from the fact that in Q4, our fall launch resonated with customers, and we saw record demand really across the globe, but largely in our U.S. business, and that also fueled the margin expansion. And then that all helped to offset the investments we've made, including investments in G&A, investment in partner wages, as well as investment in G&A. Now when we look to FY '24, we will expect some of that momentum to continue. But I would say it's more important to look on a full-year basis, and we'll continue to see margin expand more in line with what we saw on the full-year basis. But again, continued margin expansion. And it's that combination of strength in our revenue, but also strength in our reinvention, which is delivering very tangible financial results.
Laxman Narasimhan: If I could just add to this. Growth is clearly a real enabler of leverage, and you'll see that reflected in the various lines in our P&L. Additionally, we see efficiency opportunities. And later this afternoon, we're going to detail out a $3 billion savings program and efficiency over three years, with a big portion of that coming from outside the store in the supply chain, in particular, and you'll see that a portion of that is certainly coming out in our top line. And so, this gives us the real confidence as we look ahead around the kind of efficiency that we have, that gives us the ability to invest in the business and at the same time, deliver the progressive margin expansion that Rachel talked about.
Operator: Next question is coming from Lauren Silberman from Deutsche Bank. Your line is now live.
Lauren Silberman : Thank you. Congrats on the, quarter. Also, on just U.S. comps and traffic. Can you help unpack where the growth is coming from? Is it new customers, existing customers, rewards members or more occasional customers? And then can you give us an update on where you're running with transactions per store per day? Thank you.
Rachel Ruggeri: Lauren, I'll start by just saying, overall, our traffic continues to be strong and it's growing. So, when you look at the success of our performance in the quarter, particularly in the U.S., our highest-ever average weekly sales were driven by a combination of strength in traffic but also strength in overall ticket. And we saw a record number of customers coming into our stores and spending a record amount. Now those customers are both our rewards customers as well as our non-Starbucks Rewards customers. So, we're seeing growth in our customer base across the segments. And that's driving strong performance as each customer is spending more. And I think what's unique about our business, particularly over the past couple of years is we've evolved and adapted towards our changing consumer demands. And so, we're seeing total transactions growing overall, both in our comp stores, in our new stores as well as our licensed stores. And importantly, we're seeing units per transaction significantly higher. And that's driven by the growth we're seeing in drive-through as well as delivery, which has a higher attach rate or more group orders. And that's all leading to the stronger performance that we saw in the quarter and will fuel the momentum as we go forward. And in terms of traffic, when I think about FY '24, the comp guidance range that we provided includes continuing improvement in our traffic. So, our transactions per store per day improved this quarter versus last quarter and the year before. And we'll expect that improvement to continue in FY '24, as well as we'll continue to expect an improvement in ticket as we very purposely innovate around customization, more premium beverages as well as ensure we're able to continue to drive attach. And the combination of that will support our double-digit revenue growth that I guided to.
Laxman Narasimhan: If I can just add one thing to it. I think what has happened over the last several years is how much this business has evolved in order to meet the customer where it's at. And I think you're seeing that as well in traffic, in transactions, but also in what we're doing in purpose-defined stores, and later this afternoon, we're going to talk a bit about how we're going to lean in even further around how we meet customers where they are at.
Operator: Next question is coming from Sharon Zackfia from William Blair. Your line is now live.
Sharon Zackfia: Hi, good morning. Thanks, for taking my question. I was hoping you could give us an update as you talk about the transaction improving, how speed is improving or throughput, whether how you measure that in the drive-through or kind of on the front line as I would think of it walking into the store.
Laxman Narasimhan: Let me start and then Rachel can add to it. One of the things that the team has worked on incredibly on over the last year or so is putting in place a much stronger operating foundation in the stores. And I'm very proud of the progress that they are making. And that includes how we deal with the processes in the drive-thrus. You're seeing real improvement in terms of out of the window of time in the drive-thru. The team has put operating practices across these various formats. And I feel very good about the progress that they are making in that area. I think in terms of the automation or the equipment that we have also brought into the store, that has also been a driver of some of the changes that we have seen. I think just ahead of the summer, we were able to get in the portable cold foam blender into stores, which really helped our partners deal with the growth in volume on beverages in the summer. So, a combination of operating practices, the equipment that we are putting in place, all of that adds to much stronger operational foundation in our store, and we expect that to continue.
Rachel Ruggeri: The only thing I would add to that, Sharon, is that's all part of our reinvention. So, it's all about finding ways to be able to optimize the production environment so we can better support our partners in serving our customers. And to Laxman's point, we've seen tangible benefits in the quarter and actually throughout the year has driven improvements in our out-the-window time. We measure what good looks like, and we've made great improvements and there's more opportunity ahead. And that's helping us to not only more efficiently serve the customers, but it's what's leading to the margin expansion as well as the earnings growth that we're seeing. And we'll continue to further those, what I'd say, areas of focus in FY '24, specifically on staffing and scheduling as we continue to work on ensuring we have the right hours for our partners at their periods of preferences, which will create another level of stability in our store environment and greater engagement overall that will, again, help us in terms of the efficiency in serving our customers. So, we expect that momentum to continue.
Operator: Next question is coming from John Ivankoe from JPMorgan. Your line is now live.
John Ivankoe: Hi, thank you. There's been a lot of conversation this quarter about throughput, particularly at the drive-thru, but we can also talk in-store. Can you talk about your peak hour or peak 15-minute throughput opportunity? That firstly, you've already realized that you think you can realize with a more optimized store operational platform and especially having employees with greater tenure. How much more of an opportunity do we have from here?
Laxman Narasimhan: John, if I could take that on. Thank you for your question. We have more opportunities than what we have realized, but we make very good progress. If you look at staffing and scheduling and how we are working on that, I think we've made material progress in that area. And I think as a consequence of that, you've seen attrition levels now lower than where they were pre-COVID. You see tenures of partners in the store increase. And that's going to continue. I think if you just look at what we've been able to achieve with the investments that we've made in our partners with wages and other benefits that have been provided to them. If you take a look at the take-home income, on average for our partners on a year-over-year basis, it's up 20% on average. Now there's still more to come. If you go back to 2020 and you look at where we are right now, the number is about close to 50% higher, but we still have further opportunities. And I think what that's going to help us, it's going to help us at peak times. It's going to help us in the speak 15 minutes that you talked about. But also as we look at demand overall and we look at the portfolio of stores we run and how we work with digital with those, you're going to see a stock later this afternoon around how we find ways to simplify what happens in the store and also meet a broader set of demand with very careful choices about how we locate stores, what we do with stores, how we digitally amplify what we are doing in terms of demand. But also, in supply, how we link that with the equipment we're bringing in with a strong operating foundation. So, there's more opportunity than what we have now.
Operator: Next question is coming from Brian Harbour from Morgan Stanley. Your line is now live.
Brian Harbour: Good morning. Can I just ask about the step-up in your CapEx budget and what that's going to be directed towards? And I guess, more broadly, is there any sort of equipment rollout that you're kind of accelerating versus what you've previously talked about, or perhaps store remodels that could be accelerated?
Rachel Ruggeri: Brian, thank you for the question. Our CapEx will increase to around approximately $3 billion, and the majority of that, over 85%, will be focused on new store growth, increase in renovations. So, we're significantly increasing our renovations to about -- in the U.S., about 1,000 renovations next year. So, an increase in new stores globally, renovations, as well as equipment in the stores. But the larger percentage of it is really the new store growth globally as well as the renovation. The new equipment is equipment that we've spoken about, the rollout of further rollout of Negedice, for the rollout of Clover Vertica, some continuing work around refreshment and dispense. So, some of those opportunities around creating broader efficiencies to be able to create operational consistency across the stores. Then outside of that 85%, we'll be seeing supply chain modernization costs as well as some costs in China supporting an innovation and technology center. And so that's largely how the costs are made up. What we're encouraged by that is those tend to have very high return, they're very high growth-oriented investments. So, we expect to see improvement in our return on invested capital, much like what we saw this year where we achieved nearly 25% on our ROIC, given the very disciplined approach we took to investments last year. And we see this year as we increase our capital, our ability to continue to further that by making very disciplined choices in these high-return, growth-oriented investments.
Operator: Our last question today is coming from Danilo Gargiulo from Bernstein. Your line is now live.
Danilo Gargiulo : Thank you. Laxman, in the press release, you were mentioning that the reinvention plan is moving ahead of schedule. So which aspects of this acceleration are you most proud of? And which aspect do you expect to accelerate the most in the months to come?
Laxman Narasimhan: I'm very pleased with the way that the reinvention plan is implemented. A couple highlights I think the progress we've made on staffing and scheduling is extremely strong. Furthermore, if you look at what we've been able to accomplished with regard to efficiencies and the culture and the capability and the processes we now have in place in order to systematically attack these efficiencies across the business is actually very strong as well. What we are accelerating on top of that is how we think about purpose-defined stores and what we're doing in putting together a strong operating foundation in our stores. That is going to really help us as we create the infrastructure, we create the store footprint, against which we will add to the equipment that we have in stores. Our equipment pipeline, what we have, the way we manage our new equipment, what's coming in, that entire pipeline and portfolio management is entirely on track. And we feel very good about the progress we are making there. And I think that is something that we're going to continue to see going forward.
Operator: Thank you. That was our last question. I'll now turn the call over to Laxman for closing remarks.
Laxman Narasimhan: I want to thank you all for joining us this morning. I want to appreciate all your questions, and I look forward to seeing you all this afternoon when we have our strategic update, and when we get to celebrate our holiday launch with you. Thank you all for joining us this morning.
Operator: Thank you. This concludes Starbucks' Fourth Quarter and Full Fiscal Year 2023 Conference Call. You may now disconnect. |
MELI | 3 | 2,023 | 2023-11-01 22:01:09 | Martin de los Santos: Hello, everyone. I am Martin de los Santos, MercadoLibre's CFO. For those of you who haven't met me, I have been at MELI since 2007. First as a Board member and since 2012 as a public management team. For the past seven years, I have led the credit business and the last August when I took the position of CFO. I look forward to meeting as many of you as possible in due course. I am pleased to report a strong set of results in my first quarter of CFO with a strong successful third quarter across geographies, 2023 continues to show an attractive combination of growth and profitability with a record in income from operations, with strong momentum across geographies in both commerce and fintech MELI’s revenues growth accelerated. Mexico was particularly strong with revenues growing above 60% year-on-year, while Brazil also posted a greater performance with around 40% growth. These two countries have again increased their contribution to our total revenues. This strong business growth combined with cost discipline led to OpEx and SG&A dilution as the business continues to scale. Income from operations more than doubled year-on-year for the fourth consecutive quarter with margins expanding once again. Brazil was the largest contributor to our profit growth, representing a significant portion of it. During Q3, in the commerce business, we saw acceleration in GMV and items sold growth in the three main geographies where we operate with higher items provider. This higher user engagement come from continued experience improvements, especially on the logistics front where we reached 48% of fulfillment penetration and offer better delivery promises, improving conversions and further development of categories to technology. As a result, we have a record of 50 million buyers and market share gains, especially in Brazil and Mexico. Mercado Pago off-platform TPV accelerated in all main countries. We saw an increased number of users and higher engagement metrics as we position Mercado Pago as a comprehensive financial service provider. On the digital account, we are particularly excited about engagement with more people using the remunerated accounts and other asset management solutions in Brazil and Argentina and better NPS in Mexico from U.S. improvements. In payments, the highlight for Q3 has been online payment solutions represented strong growth across the region. The great business continues to perform within our expectations through very healthy spread levels. As we saw NPLs improving, particularly in Brazil, we have accelerated originations in all of our products. During Q3, we issued over 1 million credit cards and surpassed $1 billion for the first time. As our underwriting models continue to improve, we can tap into new opportunities offering larger credit lines with longer durations with the best offers of consumers. Overall, in Q3, we achieved a combination of rapid growth, scale gains and margin improvements, showing the strength of our economic model. To deliver these results, we have invested in technology and that provides a world-class user experience and enables us to be more efficient in terms of our cost structure. This results give us confidence to continue investing in future growth opportunities. And now let me get back to Richard with business news.
Richard Cathcart: During Q3, MercadoLibre we launched our loyalty program as MELI Mas, an important step to enhance our loyalty value proposition with a simpler structure, more compelling shipping benefits and premium video and audio content. With MELI Mas we now have a brand in which we can invest to raise awareness and increase engagement with MELI's ecosystem. MELI Mas gives users access to a world-class content bundle. Free shipping above R$29 and 12 months with free music from Deezer amongst other perks. Our content bundle for MELI Mas users includes Disney Plus and Star Plus and special discounts to subscribe to HBO Max, Paramount Plus, and Lionsgate Plus. Through Deezer, users are able to access a complete library of audio content and music, a service that we think users will be able to enjoy on a day-to-day basis. Users see the MELI Mas offering throughout our apps and website, where the value proposition becomes clear as they shop with us, with the MELI Mas logo clearly highlighted, building the brand of the loyalty program. The shipping benefits are key to the program. MELI Mas users get free shipping on millions of items above R$29, versus the standard free shipping threshold of R$79, if the product is in one of our fulfillment centers and chosen for delivery on the user's MELI delivery day. As consumers look for products on MercadoLibre, they will see the MELI Mas logo on the products that are eligible and they can filter their search for MELI Mas items. As a new delivery option, loyalty users can choose a specific day of the week to receive all of their packages. This solution enables us to sell and deliver lower value items with the great experience that MELI is known for, whilst maintaining cost discipline in our P&L. Users still have the option for same and next day delivery if they want their item delivered quickly, if they are willing to pay for shipping on items below the free shipping threshold, or for free for items above the threshold. To access all of these benefits, users can subscribe or earn their way in organically by engaging with MELI's ecosystem. Subscribing is quick and easy, and users can choose between a credit card, automatic charge from their MercadoLibre account, or a monthly invoice. So the subscription is accessible for different types of users. We're able to offer buyers the full benefits bundle for just the equivalent of two to three paid shipping charges. For users who earn points by shopping with MercadoLibre to get the MELI Mas membership, our credit card offers double points, enabling users to reach the loyalty status more quickly. In August, we launched a big marketing campaign to raise awareness of the program. And initial results give us confidence that MELI Mas complements our value proposition, bringing extensive benefits to even more MercadoLibre users. We're confident in the program's long-term potential because, as always, at MercadoLibre, the best is yet to come.
Operator: [Operator Instructions] And our first question this evening comes from Andrew Ruben from Morgan Stanley. Andrew, your line is open. Please go ahead.
Andrew Ruben: Hi. Thanks very much for the question and welcome again, Martin. Perhaps, Marcos taking advantage of your joining today. It's been a period of strength for the business. We've seen a lot of past year's investments flowing through to results. So as you look from here, say, over the next three to five years, I'd be curious to hear what the opportunities you see for MELI that you're personally most excited about still. Thank you.
Marcos Galperin: Hi, Andrew. How are you? Good to be here. Yes, we are really happy with the way the business has been evolving last 24 months, at least, really growing very nicely, gaining market share and lately also gaining scale and increasing margins. As you know, we don't guide, but there are many exciting things going on, particularly, obviously, AI. That hopefully will enable us to provide our users a better experience, enable us to launch innovative ideas, and also scale and gain efficiencies, whether it is in customer service, or whether it is in fraud prevention or whether it is in the way our developers, 15,000 developers, go about developing and performing quality control, et cetera. So obviously, looking forward for the next three years, I think that's a key thing to look into.
Andrew Ruben: Thanks.
Operator: Our next question comes from Irma Sgarz of Goldman Sachs. Please go ahead.
Irma Sgarz: Yes, hi. Thanks for taking my question. Congratulations on the results. Marcos, also taking advantage of you joining the call. If you're looking at the KPIs that determine compensation across the exact team or leadership team, how do you think these will evolve from here, again, thinking maybe over a multiple year basis? And asking the same question maybe in a slightly different way, are there any incrementally new KPIs to watch for as you go into this next phase of growth and investment or the Board feel should gain maybe perhaps more important to incentivize the right amount of investment versus risk taking?
Marcos Galperin: So, obviously, we try to compensate our – myself and the key employees based on long-term results, not in quarterly or even yearly – actually, our long-term retention program is a six-year program. And, obviously, we are in a very dynamic environment and a very dynamic business. If you look at MercadoLibre six years ago, both in terms of scale but also in the scope of things that we do and where we are today, extremely different companies. And I expect that to be the case in the next six years, whether it is in fintech that we are moving into, insurance that is already a business that has gained relevance and scale, whether it is assets under management that is growing so strongly across all of our geographies, whether it's our credit card business that didn't exist a few years ago and it's a very sizable business, our overall credit business. So, obviously, and there are new businesses that are coming along and that we expect them to gain scale and scope. And as they do, obviously, they will have a an impact in our results and in our compensation and in the KPIs, whether it is Mercado Play, which is our advertising supported streaming operation or whether it's Clips, which is our short videos launch, both of which are really gaining, really nice traction. So, obviously, there are many things that we're doing. And as they gain scale, they become important in terms of KPIs and also in terms of results and compensation. I don't know if that answers your question, Irma.
Irma Sgarz: Yes. I think that partly answer that. Thank you.
Marcos Galperin: Thank you.
Operator: Standby for our next question. And our next question comes from Marcelo Santos with JPMorgan. Marcelo, your line is open. Please go ahead.
Marcelo Santos: Hi, good evening. Thanks for taking my question. I wanted to discuss a bit the profitability and margin. It was a very strong print that you had this quarter, above the previous one. And in the previous one, you were indicating that you might give some back to reinvest in growth. But actually things improved from the previous quarter. So I wanted to understand what happened so that the improvement came? And how do you see this trade-off going forward? There's something new element that allowed the trade-off not to happen and you to grow and have margins at the same time. I just wanted to touch on this point.
Martin de los Santos: Thank you, Marcelo. It’s Martin here. Yes. In fact, we did have a great quarter in terms of profitability, reaching 18% EBITDA margin coming from last quarter of 16%. I would say that most of the businesses and countries performed extremely well during the quarter, particularly 3P marketplace that was the biggest contributor to margin improvements, but also the acquiring business, credit business, as well as the advertising business, in that particular order, also contributed to margin improvement. We look at by country-by-country, most of the improvement come from Brazil, where we improved 12 percentage points percentage points year-on-year, and Mexico six percentage points year-on-year. And also, we are gaining scale by growing as we did, we gained significant scale and were able to dilute part of our costs, which we obviously manage with a lot of discipline. Having said that, we have been investing behind our business, which is the main goal. We think that we are in -- we operate in an industry where we have a lot of investment opportunities that we need to make sure that we continue to look at the long-term prospects of the business. So we'll continue to invest in logistics where we increased 6 percentage points fulfillment penetration. We also, in this particular quarter, as we launched MELI Mas, we invested behind the brand to promote the new loyalty program. We continue to invest in smaller countries like Chile and Colombia. We have a team of 15,000 developers that continue to build our product and we're investing on our own product. So again, we are managing the business not to a particular target -- margin target, but we're managing for the long term. But this quarter was a very good quarter, not only because we improved the margins, but also because we grew, gained market share, in particular Brazil and Mexico.
Marcelo Santos: Okay. Thank you very much.
Operator: Standby for our next question. And the next question comes from Maria Clara Infantozzi with Itau BBA. Maria Clara, your line is open. Please go ahead.
Maria Clara Infantozzi: I'd like to start a bit about the credit business in Brazil. You mentioned that you just accelerated the penetration in the longer duration consumer products here. Can you please elaborate on that? Should we expect a shift in MELI's credit concession strategy in Brazil? And so far, how have you been receiving the evolution of the credit quality of those new cohorts, please?
Osvaldo Gimenez: Hi, Maria. Yes as we mentioned, saw an increase in the spreads we are seeing in Brazil and, therefore, felt confident to increase the pace of origination in our consumer business there. And we are -- so far, we're happy with the results we are seeing, and we continue to accelerate the pace of originations. And we have also increased the pace of issuing credit cards in Brazil. For the same reason, we are encouraged by the results we are seeing and how every time we create royal we have better, better credit scoring and solutions. .
Maria Clara Infantozzi: Thank you so much.
Operator: Standby for our next question. And it comes from Kaio Prato with UBS. Kaio, your line is open. Please go ahead.
Kaio Prato: Hello, everyone. Good evening. Thank you for taking my question. My question is also on the FinTech business, please. You mentioned during the presentation the importance of credit card strategy, to be the main financial provider of choice of your users. So in light of this, my question is, out of your almost 50 million unique FinTech users, how many clients see Mercado Pago as a principal digital account nowadays? If you have some percentage of principality that you can share. And how much do you think you can achieve in the future, please? Thank you.
Osvaldo Gimenez: Kaio, we have not disclosed in the past principality. What we have disclosed, and this continues to be the case, is that when we look at all of our users in a given country, particularly in Brazil, which is the one country where we have more of our credit portfolio and more of our credit products launch, what we are seeing is a continuous increase in the amount of products that our users are using and in the availability, not only of consumer credit but also of credit cards. And these two, together with asset under management, which is growing near triple digits in Brazil and Mexico and over triple digits in Argentina, are, I'd say, a key component of a user becoming principal. So all of the metrics are going in the right direction. The other one is TPV generated both by a credit card and a debit card. But we have never disclosed a principality measure.
Kaio Prato: Okay. Thank you very much. And just to follow-up, my last question on the -- credit card business. How are you seeing the discussion about the change in framework of credit cards in Brazil nowadays? And what could be the impact on your side, not only in terms of potential P&L impact but also in terms of your appetite for further increased origination on credit card?
Pedro Arnt: Sure, Kaio. So I think that -- this is not the first time that this is discussed in Brazil. I think the jury is still out. There are many things that are being discussed. One of them is having a potential cap on interest rates. Other one is probably limiting to some degree -- or interest-free interest rates. And the third one is probably putting a cap on the interchange each of those would affect us in different ways, still very early. Until we have the details, we are not able to tell. We believe that [indiscernible] is a key driver for consumption in Brazil and probably that should limit how much that is affected.
Kaio Prato: Okay. Thank you very much.
Operator: Our next question comes from Scott Devitt with Wedbush. Please go ahead.
Scott Devitt: I had two questions. Maybe a different spin on the first question, which is, Marcos, back in 2019, this was like a little over a $2 billion revenue business, doing like $1.1 billion in gross profit. And you're approaching like 7 times those levels now. So the growth through the pandemic, and comping the comps everything else, it's almost unprecedented, and yet you're growing at rates that are similar to where you were growing back in 2019. So I'm curious, as you think about like what's transpired over the last 4 years, if you can kind of frame how you think about the mainstream in e-commerce because of the pandemic and how that may have benefited a market like Latin America uniquely relative to other markets versus drivers of the business that were more company-specific like improvements in the e-commerce experience because of faster shipping times and things like that are the benefits of having a broader ecosystem with payments? Just how you think of the components or the build of how this business has gotten so big, so fast and just keeps growing at this pace. That's kind of the first question. And then the second one, if you could just talk a bit more about the advertising business in the quarter. I didn't -- I may have missed it. didn't see the absolute amount. But if you can just talk about how that's trending and how you're thinking about the ad business longer term. Thank you.
Marcos Galperin: Okay. Thank you Scott, so yes, COVID was in general around the world is very good ecommerce company, and the same thing happened in Latin America. We basically doubled during COVID, during those two years, 2021 and 2020. But unlike what happened in other parts of the world, we continue to grow at a very healthy rate once life resumed to normal. We're very happy about that. We think that we had done prior to 2019 a lot of things. We had invested a lot of money and efforts on mostly technology, so got us at the right time, in the right place. We were able to benefit, I think, more than other players in the region when that happened. And since then, when we grew in scale, obviously, the power of the ecosystem is very strong, and we continue to add features and functionalities and products to this ecosystem, advertising being one of them. Financing on the credit cards being another one, insurance being another one. And more recently, all the content plays, whether it's our partnership with Disney and other great content providers that we are distributing through MELI Mas, or whether it's or whether it's Mercado Play our Clips. So we continue to add features and functionalities and products brands. And I think we have a -- we have created something that is pretty unique in the region and around the world, and each part strengthens the other. And we have a lot of scale. As you mentioned, we are seven times the size we had a few years back. And more importantly, our growth rate is still very healthy, and we have a very strong balance sheet, and we intend to continue innovating, continue investing and continue focusing in the next 5 to 10 years and not in the next three to four quarters. And then Ariel can give you more background on advertising.
Scott Devitt: Thanks.
Ariel Szarfsztejn: Scott, Ariel here. So ads continue to grow well. We grew above 70% in revenue this quarter for the sixth consecutive quarter. with no major changes in strategy. We continue improving our product with feedback from advertising and promoting our solutions to different segments of sellers and brands. Product ads continues to be the main driver of growth, specifically the self-service sellers, but we are seeing more and more traction from other segments as well. . Overall, we had a quarter with 1.7% of penetration of ads as a percentage of GMV, but I think it's worth highlighting the case of Argentina. So structurally, given market dynamics, Argentina has a lower penetration. And if you were to factor in there the fact that inflation makes it even harder for advertisers to follow up our GMV growth, and also the effect of having a bit lower demand from advertising in Argentina because of structural context, more out of talks and some other effects, it's worth saying that if you were to take out Argentina of the equation, penetration advertising in our GMV, would be roughly close to 2%.
Scott Devitt: Thank you, both. Great.
Operator: Our next question comes from Melissa Byun with Bank of America. Melissa, your line is open. Please go ahead.
Melissa Byun: It may actually be Bob Ford. Congratulations on the quarter. How much of the Brazilian GMV growth is coming from markets where you now have a distribution center and faster shipping within Brazil or before you were sending that from Sao Paulo or a more distant location? And then what percent of GMV is now being delivered on a MELI delivery day? And where do you expect that to stabilize as we move forward? And then lastly, can you discuss your use of AI in search product recommendations and risk plays? Thank you.
Ariel Szarfsztejn: Hi, Bob, this is Ariel. Thanks for your questions. I think we don't typically disclose demand data based on geographic segmentations or even logistics methods. But I would say more and more we are trying to grow on both of the segments that you have highlighted in your first two questions. So we are being proactive in trying to gain traction and market share in some of the regions where our market share today is underrepresented. That means that we do see increased demand coming from areas that are more far away from our fulfillment center. Still the main capitals and cities of Brazil do concentrate a big share of our demand. Kind of same thing happens with MELI Delivery Day. It's still super early days. So not many data or not much data to be shared on that regard. But I do I want say that it's slowly gaining traction, of course, aided by the launch of Melimise in Brazil and in Mexico. So more and more, we are seeing consumers actively choosing the MELI Delivery Day as a way to receive the packages. Last question in terms of AI and search, we are working on that. I mean we are putting a lot of effort into building solutions around AI. I think we don't have much to disclose as of now, but search, reviews, questions and answers, buy box and products, as Marcos was saying, copilot for our developer. We're looking at the broad range of AI uses for MercadoLibre to boost consumer demand and efficiency. And we're happy with the progress that we have so far, but not much to be said yet.
Osvaldo Gimenez: And building on that, we have been using AI for a long time now for many, many years, both in terms of fraud prevention and credit scoring. Both two instances, they are pretty much use cases which are ideal for AI, because we have, in the case of fraud prevention, millions of transactions every day and with a clear outcome, either fraud or not fraud. So with the right variables, we can build a very strong model that has predicted and have really best-in-class fraud prevention. And with that knowledge and given the experience we have been building on credits, we have also been -- built our credit scoring models leveraging the AI.
Melissa Byun: Makes a lot of sense, Osvaldo. It seems like with the larger data lakes, faster processing speeds, more sophisticated LLMs, it just gets better. And then, Ariel, just to follow up, can you comment a little bit in terms of where you do have consumers choosing a delivery day, are you seeing materially improvements -- or improved densities and improvements in terms of average shipping costs? Or is it still a little bit too early to discuss?
Ariel Szarfsztejn: Yes. So I think it is early to discuss. We are seeing some efficiencies in our operations driven by the fact that we can consolidate shipment and take advantage of some of our idleness when we operate, I think or density in distribution, believe it's too early. So again, I'm sorry for this, but not many details to be shared. I would say the variables are moving in the direction that we expect, but too early to share numbers behind that.
Melissa Byun: Understood. Thank you very much.
Operator: Thank you. And our next question comes from Marvin Fong with BTIG. Marvin, your line is open. Please go ahead.
Marvin Fong: Good evening. Thanks for taking my questions, and congratulations on the great quarter. I'd like to ask maybe a two-part question on cross-border. So in Mexico, I think your shareholder letter cited you grew very strongly there, which is interesting because I think Temu only recently entered the country, is also seeing some strong adoption. So could you just discuss how you see the cross-border market in Mexico evolving? Is it that Temu's entry is actually growing the pie for everybody? And the second part of the question is, how might this inform your strategy in Brazil, as I understand your cross-border penetrate – or the mix relative to your GMV is very low, but that presents an opportunity for you? And then I have one other question.
Ariel Szarfsztejn: Thanks, Marvin. So I'd say before going into the details first and foremost. Over the last 24 years, we've been always competing with players from all over the world. So in a sense, we are used to having new entrants trying to get a pie of Latin America. We've seen Temu get into Mexico, in particular, in May, more or less. We've seen them making progress in app downloads and monthly active users. They seem to be spending a lot of money on marketing on social media, directed consumers, has been trying to download their app. We are, obviously, monitoring that closely. But our data suggests that there is a bigger overlap between that business and the one with other cross-border platforms. Our business in the meantime continues to perform really well, as shown by the acceleration of items sold to 38%. Unit growth has been strong across the board, including categories where some of those players are focusing on, and all ASP ranges. And our competitive advantages remain untouched, I would say, particularly logistics, which enables us to deliver fast shipping and payments, which allow us to provide attractive financing to our users. So in the end, our playbook remains the same. We continue strengthening our business with more sellers, more brands, more assortment, more financing, faster delivery, while we also continue investing in improving our own cross-border trade capabilities. And also through MELI Mas, we think we are also now offering free shipping on lower ticket items, which was not the case in MercadoLibre up until two months ago. Moving into the second part of the question, which is Brazil. I think [Remesas Conformes] is still too new. So it's hard to say. We have applied the program. We got accepted just a few weeks back. So not so much to share. But we remain confident, as I was saying, for Mexico, that the combination of fast deliveries, local payments and financing, a strong brand, buyer trust will continue to differentiate MercadoLibre versus our other companies. And simultaneously, if the new regulation allows so, we will continue building capabilities as to be able to compete in cross-border in Brazil as we are doing it today in Mexico, in Chile and Colombia.
Marvin Fong: Sure. And just my follow-up, a bigger picture question. I think it was a very strong quarter in terms of acquiring more fintech active users. And I was just curious beyond what you wrote in the shareholder letter, could you elaborate on what's driving that? Was it more internal initiatives? Or do you think it was some component just from the broader economy and whatnot? So just would love some color there. Thank you very much.
Osvaldo Gimenez: So I think there are several factors contributing to that. One of those is our remunerated account [indiscernible] both in Argentina and in Brazil, which is doing very well. What we pay our users depends on what the risk-free rate is in each of the countries. In Brazil it's around 13%; in Mexico around 10%. In Argentina, given recent spike in inflation and interest rate, it has been close to 100%. So this gives users a huge incentive to move out of banks with savings accounts, which many times pay zero, or only pay after 30 days, and move their money into Mercado Pago. I think that has been part of the driver. Another part of the driver, I think, has been, as we were saying, the increased availability and offering of credits that we're giving out, in that case, I would say it's mostly, in the case of – in Brazil and in Mexico, not so in Argentina, where we have been cautious given this rate environment.
Marvin Fong: Thank you very much. Appreciate the color.
Operator: And our next question comes from Trevor Young with Barclays. Trevor, go ahead.
Trevor Young: Great. Thanks. On the MELI Mas subscription plans, is there any color that you can share on initial subscriber counts here in the first four – two or three months, excuse me? Is that ramping as you expected? And then second question, can you give us an update on where we are in terms of logistics monetization? I realize you've indicated it will be gradual over a number of years, but just any update over the last few quarters would be helpful. Thank you.
Martin de los Santos: Thanks all for your questions, Martin here. I think it's too early to tell. As Ari mentioned before, we launched this program a few months ago. We are seeing good engagement with the program as well as with the MELI Delivery Day, but it's too early to share numbers in terms of adoption. I think in the coming quarters, we'll be -- we will share more information. But we are excited about the program. Ari?
Ariel Szarfsztejn: Yes, Trevor. So on monetizing shipping, I think our Q3 results and our year-to-date results show that we have been able to pull levers to offset some of the headwinds that we have in shipping from higher inflation rates in the logistics environment and higher fulfillment penetration that has helped us keep our total net shipping costs over GMV broadly stable in 2023. I mean, we still think that we have plenty of opportunities to improve our net shipping costs by focusing on productivity, efficiency, scale benefits, et cetera. But we also want to incentivize more sellers to use our fulfillment solutions, particularly in Brazil. So in all, there is potential to monetize fulfillment, specifically in the future if we decide to do so. But as we – we have always said, are not in a rush to do that. We are always mindful of what monetization might imply for consumer prices and competition. And we are happy with the way we are managing our P&L in general.
Trevor Young: That’s helpful. Thank you, both.
Operator: Thank you. And our next question comes from Geoffrey Elliott with Autonomous. Geoffrey, your line is open. Please go ahead.
Geoffrey Elliott: Hello. Thanks very much for taking the question. I wanted to touch on the off-line POS business in Brazil, it looks like fintech services take rates were down a little bit. We saw that you rolled out some pricing there that is cheaper for the merchant, but clearly, less beneficial for you, it looks, in terms of the MDRs that you're charging. And the publicly traded competitors, obviously, stock prices are a fraction of what they were a couple of years ago. Can you just remind us, how does that off-line POS business fit with the rest of MELI? What is the synergy there? And then if you're thinking out 5 years, 10 years, how is that going to fit into the rest of what you're doing? Does it still really make sense for that business to be a focus? Or is it something that could become smaller over time or maybe doesn't make sense to keep over time? Thank you.
Osvaldo Gimenez: Hi, Geoffrey. We see the POS business, the in-store business as a big part of our fintech offering. We allow merchants to charge with Mercado Pago offline. Some are very small merchants, some are SMBs, and even some are larger merchants. And we have been able to provide this solution in, I'd say, in a very profitable way, and we continue to do so. The profitability behind our POS business has been very good throughout the quarter. We have seen some -- have to make some changes as we move upmarket. Some of that is related to what we saw in terms of changing our go-to-market strategy. As we attract larger merchants, in some cases, what we do is we offer lower processing fees. But we get -- on the other hand, it's better for the merchant because they get lower fees, as you said. But it's good for us too, because what we see is higher activation rate and higher TPV per device. So not necessarily we're getting a lower margin in terms of margin on top of TPV, but we're getting a larger margin per device sold. And so I think that this continues to be very good for us. I'd say I'd add to that on the POS front, in this quarter, we have been changing -- making some changes beyond pricing in terms of our go-to-market strategy, and we are very encouraged by the results we're seeing, again, in terms of activation and TPV per device.
Geoffrey Elliott: And the synergy with the rest of the business with this POS machine operation, where is that?
Osvaldo Gimenez: So we are offering, I would say, on two sides. On the one hand, is many merchants, they sell online, they sell offline, through MercadoLibre they sell through the POS. So there's a synergy there in having pretty much all of their sales coming through Mercado Pago to them. . On the other hand, many of these merchants, in some cases, are individuals, and we are able to cross-sell different products to them and offer more banking products to them basically. So we offer them -- it's not only the device we're giving them and the process we're giving them. We're offering them a credit where they invest in [indiscernible]. We have started to offer them a credit card to individuals based on the business they run. And so really is part of our banking solution, and there are many products we're offering to them. There's a good synergy between all of the rest of the banking products we offer.
Geoffrey Elliott: Great. Thanks very much.
Operator: Thank you. And our next question comes from Neha Agarwala with HSBC. Neha, your line is open. Please go ahead.
Neha Agarwala: Thank you so much and congratulations on the strong quarter. Just two quick questions. First, on the 1P business, we talked earlier in the year about some acceleration, gradual acceleration in the 1P business. How is that going? And what is the vision going forward? And my second question is on the credit quality. There was a little bit of an uptick for the early delinquencies. Could you explain to us where is that coming from? Despite some pickup in the loan growth, maybe Mexico is not doing as well. So if you could talk a little bit about the early delinquencies and about how the portfolio in Mexico is performing, that would be very helpful. Thank you so much.
Ariel Szarfsztejn: Hi, Neha. This is Ariel. So 1P grew 58% year-over-year on a consolidated basis. If you were to look at this by country, Brazil actually grew considerably more than this. So the way we think about it is that 1P remains a strategic priority for us. We see this as a key lever to compete and gain market share in certain categories, consumer electronics being one of the clearest probably examples of that. We are very happy with the transformation of our 1P business over the last 12 months. We've had major improvements in our ability to manage pricing, promotions, stocks with the help of technology. We have also seen significant improvements in the way we connect and relate with suppliers and the way we negotiate with them. We think that all these progress are structural gains that will put the business on strong footing for long-term growth and market share gains. So we remain optimistic and keep investing behind that business.
Osvaldo Gimenez: Neha, and with regards to NPLs in Mexico, let me split that in two. On the merchant side, NPLs have remained very flat. The spreads are very healthy. So very good results. And we have been able to increase origination. And then on the consumer side, actually, they have increased a little bit, but by design. What happened is our spreads are very healthy we decided to take a little bit more risk and to increase the amount of origination, and that usually comes with slightly higher NPLs. But those have been priced in, in the rates we are offering. So spreads continue to be super healthy in Mexico. And that was part of the strategy, to grow faster, even though NPLs may increase, it's priced in already.
Neha Agarwala: Perfect. If I can follow up on the 1P. Could you give us some numbers regarding the penetration as a percentage of GMV, where it was at the end of last year where it is now currently, just to get an understanding of the pace of growth? Thank you so much. .
Osvaldo Gimenez: Yes. So penetration keeps improving, increasing, particularly in Brazil, we're in the low or mid-single digits, around 3% or 4% penetration. Again, we are extremely happy with the progress that we've made so far, and we'll keep investing in growing the business, while continue also improving our profitability, which has been the case this quarter.
Operator: Stand by for our next question. And it comes from João Soares with Citi. João, your line is open. Please go ahead.
João Soares: Thank you. Hi, everybody. I have two questions here. One, the first one, I just wanted to hear a little bit about Black Friday preparations. We've been hearing a lot of news how excited the company is, and maybe talk a little bit about any expectations in terms of the winning categories here. So any granularity in terms of our expectations? And the second question is talking a little bit about the 1P, just to follow up on that. In regards to profitability, how that -- you talked about in the press release about improving profitability. So just wanted to hear a little bit about where we are right now and where do you think we could be? I know the company doesn't guide, but any qualitative message on this would be appreciated. Thank you.
Ariel Szarfsztejn: Yes. Thanks, João. This is Ariel. So Black Friday penetration keeps us busy for sure. We are extremely excited with the way our company has been performing, and we think and are expecting to have a great big season. All of our teams, commercial, marketing, shipping, they are all preparing the work has to continue with the inertia that we had this quarter and this year and having a great event, both in Black Friday, Christmas, et cetera. We know this is a relevant moment for our consumers, and we want to be there satisfy their needs. Regarding profitability, as I was mentioning before, we see very strong profitability improvements, particularly in Brazil. I think we are getting smarter in the way we buy. So having better negotiations, which give us better terms. We are getting better at managing inventory. So our days of stock are getting better and hence, our working capital as well. We are getting also smarter in the way we price the items we sell. And we are also working a lot in taxation efficiency, which is key to compete in Brazil. So again, we are moving and pulling all the levers as to make this a strategic and profitable business for the company. We are yet not there, but we'll continue to be working in that direction.
João Soares: Perfect, Ariel. Thanks.
Operator: [Operator Instructions] Our next question, that comes from Deepak Mathivanan from Wolfe Research. Deepak, your line is open. Please go ahead.
Deepak Mathivanan: Great. Thank you so much. Hi, guys. A couple of questions. So first, can you give some additional color on the improved loyalty program? What are you seeing in the early days in terms of frequency, average spend compared to a non-member from the program. I know it's in early stages, but any color there would be great. And then the second one, the Central Bank interest rate is coming down in Brazil consistently. We just saw another cut today. Can you remind us the implications of this to your business on profitability? I guess, I mean we can wait for the Q to see the financing revenues. But wondering if there is a way you can help us the benefits to EBIT from the dynamic in last few months. Thank you so much.
Ariel Szarfsztejn: Hi, Deepak, Ariel here. So we don't disclose specific data on Melimise yet. But I would say, on the one hand, our old loyalty program, L6, already generated an increase in frequency and GMV per buyer whenever they decided to subscribe our program. We are seeing the same or an even better trend with the new subscribers who are joining our MELI Mas program and also with the existing subscribers who are getting used to the new benefits and the new value proposition of our program. So in general terms, we are excited with the engagement that we see in the platform. Again, too early to be seen. Communications has just started. Our product keeps evolving. So we have many, many things to continue working on as to make customers even more aware of all the benefits and the way they can interact with that program. So, excited, but I don't know, hopefully, we'll be able to share more details in the next call.
Osvaldo Gimenez: And with regards to interest rates coming down in Brazil. It tends to be good for us. for, I'd say, for several reasons. Mostly on the marketplace where interest rates are lower, we tend to see more transactions on those transactions where we charge our interest rate. And then for what we offer as [indiscernible] then the price tends to be -- the cost tends to be lower for us, so profitability improves. And then on the fintech side, I would say it's also positive but closer to neutral because many times what happens is competitive pressures make that we have to pass those savings to merchants. That has been the case when rates increase and will probably be the case as we decrease. So overall, it's positive for us.
Operator: Our last question comes from [William Wang] with Susquehanna International. William, your line is open. Please go ahead.
Unidentified Analyst: Hi, guys. Thanks so much for squeezing me in here at the last minute. I just wanted to quickly ask on credit. So last quarter, I think there were comments about expanding lending into mid-risk segments, no higher risk segments just yet. So I just wanted to ask what were you seeing there? Were there any surprises or adjustments that you encountered?
Osvaldo Gimenez: Actually, that is exactly what we're doing. We have been increasing originations in Brazil, both on the on the consumer credit side and credit card side. On the consumer credit, probably what's happening is, to some degree, we are -- remember, up until a year ago, we were issuing more credit, then we became more restrictive. So you don't yet see this impact in terms of the total portfolio. But originations are up, and we are expanding, as you said, into the mid-risk segment. And also on the credit card front, we have been able to expand our offering, and that's where we are issuing more cards by -- also by addressing this mid-risk segment and incorporating more information from third parties into our models.
Operator: And this concludes the question-and-answer session. I would like to turn it back now to Martin de los Santos, Chief Financial Officer for MercadoLibre.
Martin de los Santos: Thanks, everybody, for your questions. I'm looking forward to reporting back to you next year with our fourth quarter results. Good night.
Operator: Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. |
QCOM | 4 | 2,023 | 2023-11-01 19:40:05 | Operator: Ladies and gentlemen, thank you for standing by. Welcome to Qualcomm’s Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded November 1, 2023. Playback number for today's call is 877-660-6853. International callers, please dial 201-612-7415. The playback reservation number is 137-41-657. I would now like to turn the call over to Mauricio Lopez-Hodoyan, Vice President of Investor Relations. Mr. Lopez-Hodoyan, please go ahead.
Mauricio Lopez-Hodoyan: Thank you, and good afternoon, everyone. Today's call will include prepared remarks by Cristiano Amon and Akash Palkhiwala. In addition, Alex Rogers will join the question-and-answer session. You can access our earnings release and a slide presentation that accompany this call on our Investor Relations website. In addition, this call is being webcast on qualcomm.com, and a replay will be available on our website later today. During the call today, we will use non-GAAP financial measures as defined in Regulation G, and you can find the related reconciliations to GAAP on our website. We will also make forward-looking statements, including projections and estimates of future events, business or industry trends or business or financial results. Actual events or results could differ materially from those projected in our forward-looking statements. Please refer to our SEC filings, including our most recent 10-K which contain important factors that could cause actual results to differ materially from the forward-looking statements. And now to comments from Qualcomm's President and Chief Executive Officer, Cristiano Amon.
Cristiano Amon: Thank you, Mauricio, and good afternoon, everyone. Thanks for joining us today. In fiscal Q4, we delivered non-GAAP revenues of $8.7 billion, and non-GAAP earnings per share of $2.02 above the high-end of our guidance. Revenues from our chipset business of $7.4 billion reflect a more stable Android handset environment. Licensing business revenues were $1.3 billion. During the quarter, we also made significant progress on our leading technology and product road maps while improving operational efficiency. We remain fully focused on our future growth and diversification opportunities. Let me now discuss key highlights from the business. As we enter the age of generative AI, we're seeing an unprecedented pace of innovation. On-device Gen AI is evolving in parallel with Gen AI in the cloud enabling entirely new use cases. It has the potential to change how we interact with our devices making the user experience more natural intuitive, relevant and personal with increased immediacy, privacy and security. We have quickly established Qualcomm as a leader in on-device Gen AI for smartphones, next generation laptops, XR and automotive, and we are well-positioned to benefit from this opportunity. We expect high performance on-device AI to become a requirement over the next few years, driving content, units, or both. Our Snapdragon platform is highly differentiated from its competitors. First, we significantly increased the AI processing performance in power efficiency of our best-in-class NPU, CPU and GPU. Second, we are collaborating with multiple partners in ecosystems to enable a host of consumer and productivity based AI models running natively on our platform. Third, we're enabling multibillion parameter Gen AI models to run continuously and concurrently for multiple use cases, including multimodal. For example, in the latest Snapdragon 8 Gen 3 smartphone platform, state-of-the-art large language models, such as Llama and [Vicuna] (ph) up to 10 billion parameters are running at up to 20 tokens per second. And large vision models such as stable diffusion can generate images from text in less than one second with ultra-low power consumption. As always running on-device Gen AI becomes pervasive we believe it will create one of the most significant changes in user experience similar to the transition from the feature phone to the smartphone and the introduction of the graphical user interface for PCs. Snapdragon will play a significant role in this transformation. We also reached an important milestone in our expansion into PCs with the announcement of our Snapdragon X Elite platform. It is the result of a relentless pursuit to create the ultimate intelligent computing experience and establish Snapdragon as the industry leader in performance and power efficiency. The Snapdragon X Elite includes our first implementation of the custom Oryon CPU, which exceeds the multi-threaded CPU performance of any x86 or ARM competitor in its class. It also matches the single-threaded CPU peak performance of the leading x86 CPU competitors at 70% less power. Additionally, our premium integrated Adreno GPU delivers up to two times faster performance than the competition at ISO power or matches competitor peak PC performance as 74% less power. Snapdragon X Elite also features our newest Hexagon NPU. With 45 tops of performance, the Hexagon NPU is capable of running Gen AI models with over 13 billion parameters on-device. In total AI performance of the Snapdragon X Elite across CPU, GPU and NPU is 75 tops, the highest in the industry. Microsoft is redefining the entire Windows experience with the AI Copilot and the Snapdragon X Elite is built from the ground up for this opportunity. We look forward to PCs powered by Snapdragon X Elite from leading OEMs starting mid 2024. The merging of physical and digital spaces remains a significant future opportunity for Qualcomm and we recently launched a Snapdragon AR1 platform, our first dedicated platform for smart glasses. AR1 Gen 1 was developed in close collaboration with Meta and powers the new Ray-Ban Meta smart glasses. It features a dual ISP camera system for premium photos and videos as well as powerful on-device AI for image enhancement virtual assistance, real-time translation, visual search, and more. Together with Meta, we're developing next generation technologies to create the future of spatial computing. The AR1 Gen 1 along with a previously announced Snapdragon XR Gen 2 are a testament to the strength of this long standing partnership. Across the industry, Snapdragon remains the platform of choice for all leading VR, MR and AR designs. In networking, we continue to be a global Wi-Fi leader across enterprise and home networks as well as broadband gateways. Our Wi-Fi 7 solutions are seeing strong traction with more than 350 design wins across all categories to-date. We recently announced several new collaborations, including with Charter Communications in the U.S. and EE in the UK, both of which are preparing to roll out enhanced next generation Wi-Fi 7 connectivity to the residential and small and medium size business customers. We’re excited about the launch of our Fiber Gateway Platform which adds 10 gigabit passive optical network capabilities to our portfolio. With Fiber, in addition to 5G and Wi-Fi 7, we're now positioned to lead in next generation broadband solutions. Additionally, our unique service defined Wi-Fi technology signature feature introduced with our Wi-Fi platforms offers a unified data flow management architecture from cloud to device. It delivers orchestration, classification, scheduling, and insights to enable the end-to-end management of home networks in real-time optimizations across devices. In automotive, the digital transformation of the industry continues to bring new levels of computing, intelligence and cloud connectivity to the vehicle. These trends are driving new user experiences, advancements in driver assistance, autonomy, and safety. They also offer the potential for new revenue opportunities as vehicles gain the ability to evolve with over the air updates in digital services. The vehicle is becoming software defined and the Snapdragon Digital Chassis remain at the center of this transformation. We are pleased that our Digital Chassis solutions will bring advanced capabilities to the upcoming Cadillac ESCALADE IQ, which is planned for commercial production in 2024. The Cadillac ESCALADE IQ will be equipped with the Snapdragon Cockpit, Snapdragon Auto Connectivity and Snapdragon Ride platforms. Additionally, we're proud of our partnership with BMW for all vehicles as well as the upcoming Neue Klasse. We're also excited that the Snapdragon Digital Cockpit and Connectivity solutions now powered the new Mercedes Benz User Experience starting with the 2024 E-Class sedan. We recently expanded our Digital Chassis offering with the launch of two new platforms for two wheelers and other vehicle classes such as motorcycles, e-bikes, scooters and all-terrain vehicles. Our new platform design wins and launches with Gogoro Harley-Davidson and others are receiving positive feedback from the ecosystem on their ability to advance technology development and bring new user experiences to these vehicles. Finally, we announced a new long-term relationship with Amazon Web Services to enable automakers to integrate cloud technologies into their vehicle development lifecycle. The offering combines the Qualcomm Cloud AI 100 solution our Snapdragon Ride platforms as well as AWS breadth of services and capabilities. This will advance the future of software defined mobility and change how vehicles are designed and developed. In handsets, we announced our latest premium mobile platform the Snapdragon 8 Gen 3, which delivers industry leading performance and extraordinary experiences to consumers for the upcoming Gen AI era. Some key features include intelligent capture with the world's smartest AI powered camera, console level gaming with ray tracing with global illumination, studio quality audio, the world's first XSPAN technology, best-in-class connectivity, and the world's fastest on-device AI processing on a smartphone. We look forward to flagship device launches powered by the Snapdragon 8 Gen 3 by global OEMs and smartphone brands, including Xiaomi, Honor, OPPO, Vivo, OnePlus, Sony, and More. In addition, we recently entered into an agreement with Apple to apply Snapdragon 5G Modem-RF systems for smartphone launches in 2024, 2025 and 2026. This agreement reinforces our track record of sustained leadership across 5G technologies and products. We are proud of our ongoing relationship with Apple. As we look forward, our technology roadmap has never been stronger and the fundamentals of Qualcomm's growth drivers remain unchanged with significant opportunities in the coming years. We continue to focus on stockholder returns in executing on our ongoing diversification opportunities while maintaining operating discipline. I would now like to turn the call over to, Akash.
Akash Palkhiwala: Thank you, Cristiano, and good afternoon everyone. I'll start with our fourth fiscal quarter results. We delivered non-GAAP revenues of $8.7 billion and EPS of $2.02, which is above the high-end of our guidance. QTL revenues of $1.3 billion and EBT margin of 66% were in-line with our expectations. QCT delivered revenues of $7.4 billion, an EBT margin of 26%, which were near the high-end of our guidance on strength in handset and automotive revenues. Handset revenues of $5.5 billion increased 4% sequentially and were higher than expectations due to the benefit from the early stages of recovery in Android demand. IoT revenues of $1.4 billion were down 7% quarter-over-quarter, including softness in industrial IoT demand. Automotive revenue grew 23% sequentially to $535 million, making this the 12th consecutive quarter of double-digit percentage growth on a year-over-year basis. Non-GAAP operating expenses decreased 1% sequentially to $2.2 billion. Before turning to guidance, I'll summarize our fiscal ‘23 results. We delivered non-GAAP revenues of $36 billion and EPS of $8.43 despite the challenging macro environment. We remain focused on our strategic priorities of extending technology leadership and driving revenue diversification, while taking significant steps to improve our operating efficiency. We continued our strong momentum in automotive and delivered record revenues of $1.9 billion, with year-over-year growth of 24%, progressing towards our target of greater than $4 billion in revenue by 2026. We exceeded our fiscal '23 cost action target, reducing non-GAAP operating expenses by 7% relative to the fiscal '22 exit rate, executing on our commitment to manage the cost structure given the current operating environment. Our business continues to generate strong free cash flow, with a record of $9.8 billion. Lastly, our balance sheet remains strong with $11.3 billion in cash and marketable securities. Now, turning to guidance. We are seeing early signs of stabilization in demand for global 3G, 4G, 5G handsets. We now estimate that calendar ‘23 handsets will be down mid-to-high single-digit percentage relative to calendar ‘22, an improvement from our prior expectations. In the first fiscal quarter of ‘24, we are forecasting revenues of $9.1 billion to $9.9 billion and non-GAAP EPS of $2.25 to $2.45. In QTL, we estimate revenues of $1.3 billion to $1.5 billion and EBT margins of 70% to 74% with sequential growth driven by an increase in global handset units for the holiday season. In QCT, we expect revenues of $7.7 billion to $8.3 billion and EBT margins of 26% to 28%. On a sequential basis, we estimate double-digit percentage growth for QCT handset revenues and anticipate both IoT and automotive revenues to decline consistent with last year. QCT handset revenue forecast includes the benefit of normalization of Android channel inventory and higher demand due to the acceleration of flagship launches with our newly announced Snapdragon 8 Gen 3 mobile platform. Notably QCT handset forecast include sequential revenue growth of greater than 35% from Chinese OEMs. QCT IoT revenue forecast reflects the industry-wide cyclical factors we've previously discussed, including lower demand and elevated channel inventory. Lastly, we expect non-GAAP operating expenses to be flat relative to the fourth fiscal quarter. As we enter fiscal ‘24, we are encouraged by the early signs of demand stabilization in handsets and our strong competitive positioning across revenue streams. Key industry trends such as heterogeneous mobile computing and on-device generative AI provide a strong foundation for content growth and expansion to new device categories, driving growth opportunities for Qualcomm. In closing, I want to thank our employees for their hard work and dedication and for remaining focused on execution and continuing to deliver industry leading products. This concludes our prepared remarks, back to you, Mauricio.
Mauricio Lopez-Hodoyan: Thank you, Akash. Operator, we are now ready for questions.
Operator: Thank you. [Operator Instructions] The first question comes from Samik Chatterjee with JP Morgan. Please proceed with your question.
Samik Chatterjee: Yes. Hi. Thank you. Thanks for taking my questions and, congrats on the results here. I guess if I can start with Cristiano your comments about on-device AI becoming pervasive in a few years, I think investors are largely looking for more sort of evidence and validation that this is going to be a key focus area for a lot of OEMs smartphones and other device OEM. So, as you look over the next sort of 12 to 18 months, what should investors look at in terms of more validation of either wins or revenues that you expect from the monetization of the trend, in relation to what investors can really look to as milestones to validate that this is actually going to be sort of playing out over the next three to four years. And I have a follow-up.
Cristiano Amon: Thank you so much, Samik, for your question. For those that have not seen, I think, I would recommend to see the highlights of our Snapdragon Tech Summit that just happened a couple of weeks ago when we announced the results of our investments in Gen AI. I'll tell you Samik that on-device Gen AI, as I mentioned in my prepared remarks, are evolving in parallel to the cloud. And it's going to have a significant impact in how you change the user experience. Just think about a simple use case as you're texting, every single test that you write could be an input to a model, and that could bring prediction of your behavior and bring other applications. We demonstrated a number of use cases. They're under development by many other OEMs. There are a number of different models from large language models to large visual models. One unique position of Qualcomm we have many of those models running natively on a platform. We're creating a model zoo for Snapdragon. And you saw announcements from Microsoft, from Meta, from what we're doing on Android, we're doing with our Chinese partners. And you're going to start to see those signs. Especially what flagship device is launching in ‘24, as you started to see those use cases changing photography, changing, messaging, changing scheduling, changing assistance, how you should think about this financially for us? You have the potential to create a new cycle for phones, and it will have an impact on increased silicon content. Just to put in perspective, we have significant increased the processing performance of our AI, processing in the device or NPU is going to have silicon content, is going to have an impact on mix, and it's going to have an impact on unit of all of it. And it's likely going to start as use cases get developed with flagships launching ‘24, but it could be very significant as you look at the next two to three years.
Samik Chatterjee: Okay. Got it. And for my follow-up, I guess, you're sounding a lot more positive around the recovery in the Android OEMs, sort of the smartphone market. I think investors at the same time are grappling with the potential sort of puts and takes, particularly when it comes to your primary or a large, Android customer Samsung using more in house solutions going forward. So, when we think about sort of, seasonality beyond the December quarter, particularly around the launch periods, how should we think about your market share with Samsung progressing and what impact does that have on relative to your typical seasonality from December to March? Thank you.
Cristiano Amon: Very good question. Let me unpack that question. Let's divide the conversation in two. I think the first part of the conversation, as we said in the prepared remarks, we're happy that the inventory dynamics that we have seen within the Android, business are largely behind us right now. And, one data point that we provided in a cautious, I think, remarks is sequentially from Q4 fiscal to our guide, we're seeing a total growth of revenue from Chinese OEMs, both in China and outside China of 35%. And I think that shows that our customers are in a great position. I think even facing new interests in the market. And, it's also strength of our road map and the stabilization of the market. The second question is about Samsung, look, we're happy with partnership with Samsung. There's the upcoming launch of the GS24. We expect to have the majority share. Our product is really great. I think as I said, we probably have one of the best product roadmaps in the history of the company, especially in the Gen AI processing capabilities. And the product is getting better. We were happy to talk about what we have done in PC with our new Oryon CPU. That CPU was coming to mobile especially in ‘25, and we expect even more, I think, evolution of Gen AI. So the roadmap gets better over time. Overall, we're positive about our relationship Samsung. Thank you.
Operator: Our next question is from Matt Ramsay with Cowen. Please proceed with your question.
Matt Ramsay: Thank you very much guys. Good afternoon. I guess for my first question, Cristiano, I did pick up on the 35% growth sequentially with China OEMs. But you guys, the question I've been getting a ton is around Huawei and what they're doing. So, you guys called out, I think, last quarter that they were going to be getting some supply on seven nanometer from SMIC and being able to do some devices themselves. And you called out an impact to your revenue. But I think longer term into all of next calendar year, there's some expectation that they might get some more supply. Some of it from SMIC on seven, some of it from SMIC on 16. And that might be a unit headwind to some of your other OEM customers. Maybe you can sell into them as well on 4G. So, if you could unpack a little bit of what's going on with Huawei and how you see it impacting the market in China that would be helpful. And I have a follow up. Thanks.
Cristiano Amon: Thank you for the question, Matt. I think maybe separate and first, as we indicated in the last earnings call, I think we indicated that we don't have any more projection of selling our 4G, I think, SOCs to Huawei. And, going forward, we don't expect to have any significance, it's going to be a very small, I think, contribution from Huawei. I think the more interesting answer to your question, and that's the reason I provide the 35% data point, is as Huawei launched the device, we what we are seeing from our customers is continue, I think, growth from our customers on the Android side. We see a mix improvement of our customers moving towards flagship and, it's kind of reflected in our numbers. So it does not change, I think, the trajectory that we have with our Android customers in China. And there is a possibility that I think that Huawei is upgrading their existing customer base. You know there was a data point, there's about a 100 million Huawei former customers with a four to five year old Huawei phone, and that could have an impact on increasing the TAM.
Matt Ramsay: Thank you, Cristiano. I guess as my follow-up, it was very impressive, some of the products that you put forward for the PC market at the latest Snapdragon Summit, I think you were right to call out the performance levels, the power levels and the much, much different support from Microsoft. I guess what I'm trying to understand a little bit more is support for ARM PCs, whether in gaming or in enterprise use cases, by other ISVs. So folks that might need to use other end applications that wouldn't be touched directly by Qualcomm or directly by Microsoft. Cristiano could you give us a little bit of an update there? What are you seeing from the ISV ecosystem and in what parts of the PC market do you see potential momentum for your products? Thanks.
Cristiano Amon: Look, there's a lot to unpack here. I can speak about this for a whole day, but I'm going to try to be succinct. First thing, we're incredibly proud of the accomplishments of our team. I think, Snapdragon X Elite took the leadership position in this space for any mobile computing device. We're incredibly happy with performance of the new CPU, both single-threaded and multi-threaded performance. But not only that, I think it's important to highlight the AI processing capability because that's key to answer your question. If you look, versus announcements on NPU or some of the other ARM competitors. We had 45 tops performance on the NPU with a total tops performance on X Elite of 75. And that aligns with the transition that Microsoft is making towards a Windows AI future, especially the new services with the Copilot and everything we're doing with Microsoft, on-device working together on-device AI with the cloud and with the Azure endpoint. We're excited about that. And you should start thinking about the PC business, almost like the auto business. We're focused on next generation PCs, not existing PCs, and as those windows started to switch to Windows AI and our platform launches. it create opportunity for us to start gaining scale. Specifically to your question. Microsoft has been very active together with us of bringing a lot of applications natively through the platform. I think we had, a significant progress made across consumer in commercial applications. You continue to see announcements and Windows 11 can also run every, x86, 32, and 64 bit to the Microsoft emulation. We also made significant strides in the emulation performance. So, I think Snapdragon X Elite represents the results of this Microsoft Qualcomm collaboration. And I'll finish the answer by saying, if you look at the announcements of other computing companies talking about having an ARM based PC preprocessor, that is validation that that's our TAM now. It is going to be part of the expansion of TAM for Qualcomm. We're a new player and we look at this as a growth opportunity. We’re excited about it.
Operator: Our next question comes from the line of Mike Walkley with Canaccord Genuity. Please proceed with your question.
Mike Walkley: Great. Thanks. A quick question for Akash. I think a strong cost execution coming in ahead of plan for exiting the fiscal ‘23, and flattish into the start to Q1. How should we think about OpEx level plan for the year? Is there more areas to cut or you think your main kind of flattish for the year from the good start?
Akash Palkhiwala: Yes, thanks, Mike, for the question. Yes, we're very happy that we set a target for fiscal ‘23 of a reduction of 5% relative to the ‘22 exit rate. And we came in at 7%. As we've continued to mention, we, we have recommitting to operating discipline and we did implement additional actions this quarter proactively. And the way we are managing our portfolio is really while we are reducing cost, we want to ensure that we continue to invest, appropriately in technology leadership and diversification in some of the areas that Cristiano just went through. So that's the balance we are trying to strike. And, and as we look at the rest of the year, again, we're committed to maintaining operating as we move forward. I think we're in a very good place from an OpEx perspective. We are investing in the right areas and we'll, we'll focus on those, that scale.
Mike Walkley: Great. Thanks. And kind of building on that, my follow-up question to you, Cristiano. Just to follow-up on the on-device, Gen AI opportunity, how should we think about the increased dollar content per device for Qualcomm or increased ASPs relative to your high-end Snapdragon shipped today? Thank you.
Cristiano Amon: Look, let me start and see if, Akash wants to add any, something else to the answer. The way we think about this is let, you rather than provide a specific dollar content is, it has a mix improvement and it will drive towards a richer mix of higher in premium tier devices. It has an ASP increase, especially because of the accelerated performance for AI. And we're combining that with significant advancements in CPU and GPU as well. And it has the opportunity to drive units, whether it's a new upgrade cycle, or share gains. Akash, I don't know if you want to add anything.
Akash Palkhiwala: Well, and maybe just the other thing to keep in mind is outside handsets as we talk about PC opportunity. Of course, our AI leadership becomes extremely important there. And then also within IoT, we think about Gen AI as something that's going to be a key technology going forward. It'll expand our addressable market, expand the dollars we make per device on, in that area as well. So, it's a much broader play for us, including automotive with ADAS, IoT and PC.
Operator: Our next question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi guys. Thanks for taking my questions. For my first one, I want to ask the March quarter seasonality question a little more directly. And Akash, can you just give us some of the puts and takes on that March quarter seasonality? I mean, we've got a strong Apple quarter presumably in December that rolls off. We've got Samsung that launches, although we can question what the share is. We've got other things going on. Just how do we think about that seasonality in the context of everything that's going on, which we'll be expecting?
Akash Palkhiwala: All right. Sure. So let me maybe try to address, shape of the year as a broader comment. I mean, we do expect the first quarter and the fourth quarter to be the strongest quarters within the year. And then third quarter, as you know, is typically the lower quarter because we don't have a flagship phone launch that happens during the quarter. But, when you step back and kind of look at as we enter fiscal 2024, we're very happy with kind of the early signs of stabilization in the global handset market. And so we are cautiously optimistic as we go forward with that stabilizing and the normalization of Android channel inventory, we are on a strong trajectory as we go through the year.
Stacy Rasgon: Got it. That's helpful. For my second question, I want to ask about the new Apple agreement. So you put that out a little while ago. You're modeling 20% share now in the phone that launches in ‘26. So that'll be primarily a fiscal ‘27 issue. How should we think about, the shape of that in ‘24 and the launches that happened in ’24 and ‘25? Do we assume that you've got close to 100% of the majority of the units there and then it drops down for modeling purposes to 20% on the ‘26 launch or like, what does that look like?
Akash Palkhiwala: Yes. So the way you should think about the new agreement with our kind of going into specifics, the framework is very consistent with the previous agreement. It covers three launches. So, the launch in ‘24, launch in ‘25, and launch in ‘26. And, again, the framework is consistent with what we had before. For financial planning purposes, we're taking the same approach as we did with last agreement, and that's 20% you mentioned where in the last year, we are planning as if we're going to get 20% share. But you know, to the extent that we get more than that, that'd be upside for our plan.
Operator: Our next question is from the line of Ross Seymore with Deutsche Bank. Please proceed with your questions.
Ross Seymore: Hi guys. Thanks for letting me ask a question. I just wanted to dive a little bit into the automotive and IoT sides of things. Just a clarification for your fiscal fourth quarter guide, Akash. I believe you said they'd be somewhat similar to last year. I just wondered what you meant by that. And then a bigger cyclical question, we've heard a number of different companies talk about inventory burn in those two markets. You guys highlighted it in IoT, so I wondered where we were there. And are you seeing anything in automotive?
Akash Palkhiwala: Sure. So, the financial guidance we gave is that the year over -- the quarter-over-quarter trend from September quarter to the December quarter in automotive and IoT will be consistent with last year. So if you look at last year, automotive was down, I think, 1% or 2%. And so we're guiding effectively down 1% or 2% or flat for automotive. We obviously had a very strong quarter in the September quarter. The business traction continues to accelerate for us. The product roadmap is great. As Cristiano outlined in his prepared remarks, the relationship with the customers was very strong as well. So, we continue to be optimistic and we're well on our way to execute on the financial targets we have given long-term. From an IoT perspective, again the same guidance that it's consistent with last year, what the trend we saw between the September December quarter. And really when you think about IoT, we're seeing some of the same factors that other players in the industry are seeing, some demand weakness coupled with channel inventory. As we look forward, we think our first quarter as the bottom for the year for IoT. We expect to strengthen from that point on, and especially as we get into the second half of the fiscal year, with the environment normalizing, but then also very increasingly strong traction for our products. We think we'll have a strong second half in IoT.
Ross Seymore: Just wanted to ask a follow-up on the gross margin side of things. Cristiano, you talked about AI at the edge and across a number of different products, whether it's the PC side, the handset side, etcetera. I just wondered what does that mean to the gross margin within QCT. It seems like it opens up new TAMs on the unit side. Outside of handsets, probably increases the TAM from a dollar content on the handset side. Does that yield upside to gross margin about the same? Just what are the puts and takes as we translate all that to the profitability side?
Akash Palkhiwala: Sure. So, from a shorter term perspective, as you'll see from our guide, we did we did very well in September quarter, we are guiding in-line for December quarter. I think your question is more of a longer term opportunity of the expansion of our gross margin as we get into these new areas. And we definitely agree that I think as we scale in outside handsets especially in automotive and IoT, we have an opportunity for margin expansion.
Cristiano Amon: You know, Ross, this is Cristiano. Just two things I want to add real quick on the first question and then on this. As, we can scale in markets, for example, such as auto and in certain segments of the IoT, like PCs, XR, those things, they also have the opportunity to give us operating margin efficiency because our R&D is highly leveraged, especially on the computing the connectivity part. So the more that we get scale, we’ll continue to probably be accretive to margins. I want to make a quick comment on your IoT. You should look at the IoT dynamics, not all IoT are created equal. I think we have a lot of things within our IoT. So there's existing business that are subject to the some of the inventory dynamics, but there are new growth opportunities there. One of I remind everyone that PC is in there, which is, likely going to be material in fiscal ‘25, if you think about devices with the X Elite or launching towards the second of ‘24, you have XR, which was still in the early phase of that opportunity, it has networking, we have Fiber, we didn't have it before. So, I think we're positioned now to expand in networking with Fiber and 5G and Wi Fi-7 is positive. And, you know, it has still an opportunity to move, processing to the edge when IoT next. So, we're going to be -- those are less subject to the some of the cyclical dynamics we're seeing right now for existing business. Thank you.
Operator: Our next questions are from the line of Christopher Rolland with Susquehanna. Please proceed with your questions.
Christopher Rolland: Thanks for the question, guys. How are you guys thinking about global handset units over your next fiscal year? And then also given your new product launches here, how should we think about Qualcomm ASPs, as we progress for the next fiscal year as well.
Akash Palkhiwala: Chris, it's Akash. So, as we mentioned on the call, we’ve seen kind of early signs of stabilization in the handset market, including in China. And for calendar 2023, we now expect mid to high single digit versus 2022, which is an improvement from what we had before. As we look at 2024, the recent demand stabilization obviously provides a positive setup as we go into the year. So we are cautiously optimistic on how 2024 plays out. But specifically on 5G units, which is really our target market, we expect high single digit to low double digit growth from 2023 into 2024. So that's kind of the market that we pursue and we think there's growth opportunity there going into next year. From an ASP perspective, because of all the factors we discussed earlier in the call with the chips becoming way more capable, especially with GenAI, we think we are on a good trajectory to continue to expand our ASP consistent with the last three year trend. So if you look at our last three year trend, we've added, approximately 10% increase in any tier of chipset every year. And we think as we look forward, we have the opportunity to do that, going forward.
Christopher Rolland: That's a great update. Thank you. Another question for you quickly. There was some new language in your 10-K around the, European Commission proposing regulations around standard essential patents, potentially devaluing those patents I wasn't familiar with this. How serious do you think that risk could be? And are there any other meaningful developments in any other geographies? Or are we all kind of status quo?
Alex Rogers: Yes. So thanks for that question. This is Alex. We've been tracking these developments in the European Union. There's actually a, variety of parks to this proposed regulation ranging from wanting more transparency and ownership of SEPs and essentiality of SEPs to, to other issues relating to kind of pre-legal processes and, and other sorts of regulations that would affect the licensing and go to court process. The European Union right now is in what they call a trialogue process. It's going to take a while to get through, parliament, and the member states are going to weigh in. The commission's going to weigh in. The European Patent Office is actually opposed to parts of the regulation. Erickson and Nokia, of course, weighing in as well. So this is going to be a fairly, messy just call it legislative process that will take some number of years to sort out. It's being followed in other jurisdictions. We're following it here in the US. The US Patent Trademark Office has weighed in somewhat negatively I think. And it's being followed in China as well. So this will kind of play out over some years. It's not that unusual to have a variety of different SEP related, policy initiatives underway in different jurisdictions.
Operator: Our next question is from the line of Chris Caso with Wolfe Research. Please proceed with your questions.
Chris Caso: Yes, thank you. Good evening. The first question is regarding the overall handset demand and understand the comments you made about 5G units going into next year. I guess one part of the question is with the increase that you saw in the China business. How much of that do you believe was associated with just inventory normalization as opposed to actual more end market units. And then what does that mean for QTL, which has also been somewhat depressed because of the lower handset market, what should we expect on that as we go into next year?
Akash Palkhiwala: Yeah, Chris, it's Akash. So, the way we think about the handset market is we've seen a stabilization in the market and we're projecting forward, especially into the December quarter and QTL's guide as something that stable market represents. And so we're guiding a midpoint of $1.4 billion, sequential growth of 11%. In terms of breaking down the revenue growth in QCT, between inventory and market, obviously, it's kind of difficult to do over a quarter. But we do think that inventory is a big part of it. And it's really the market is stabilizing where it's at with inventory really driving a majority of the improvement in addition to our market share position and revenue growth that comes with, content increase as new chips get launched.
Chris Caso: Got it. And with regard to QTLN, I guess I'd assume to see the QTL numbers to come back closer to where we've seen them in the past. That's going to require some more, improvement in end market demand, is that accurate?
Akash Palkhiwala: I mean, QTL revenue forecast is really a function of the scale of the overall handset market and so as the scale changes, it would improve QTL revenues as well.
Operator: Our next question is from the line of Brett Simpson with Arete Research. Please proceed with your questions.
Brett Simpson : Yeah. Thanks very much. My question was really on fiscal 2024 android, smartphone outlook. And I guess there's a lot of moving parts here with Huawei building up their own chipsets. And we've all seen the volumes they're talking about for next year. And you've also got a fairly high share in flagship segments with Samsung. So just looking at fiscal 2024, can you perhaps just provide us a framework for whether or not Qualcomm can grow Android's handset sales in fiscal 2024? Thank you.
Akash Palkhiwala: Brett, we're not, we're not guiding the full year at this point. We gave you the guidance for first quarter and I gave you an outline as well of how we expect the shape of the year to play out for the overall company. And I think those pointers should give you a sense of our view into the year.
Brett Simpson : Okay. May maybe just to follow-up, Akash, in terms of your OpEx plan for fiscal 2024, I mean, we've seen your sales in fiscal 2023 decline, an operating profit down pretty significantly in fiscal 2023. How are you thinking about the OpEx for fiscal 2024? And I guess, and specifically, when I look at Qualcomm's headcount, over 50,000 people in the business and a lot of your large fabless peers have about half that headcount. How do we think about the sort of spending plan for next year just given the puts and takes here. Thank you.
Akash Palkhiwala: Yeah. So, Brett, as you're aware, through calendar, through fiscal 2023 we took, action on cost reductions a couple times. And as I also mentioned, this quarter we've taken additional action. So the idea is how do we maintain operating discipline while continuing to invest in the diversification initiatives that are so important for the company going forward. And what you're seeing in our forecast is a representation of those factors.
Operator: Thank you. Our final question is from the line of Tal Liani with Bank of America. Please proceed with your questions.
Tal Liani: I want to ask about market share. Next year, MediaTek is saying that they're doing great and they're gaining share, Huawei published now their target for 100 million units versus 60 million that they had before. And the question is, how do you feel about your market share for handset sourced within China? What are the areas maybe that you are strong at? What are the areas that you think you'll see more competition? Thanks.
Alex Rogers: Akash, I will start and maybe you had some quantitative comments. Tal, I think I will say if you just recap, in fiscal 2023 that just ended, we had a share increase, both globally and in China, of sell through. And we'd like, I think the direction that we have been going as we said, we will continue to retain, majority share at Samsung. We feel good about that relationship going forward. And we have, seen traction from premium and high tier before Chinese OEMs in spite of the launch of in the successful I think, initial sales of a newcomer, and that's kind of also reflected in the sequential, 35% growth. Akash, I don't know if there anything you'd like to add.
Akash Palkhiwala: No, I'll just say, this competitive environment is no different than what we've had in the past. And really, if you look at our current products and going forward, we think our competitive differentiation is actually accelerating both with our custom CPUs coming into our handset product line. And with GenAI in addition to kind of other factors that differentiate us. So, we're pretty confident as we go forward, we're in a good place from a competitive positioning perspective and content increase.
Tal Liani: Thank you.
Operator: Thank you. That concludes today's question and answer session. Mr. Amon, do you have anything further to add before adjourning the call?
Cristiano Amon: No, Thank you all for listening to and participating in the call. I just want to say thank you to our employees. Our suppliers, our partner, and I think we're being focused on the things we can control and really focus on building incredible, I think, products as we continue to change Qualcomm from a communications company to a connected computer company and go into new markets. Thank you again and looking forward to talk to you all next quarter.
Operator: Ladies and gentlemen, this concludes today's conference call. You may now disconnect. |
AMD | 3 | 2,023 | 2023-10-31 22:59:08 | Operator: Greetings, and welcome to the AMD 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. And it is now my pleasure to introduce to you Mitch Haws, Vice President, Investor Relations. Thank you, Mitch. You may begin.
Mitch Haws: Thank you, John, and welcome to AMD's third quarter 2023 financial results conference call. By now, you should have had the opportunity to review a copy of our earnings press release and the accompanying slides. If you had not had the chance to review these materials, they can be found on the Investor Relations page of amd.com. We will refer primarily to non-GAAP financial measures during today's call, and the full non-GAAP to GAAP reconciliations are available in today's press release and slides posted on our website. Participants on today's conference call are Dr. Lisa Su, our Chair and Chief Executive Officer; and Jean Hu, our Executive Vice President, Chief Financial Officer and Treasurer. This is a live call and will be replayed via webcast on our website. Before we begin, I would like to note that Forrest Norrod, Executive Vice President and General Manager, Data Center Business Solutions unit, will attend the UBS Technology Conference on Tuesday, November 28. AMD will host its Advancing AI Event on December 6, when AMD and its key ecosystem partners and customers will showcase the AMD products and partnerships that will shape the advancement of AI. The event will be live streamed on our website. Jean Hu, Executive Vice President, Chief Financial Officer and Treasurer, will attend the Barclays Global Technology Conference on Thursday, December 7. And our fourth quarter 2023 quiet time is expected to begin at the close of business on Friday, December 15. Today's discussion contains forward-looking statements based on current beliefs, assumptions and expectations, speak only as of today and as such, involve risks and uncertainties that could cause actual results to differ materially from our current expectations. Please refer to the cautionary statement in our press release for more information on factors that could cause actual results to differ materially. With that, I will hand the call over to Lisa. Lisa?
Lisa Su: Thank you, Mitch, and good afternoon to all those listening in today. We executed well in the third quarter, delivering strong top line and bottom line growth, achieving multiple milestones on our AI hardware and software road maps and significantly accelerating our momentum with customers for our AI solutions. In PCs, there are now more than 50 notebook designs powered by Ryzen AI in market, and we are working closely with Microsoft on the next generation of Windows that will take advantage of our on-chip AI Engine to enable the biggest advances in the Windows user experience in more than 20 years. In the Data Center, multiple large hyperscale customers committed to deploy Instinct MI300 accelerators, supported by our latest ROCm software suite and the growing adoption of an open hardware-agnostic software ecosystem. Looking at the third quarter financial results, revenue grew 4% year-over-year and 8% sequentially to $5.8 billion, driven by record server CPU revenue and strong Ryzen processor sales. Turning to the segment results. Data Center segment revenue of $1.6 billion was flat year-over-year and up 21% sequentially as solid demand for both 3rd and 4th Gen EPYC processor families resulted in record quarterly server processor revenue. We gained server CPU revenue share in the quarter as 4th Gen EPYC CPU revenue grew more than 50% sequentially, crossing over to represent a majority of our server processor revenue and unit shipments. In cloud, while the demand environment remained mixed in the quarter, EPYC CPU revenue grew by a strong double-digit percentage sequentially as hyperscalers expanded deployments of EPYC processors to power their internal workloads and public instances while optimizing their infrastructure spend. Nearly 100 new AMD-powered cloud instances launched in the quarter from Amazon, Google, Microsoft, Oracle, Tencent and others, including multiple general instances that deliver leadership performance for general purpose, HPC, bare metal and memory optimized workloads. In enterprise, while overall demand remains soft, we are seeing strong indications that the significant performance and TCO advantages of Genoa and our expanded go-to-market investments are paying off as enterprise revenue grew by a double-digit percentage sequentially. We closed multiple new wins with leading automotive, aerospace, financial services, pharmaceutical and technology customers, and the number of enterprise customers actively testing EPYC platforms on-prem increased significantly quarter-on-quarter. We also expanded our 4th Gen EPYC processor portfolio with the launch of our Ciena processors that deliver leadership energy efficiency and performance for intelligent edge and telco applications. Dell, Lenovo, Super Micro and others launched new platforms that expand our EPYC CPU TAM to address telco, retail and manufacturing applications. With the launch of Ciena, we now offer the industry's most performant and most energy-efficient portfolio of server processors across cloud, enterprise, technical, HPC and edge computing. I am very pleased with the momentum we have built for our EPYC CPU portfolio. We are building on this momentum with our next-gen Turin server processors based on our new Zen 5 core that delivers significant performance and efficiency gains. Turin is in the labs of our top customers and partners now, and customer feedback has been very strong and we're on track to launch in 2024. Looking at our broader Data Center portfolio, we made significant progress in our Data Center GPU business in the third quarter as the multiyear investments we have made in our hardware and software road maps resulted in significant customer traction for our next-generation Instinct MI300 accelerators and particularly our Instinct MI300X GPU that delivers leadership inferencing and training performance. On the hardware side, bring-up and validation of our MI300A and MI300X accelerators continue progressing to plan with performance now meeting or exceeding our expectations. Production shipments of Instinct MI300A APUs started earlier this month to support the El Capitan Exascale supercomputer, and we are on track to begin production shipments of Instinct MI300x GPU accelerators to lead cloud and OEM customers in the coming weeks. On the software side, we further expanded our AI software ecosystem and made great progress enhancing the performance and features of our ROCm software in the quarter. In addition to ROCm being fully integrated into the mainline PyTorch and TensorFlow ecosystems, Hugging Face models are now regularly updated and validated to run on Instinct accelerators and other supported AMD AI hardware. AI start-up, Lemon.ai announced they achieved software parity with CUDA for LLMs running on Instinct MI250 GPUs, enabling enterprise customers to easily deploy production-ready LLMs fine-tuned for their specific data on Instinct MI250 GPUs with minimal code changes. We also strengthened our AI software capabilities with the strategic acquisitions of Mipsology and Nod.ai. Mipsology is a long-standing partner with proven expertise delivering AI software and solutions running on top of our adaptive SoCs for data center, edge and embedded markets. Nod.ai adds a highly experienced team with a track record of substantial contributions to open-source AI compilers and industry-leading software already used by many of the largest cloud enterprise and AI companies. Nod's compiler-based automation software can significantly accelerate the deployment of highly performant AI models optimized for our Instinct, Ryzen, EPYC, Versal and Radian processors. Based on the rapid progress we are making with our AI road map execution and purchase commitments from cloud customers, we now expect Data Center GPU revenue to be approximately $400 million in the fourth quarter and exceed $2 billion in 2024 as revenue ramps throughout the year. This growth would make MI300 the fastest product to ramp to $1 billion in sales in AMD history. I look forward to sharing more details on our progress at our December AI event. Turning to our Client segment. Revenue increased 42% year-over-year and 46% sequentially to $1.5 billion. Sales of our Ryzen 7000 processors featuring our industry-leading Ryzen AI on-chip accelerator, grew significantly in the quarter as inventory levels in the PC market normalized and demand began returning to seasonal patterns. Revenue for our latest-generation client CPUs powered by our Zen 4 core more than doubled sequentially as we saw strong demand for our Ryzen 7000 Series notebook and desktop processors that deliver both leadership energy efficiency and performance across a wide range of workloads. In commercial, we launched our first Threadripper Pro workstation CPUs based on our Zen 4 Core that deliver unmatched performance for multi-threaded professional design, rendering and simulation applications. Dell, HPE and Lenovo announced an expanded set of workstations powered by new Threadripper Pro processors as we focus on growing this margin-accretive portion of our client business. Looking forward, we are executing on a multiyear Ryzen AI road map to deliver leadership compute capabilities built on top of Microsoft's Windows software ecosystem to enable the new generation of AI PCs that will fundamentally redefine the computing experience over the coming years. Now turning to our Gaming segment. Revenue declined 8% year-over-year and 5% sequentially to $1.5 billion as lower semi-custom revenue was partially offset by increased sales of Radeon GPUs. Although semi-custom SoC sales declined in line with our projections for this point in the console cycle, overall revenue for this console generation continues tracking significantly higher than the prior generation based on strong demand for Microsoft and Sony consoles. In Gaming Graphics, revenue grew both year-over-year and sequentially, driven by increased demand in the channel. We expanded our Radeon 7000 series with the launch of new RX 7000 Series enthusiast desktop GPUs that offer leadership price performance for 1440p gamers. Turning to our Embedded segment. As we expected, revenue decreased 5% year-over-year to $1.2 billion. Sequentially, revenue declined 15% as lead times normalized and customers focused on reducing inventory levels. We expanded our leadership Versal SoC portfolio in the quarter with the launches of our first adaptive SoCs with on-chip HBM memory that deliver significant performance and efficiency for memory-bound data center, network, test and aerospace applications. We also announced our next-generation space-grade Versal SoC that integrates an enhanced AI Engine and is the industry's only solution that supports unlimited reprogramming during development and after deployment. For the fintech market, we launched our latest Alveo Accelerator card that delivers a 7x improvement in latency compared to our prior generation and has already been deployed by multiple trading firms in their ultra-low latency training platforms. Since closing our acquisition of Xilinx a little over 1.5 years ago, our Embedded business has grown significantly, driven by our leadership products. Looking ahead, based on our current visibility, we expect Embedded segment revenue to decline sequentially as customers continue working through elevated inventory levels through the first half of 2024. Over the medium term, we see strong growth opportunities for our Embedded business based on our significant design win traction and our broad and differentiated portfolio of embedded FPGAs, CPUs, GPUs and adaptive SoCs that can address a larger portion of our customers' compute needs. In summary, I'm pleased with our third quarter financial results, driven by the significant acceleration of Zen 4 server and client processor sales. Looking at the next couple of quarters, we expect strong growth in our Data Center business, driven by both EPYC and Instinct processors. This growth will be partially offset by softening demand in our Embedded business and lower semi-custom revenue, given where we are in the console cycle. As the PC market returns to seasonal patterns, we believe we are well positioned to gain profitable share in the premium and commercial portions of the market based on the strength of our product offerings. We are focused on accelerating our leadership AI capabilities across our entire product portfolio, executing on our hardware and software road maps and expanding our enterprise computing footprint. I look forward to sharing more details on our AI progress in a few weeks at our together we advance AI event. Now I'd like to turn the call over to Jean to provide additional color on our third quarter results and our outlook for Q4. Jean?
Jean Hu: Thank you, Lisa, and good afternoon, everyone. I'll start with a review of our financial results for the third quarter and then provide our current outlook for the fourth quarter of fiscal 2023. We delivered better than expected third quarter results with revenue of $5.8 billion and diluted earnings per share of $0.70. On a year-over-year basis, revenue increased 4% as growth in the Client segment revenue was partially offset by lower Gaming and Embedded segment revenue. Revenue was up 8% sequentially, driven by growth in both the Client and the Data Center segment. Gross margin was 51%, up approximately 1 percentage point year-over-year primarily driven by stronger Client segment revenue and product mix. Operating expenses were $1.7 billion, an increase of 12% year-over-year, primarily driven by higher R&D investment to support our significant AI growth opportunity. Operating income was $1.3 billion, representing a 22% operating margin. Taxes, interest expense and other was $141 million. For the third quarter, diluted earnings per share was $0.70 compared to $0.67 in the same period last year. Now turning to our reportable segment. Starting with the Data Center segment, revenue was $1.6 billion, flat year-over-year as growth in the EPYC processor sales was offset by a decline in adaptive SoC product sales. Data Center revenue grew 21% sequentially, primarily driven by strong sales of our 4th Gen EPYC processors to both cloud and enterprise customers. Data Center segment operating income was $306 million or 19% of revenue compared to $505 million or 31% a year ago. Lower operating income was primarily due to increased R&D investment to support future AI revenue growth and product mix. Client segment revenue was $1.5 billion, up 42% year-over-year, primarily driven by higher sales of Ryzen mobile processors. On a sequential basis, revenue grew 46% as PC market conditions continued to improve, and we ramped our Ryzen 7000 series to meet strong demand. Client segment operating income was $140 million or 10% of revenue compared to an operating loss of $26 million a year ago, driven by higher revenue and a disciplined OpEx management. We are pleased that the Client segment returned to profitability in the third quarter. Gaming segment revenue was $1.5 billion, down 8% year-over-year, primarily due to a decrease in semi-custom revenue, partially offset by increase in Radeon GPU sales. On a sequential basis, Gaming segment revenue declined 5%, in line with our expectations as we are now in the fourth year of the console cycle. Gaming segment operating income was $208 million or 14% of revenue compared to $142 million or 9% a year ago, primarily driven by higher Radeon GPU revenue. Embedded segment revenue was $1.2 billion, down 5% year-over-year, primarily due to lower sales to the communication market. On a sequential basis, Embedded segment revenue declined 15%, primarily due to inventory correction at customers in several end markets. Embedded segment operating income was $612 million or 49% of revenue compared to $635 million or 49% a year ago. Turning to the balance sheet and the cash flow. During the quarter, we generated $421 million in cash from operations and the free cash flow was $297 million. In the fourth quarter, we expect to pay approximately $550 million in cash taxes, primarily due to previously deferred taxes from California disaster relief efforts made available by the IRS. Inventory decreased sequentially by $122 million to $4.4 billion. At the end of the quarter, cash, cash equivalents and short-term investment was strong at $5.8 billion. We returned $511 million to shareholders, repurchasing 4.8 million shares and we have $5.8 billion in remaining share repurchase authorization. Now turning to our fourth quarter 2023 outlook. We expect revenue to be approximately $6.1 billion, plus or minus $300 million, an increase of approximately 9% year-over-year and 5% sequentially. Year-over-year, we expect revenue for the Data Center and the Client segments to be up by strong double-digit percentage, the Gaming segment to decline, given where we are in the console cycle, and the Embedded segment to decline due to additional softening of demand in the embedded market. Sequentially, we expect Data Center segment to grow by strong double-digit percentage, Client segment revenue to increase and the Gaming and Embedded segment to decline by double-digit percentage. We expect non-GAAP gross margin to be approximately 51.5%, non-GAAP operating expenses to be approximately $1.74 billion, non-GAAP effective tax rate to be 13% and the diluted share count is expected to be approximately 1.63 billion shares. In closing, I’m pleased with our execution in the third quarter with year-over-year growth in revenue, gross margin and earnings per share. In the fourth quarter, we expect to benefit from strong Data Center and Client momentum, driven by MI300 AI accelerated ramp and the strength of our high performance leadership Zen 4 family of products despite lower sales in the Gaming segment and additional softening of demand in the embedded market. Looking ahead, the investment we are making in AI across our Data Center, Client, Gaming and the Embedded segment enable us to offer one of the best industry’s broadest portfolio, targeting the most compelling opportunities and positioning us to drive long-term profitable growth. With that, I’ll turn it back to Mitch for the Q&A session.
Mitch Haws: Thank you, Jean. John, we're happy to poll the audience for questions.
Operator: Thank you, Mitch. We will now be conducting a question-and-answer session. [Operator Instructions] And the first question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Great. Thank you so much. Lisa, I had two questions. My first one is on the Data Center GPU business. You talked about '24 revenue potentially exceeding $2 billion. I was hoping you could provide a little bit more color. What percentage of this is AI versus supercomputing or other applications? Within AI, maybe talk about the breadth of your customer lineup. And how should we think about which workloads you're addressing, again, within the context of AI? Is it primarily training or inference or both?
Lisa Su: Great. Thanks, Toshiya, for the question. So look, we've made significant progress on the overall MI300 program. I think we're very happy with how the technical milestones look. And then also, we've made significant progress from a customer side. Your question as to how the revenue evolves, so the way to think about it is, in the fourth quarter, we said revenue would be approximately $400 million, and that's mostly HPC with some -- the start of our AI ramp. And then as we go into the first quarter, we actually expect revenue to be approximately similar in that $400 million range. And that will be mostly AI so with a very small piece being HPC. And as we go through 2024, we would expect revenue to continue to ramp quarterly, and again, it will be mostly AI. Within the AI space, we've had very good customer engagement across the board from hyperscalers to OEMs, enterprise customers and some of the new AI start-ups that are out there. From a workload standpoint, we would expect MI300 to be on both training and inference workloads. We're very pleased with the inference performance on MI300, so especially for large language model inference, given some of our memory bandwidth and memory capacity. We think that's going to be a significant workload for us. But I think we would see a broad set of workloads as well as broad customer adoption.
Toshiya Hari: Thank you. And then as my follow-up, a question on the server CPU side. You talked about Genoa growing really nicely in the quarter. I think you talked about both units and volume being bigger than its predecessor. Is the growth that you're seeing or the growth that you saw in Q3 and the growth that you're guiding to for Q4, is this primarily a function of share growth or are you actually seeing a pickup in the overall market? And I ask the question because, obviously, year-to-date, there's been a significant shift away from traditional compute to accelerated computing, but are you actually starting to see signs of stabilization or even improvement on the traditional compute side? Thank you.
Lisa Su: Sure. So the way I would frame it is we're very pleased with our third quarter performance as it relates to EPYC overall. I think the 4th Gen EPYC, so that's Genoa Plus Bergamo actually ramped very nicely. We got to a crossover in the third quarter, which is a little bit ahead of what we had previously forecasted. And when I look underneath that, I would say with a strong growth in both cloud. Cloud was strong so strong double-digits. The adoption is pretty broad across first-party and third-party workloads and new instances. And then on the enterprise side, we've also seen some nice growth across our OEMs. And so from the standpoint of, is it the market recovery or is it share gain? I think it's some of both. From a market standpoint, I would say it’s still mixed. I think enterprise is still a little bit mixed depending on sort of which region from a macroeconomic standpoint. Cloud depends a bit on the customer set. But overall, I think we’re pleased with the progress and the leadership of EPYC has ended up, allowing us to grow substantially in the third quarter and then into the fourth quarter.
Operator: And the next question comes from the line of Aaron Rakers with Wells Fargo. Please proceed with your question.
Aaron Rakers: Yeah. Thank you for taking the questions. Just to build off that last question, Jean, I think last quarter, you kind of endorsed the notion that your Data Center business would grow. I think it was in the high-single digit range. I think you started the year thinking like 10. So I guess the question is, do you still see that kind of growth rate setup? And how has that $400 million evolved underneath that? Has that -- was it $300 million now going to $400 million? Just how has that changed over the course of the last quarter just to level set that Data Center expectation?
Jean Hu: Yeah. So I think for the second half, we said we expect Data Center business to grow approximately 50% versus first half. But right now based on what we are seeing, we continue to see in that similar range of that 50%. So we are very happy and pleased about the strong momentum of our Data Center business. On the GPU side, Lisa mentioned about $400 million, around $400 million. As we go through the quarter, we have a strong engagement with the customers. So we do see the progress continues and we see customers placing orders. So that's why when we go through the quarter, we start to increasingly confident about the revenue profile in Q4 we are guiding.
Lisa Su: Yeah. And Aaron, if I could add to that -- if I can just add to that. I think what we've seen is the adoption rate of our AI solutions has given us confidence in not just the Q4 revenue number but also sort of the progression as we go through 2024.
Aaron Rakers: Yeah. That's helpful. And maybe just the follow-up, how would you characterize the supply side of the equation? As you look at that $2 billion number, do you feel confident that you've got adequate visibility in the supply side to hit those expectations, any update on that side?
Lisa Su: Sure, Aaron. So we've been planning the supply chain for the last year and we're always planning for success. So certainly, for the current forecast of greater than $2 billion, we have adequate supply. But we have also planned for a supply chain forecast that could be significantly higher than that, and we would continue to work with customers to build that out.
Operator: And the next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
Joseph Moore: Great. Thank you. Following up on the Data Center GPU, can you talk about the breadth of customers that you might see there? How -- I assume it's fairly concentrated in year one, but you also did mention multiple hyperscalers. Can you just give us a sense for how concentrated that might be?
Lisa Su: Yeah. Sure, Joe. So we've been engaging broadly with the customer set. I think in the last earnings call, we said that our engagements had increased 7 times and so there is a lot of interest in MI300. We will start, let's call it, more concentrated in cloud, sort of several large hyperscalers. But we're also very engaged across the enterprise and there's a lot of interest. Our partnerships with the OEMs are quite strong. And when we think about sort of the breadth of customers who are looking for AI solutions, we certainly see an opportunity, especially as we get beyond the initial ramp to broaden the customer set.
Joseph Moore: Great. And now that you're getting a look at volume in that space, can you talk about, are the gross margins there going to be comparable to your other Data Center businesses?
Jean Hu: Yeah. So on the gross margin side, we do expect our GPU gross margin to be accretive to corporate average. Of course, right now, we are at a very, very early beginning of the ramp of the product. As you probably know, typically when you ramp new product, it takes some time to improve yield, testing time, manufacturing efficiency. So typically, it takes a few quarters to ramp the gross margin to a normalized level. But we are quite confident that our team is executing really well.
Operator: And the next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Lisa, I also wanted to ask about that $2 billion number for Data Center GPU next year. That's still a pretty small portion, obviously, of the total TAM. Where do you think that can go? Do you think when we look at this out a couple of years, do you think you can be 15%, 20% share for total Data Center GPU or do you have aspirations to be even larger than that?
Lisa Su: Yeah, Tim. I mean, I would say that, first of all, this is an incredibly exciting market, right? I think we all see the growth in generative AI workloads. And the fact is, we're just at the very early innings of people truly adopting it for enterprise, business productivity applications. So I think we are big believers in the strength of the market. We previously said we believe that the compound annual growth rate could be 50% over the next three or four years. And so we think the market is huge and there will be multiple winners in this market. Certainly, from our standpoint, we want to be -- we're playing to win and we think MI300 is a great product, but we also have a strong road map beyond that for the next couple of generations. And we would like to be a significant player in this market so we'll see how things play out. But overall, I would say that I am encouraged with the progress that we're making on hardware and software and certainly with the customer set.
Timothy Arcuri: Thank a lot. And then Jean, I just wanted to ask on March. I know that there's a lot of moving parts. It sounds like Data Center is up but PC is going to be down, normal seasonal and Embedded and Gaming sound down as well. So can you just help us shape sort of how to think about March? Is it down a smidge? Is it flat? Could it be up a little bit? And maybe then how to think about like first half, back half next year, if you even want to go there. Thanks.
Jean Hu: Hey, Tim. We're guiding one quarter at a time. But just to help you with some of the color, as Lisa mentioned earlier, we said the Data Center GPU revenue will be flattish sequentially. That's the first thing, right? The mix will shift from El Capitan majority in Q4 to predominantly more for AI in Q1. So that -- because of the long lead time manufacturing cycle, we feel like it's going to be a similar level of revenue with the Data Center GPU. But in general, if you look at our business, we do have a seasonality. Typically Q1, the Client business, server business, Gaming business seasonally is down. Of course, right now, we definitely have a little bit more seasonality, given Embedded and the Gaming dynamics we are seeing right now. Server and Client typically were down sequentially, seasonally too. But overall, I think we are really focused on just execution. We probably can provide more color when we get close to Q1 2024, and especially, Lisa, please add if we have any color we can provide on the whole year 2024.
Lisa Su: Yeah. No, I think that covers it. When we look at the various pluses and minuses, I think we feel very good about the Data Center business. It continues to be a strong growth driver for us as we think about 2024 for both server as well as our MI300 clients as well, we think incrementally improves from a market standpoint as well as we believe we can gain share, given the strength of our product portfolio. And then we have the headwinds of Embedded in the inventory correction that we'll go through in the first half and the console cycle. So I think those are the puts and takes.
Operator: And our next question comes from the line of Vivek Arya with Bank of America. Please proceed with your question.
Vivek Arya: Thanks for taking my question. Lisa, on the MI300, many of your hyperscaler customers have internal ASIC solutions ready or in the process of getting them ready. So if inference is the primary workload for MI300, do you think it is exposed to replacement by internal ASICs over time or do you think both MI300 and ASICs can coexist, right, along with the incumbent GPU solution?
Lisa Su: Yeah. I think Vivek, when we look at the set of AI workloads going forward, we actually think they're pretty diverse. I mean, you have sort of the large language model training and inference then you have what you might do in terms of fine-tuning off of a foundational model and then you have, let's call it, straight inferencing what you might do there. So I think within that framework, we absolutely believe that MI300 has a strong place in the market, and that's what our customers are telling us and we're working very closely with them. So yes, I think there will be other solutions, but I think for the -- particularly for the LLMs, I think GPUs are going to be the processing of choice and MI300's very, very capable.
Vivek Arya: Got it. And then a question, Lisa, on just this interplay between AI and traditional computing. It seems like especially when it relates to ASPs and units, seems like server CPU makers are kind of holding the line on price per core. But at the same time, the cloud players are extending the depreciation and replacement cycle of traditional server CPUs. So I'm just curious to get your take. What do you think is the interplay between units and ASP, right? If you were to take a snapshot of what you have seen in '23 and how it kind of informs you as you look at '24, that is it possible that maybe unit growth in server is not that high but you are able to make up for it on the ASP side. So just give us some color on, one, what is happening to traditional computing deployments? And secondly, is there a difference in kind of the unit and ASP interplay on the server seat side?
Lisa Su: Yeah. I think it's a good point, Vivek. So I mean, if I take a look at 2023, I think it's been a mixed environment, right? There was a good amount of, let's call it, caution in the overall server market. There was a bit of inventory digestion at some of the cloud guys and then some optimization are going on with enterprise, again, somewhat mixed. I think as we go forward, we've returned to growth in the server CPU market. Within that realm, because these -- like for example, 4th Gen EPYC, somewhere between 96 and 128 cores. I mean, you just get a lot of compute for that. So I do think there is the framework that unit growth may be more modest, but ASP growth, given the core count and the compute capability will contribute to overall growth. So from a traditional server CPU standpoint, I think we do see those trends. 2023 was a mixed environment and I think it improves as we go into 2024.
Operator: And the next question comes from the line of Blayne Curtis with Barclays. Please proceed with your question.
Blayne Curtis: Thanks for taking the question. I want to ask on the Embedded side. I think last quarter, you kind of talked about the headwinds being mostly in the communications end market. You're guiding it down in December. I was curious if that weakness is spread. And then your competitor talked about kind of a reset getting back to pre-pandemic levels. Just kind of curious how you framed that reset? You said it'd be weak to the first half.
Lisa Su: Yeah. Absolutely, Blayne. So I think when we look at end markets, I think communications was weak in sort of last quarter and it certainly continues to be weak. We see 5G sort of CapEx just down overall. On the other market where we see a little bit of, let's call it, soft end market demand would be industrial and that's a little bit more geographic, so a little bit worse in Europe than in other geographies. The other end markets are actually relatively good. And what we just see is that inventory is high, just given where we were with lead times coming into the sort of through the pandemic and with the high demand that was out there. As the lead times have normalized, people are drawing down their inventories and they have an opportunity to do that, given the normalization. So from an overall standpoint, we think demand is solid. And what we view is that we have a very strong portfolio in Embedded. We like sort of the combination of the, let's call it, the classic Xilinx portfolio together with the Embedded processing capabilities that we add. Customers have seen sort of that portfolio come together, and we've gotten some nice design win traction as a result of that. So we have to get through sort of the next couple of quarters of inventory correction, and then we believe we'll return to growth in the second half of the year.
Blayne Curtis: Thanks. And then, I just wanted to ask on the PC market. I think you and Intel have seen -- you were under-shipping in the first half. Maybe you're kind of over-shipping a little bit now, restocking. I'm just kind of curious to your perspective of what that normalized run rate is in terms of the size of the PC market and kind of any perspective if inventory levels are starting to move back up.
Lisa Su: Yeah. I would say, again, Blayne, when we looked at sort of the third quarter and sort of the environment that we’re in now, I think inventory levels are relatively normalized, and so the selling and consumption are fairly close. We were building up for a holiday season that is a strong season for us overall. When I think about the size of the market, I think from a consumption standpoint this year is probably somewhere like 250 million to 255 million units or so. We expect some growth going into 2024 as we think about sort of the AI PC cycle and some of the Windows refresh cycles that are out there. And I think the PC market returns to, let’s call it, a typical seasonality, in which underneath that, we have a strong product portfolio. And we are very much focused on growing in places like high-end gaming, ultrathins, premium consumer as well as commercial. So those are -- that’s how sort of we see the PC market.
Operator: And the next question comes from the line of Matt Ramsay with TD Cowen. Please proceed with your question.
Matthew Ramsay: Thank you very much. Good afternoon. Lisa, I wanted to maybe ask the AI question a little bit differently, not just focused on your GPU portfolio, but more broadly. I think one of the big surprises to a lot of us is, how quickly the AI market changed from accelerator cards to selling full servers or full systems for your primary competitor. And they've done a lot of innovation not just on GPU, but on CPU on their own custom interconnect, et cetera. So what I'd like to hear a little bit of an update on is just how you think about your road map going forward across CPU, GPU and networking and particularly the networking part as you look to continue to advance your AI portfolio. Thanks.
Lisa Su: Yeah. Thanks, Matt. I think it's an important point. What we're seeing with these AI systems is they are truly complicated when you think about putting all of these components together. We are certainly working very closely with our partners in putting together sort of the full system, CPU, GPUs as well as the networking capability. Our Pensando acquisition has actually been really helpful in this area. I think we have a world-class team of experts in this area, and we're also partnered with some of the networking ecosystem overall. So going forward, I don't think we're going to sell full systems, let's call it, AMD-branded systems. We believe that there are others who are more set up for that. But I think from a definition standpoint and when we're doing development, we are certainly doing development with the notion of what that full system will look like. And we'll work very closely with our partners to ensure that, that's well defined so that it's easy for customers to adopt our solutions.
Matthew Ramsay: Got it. Thank you for that perspective. As my second question, Jean, I wanted to dig into gross margin a little bit and just, I guess, complement you and the team on being able to guide up for the fourth quarter. Sequentially, gross margin if we, I guess, rewound the clock back to the beginning of the year and the Embedded segment would be down from the peak to where you're guiding the fourth quarter, maybe down by a third. I wouldn't have thought gross margin would have hung in as well and grown sequentially each quarter through the year. Obviously, Client margins got better. But maybe you could walk us through some of the puts and takes on gross margin, and inside of each segment, where you're making progress because I imagine some of that progress is pretty positive underneath. Thanks.
Jean Hu: Yeah, Matt. Thank you for the question. Yes, there are a few puts and takes, especially in a mixed demand environment. So let me just comment on Q3 first. We are very pleased with our gross margin expansion sequentially, 140 basis points. As you mentioned, the Embedded segment, revenue actually declined double-digits sequentially. There are two primary drivers. The first one is definitely Data Center grew 21% sequentially, which should provide a tailwind to our gross margin. Secondly, as we go through the inventory correction in PC market, we did encounter some headwinds in the Client segment gross margin. And in Q3, we saw very significant improvement with our client segment gross margin. I think going forward, the pace of Client segment improvement will moderate, but it will continue to drive incremental gross margin improvement in Client segment. So that really is why we are able to drive sequential growth in Q3. And in Q4, I would say the major dynamics is with a very strong double-digit growth in Data Center business, we definitely have the tailwind, which more than offset the Embedded segment decline sequentially double-digit again. I think going forward, it's really mix, primarily mix is driving our gross margin, but we feel pretty good about second half next year when we can expand the Data Center significantly and especially, Embedded segment start to recover, we should be able to drive more meaningful gross margin improvement in second half.
Operator: And the next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Lisa, I had a question on the MI300 side of things. When you go to market, obviously, there's been shortages this year of GPU accelerators, and so a second source is definitely needed. But beyond just providing that second source role, can you just walk us through some of the competitive advantages that the customer lists that you're going to talk about on the sixth is finding to be so attractive relative to your primary competitor?
Lisa Su: Yeah. I think there's a couple of different things, Ross. I mean, if we start with, it's just a very capable product. The way it's designed from a triplet standpoint, we have a very strong compute as well as memory capacity and memory bandwidth. In inference, in particular, that's very helpful. And the way to think about it is on these larger language models, you can't fit the model on one GPU. You actually need multiple GPUs. And if you have more memory, you can actually use fewer GPUs to infer those models, and so it's very beneficial from a total cost of ownership standpoint. From a software standpoint, this has been perhaps the area where we've had to invest more and do more work. Our customers and partners are actually moving towards an area where they're more able to move across different hardware so really optimizing at the higher-level frameworks. And that's reducing the barrier of entry of sort of taking on a new solution. And we're also talking very much about, going forward, what the road map is. It's very similar to our EPYC evolution. When you think about sort of the -- our closest partners in the cloud environment, we work very closely to make each generation better. So I think MI300 is an excellent product and we'll keep evolving on that as we go through the next couple of generations.
Ross Seymore: For my follow-up, I want to focus on the OpEx side of things. You guys have kept that pretty tight over the years. Jean, I just wondered what the puts and takes on that might be heading into 2024. I think you're exiting this year at about up kind of high single digits, maybe 10% year-over-year. Any sort of unique puts and takes, especially as you guys are driving for all that MI300 success as we think about OpEx generally in 2024?
Jean Hu: Yeah. Thanks for the question. Our team has done an absolutely great job in reallocating resources within our budget envelope to really invest in the most important areas in AI and the data center. We are actually in the planning process for 2024. I can comment on a very high level, given tremendous opportunities we have in AI and the Data Center, we definitely will increase both R&D investment and go-to-market investment to address those opportunities. I think the way to think about it is our objective is to drive top line revenue growth much faster than OpEx growth, so our investment can drive long-term growth. And we also can leverage our operating model to really actually expand earnings much faster than revenue. That’s really how we think about running the company and driving the operating margin expansion.
Operator: And the next question comes from the line of Harsh Kumar with Piper Sandler. Please proceed with your question.
Harsh Kumar: Hi, Lisa. I had a strategic one for you and then somewhat of a tactical one. On the strategic side, as your key competitor is sort of getting their act together on the manufacturing technology and the nodes, would it not be feasible to think that their manufacturing cost could be significantly better, let's say, than that of yours? And so if that's the case down the line one year or two years out, I'm curious what kind of value-add offerings would AMD have to provide to a customer to keep the market share that you have in the server space, data center space and then keep that growing as well?
Lisa Su: Yes, Harsh. Maybe I should just take a step back and just talk about sort of the engagement that we have with our data center customers. When we think about sort of the EPYC portfolio and what we've been able to build over the last few generations and what we have going forward with Zen 5 and beyond, process technology is only one piece of the optimization. It's really about process technology, packaging. We're leading sort of the usage of chiplets and 2.5D and 3D integration and then when you go to architecture and design. So it's really the holistic product. And from a pricing standpoint, actually, price is only one aspect of the conversation. Much of the conversation is on how much performance can you give me at what efficiency. So from a -- from an overall efficiency standpoint, I think we've developed fantastic products. We are working closely with our customers to ensure that we continue to evolve our overall portfolio. So I think from a value-added standpoint, it's providing the best TCO is what our customers are looking for, and that's where our road map is headed. Going forward, I think having the CPU, the GPU, the FPGAs, the DPUs, I think it gives us actually a nice portfolio to really optimize not just on a single component basis but on sort of all of the different workloads that you need in the data center.
Harsh Kumar: Very helpful, Lisa. And then for my follow-up, a lot of folks that we talk to think that compute game is shifting completely from CPUs to GPUs. [Technical Difficulty] So it was actually very encouraging to hear you talk about your core EPYC CPUs and the traction that you're seeing with the new generation of CPUs. So I'm curious, if I was to ask you how you think the long-term growth prospects for the next, call it, two to three to four years our for your CPU business, not the GPU but the CPU business, I'm curious what the answer would be.
Lisa Su: Yeah. So look, I'm a big believer and you need all types of compute in the data center, especially when you look at the diverse set of workloads. There's a lot of excitement around AI, and we are very much clear that, that is the number one priority from a growth standpoint going forward. But the EPYC CPU business, we feel like we've consistently gained share throughout the last few years. And even with that, we're still underrepresented in large portions of the market, right? We're underrepresented in enterprise. We've seen some nice sort of sequential growth and nice prospects there, but there's a lot more we can do in enterprise. And we're still underrepresented in cloud third-party workloads, which, again, it's a -- you have to sell through the cloud manufacturers. So I think overall, we feel good about our EPYC leadership and also our go-to-market efforts that will help us continue to grow that business in 2024 and beyond.
Mitch Haws: Operator, we have time for two more questions.
Operator: Okay. And the next question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question/
Stacy Rasgon: Hi, guys. Thanks for taking my questions. First, I wanted to just dial in on the Q4 guidance. If you are going to grow Data Center 50% half over half and I assume Client is up sequentially, implies Gaming and Embedded both likely down sequentially in the 20% range. I know you said double-digits. But is that right? And if that is true, especially for Embedded, what does that mean going forward into next year? I know you said it's going to be weak in the first half. Does that mean -- I mean, is it stable at these levels or does it continue to decline through the first half until things stabilize? Just how do we think about that in the context of the guidance that you've given for Q4?
Lisa Su: Yes. Sure, Stacy. Let me take that and then Jean might add a few comments. So without getting very specific, I would say I think your comments about Data Center and Client are correct. And then from an Embedded and Gaming standpoint, we would say Embedded, think about it down similar levels sort of in the teens compared to sort of Q3 was down in the teens and Q4 will be down in the teens. And then Gaming, from a console standpoint, we do expect that to be down a bit more than that. And then as we go into Q1, again without being -- there are lots of things that need to happen. We would expect that both gaming and embedded would be down into Q1 as well and sort of the other comments would be more around seasonality. Does that help?
Stacy Rasgon: That does help. For my follow-up, again, I wanted to ask about gross margins. So I know that they've been extending through the year, but for the full year, they're actually down. And I get the mix things and everything else. But as I look into next year, like how do I think about this because it sounds like Embedded is going to be pretty weak next year. Client is what it is. Data Center is growing but it does feel like even if the GPUs are accretive, they're not accretive yet, and it's going to take them a while to get to be accretive. Like how much do you think you can expand gross margins year-over-year like in '24 versus '23, given the trends that we have entering the year?
Jean Hu: Yeah. Hi, Stacy. I'll say the first thing is, if you look at 2023, it's a very unusual year for the industry, right, especially the PC market. It's one of the worst down cycles during the last 3 decades. So during that kind of a down cycle, definitely, we had headwinds on gross margin side, on our Client business, which we have made significant progress in Q3 and Q4 in second half. Going into next year, the mix primarily is the driver of our gross margin. The way to think about it is Data Center is going to be the largest incremental revenue contributor next year. And then with both Gaming and Embedded facing continued sequential decline, I think it's all about the mix. We do expect next year will improve gross margin versus 2023, especially second half. So that's how we think about it right now.
Operator: And our final question comes from the line of Christopher Rolland with Susquehanna. Please proceed with your question.
Christopher Rolland: Thanks for the question. There was an article suggesting that you guys could be interested in doing some ARM-based CPUs. I guess I'd love any thoughts that you have there on that architecture for PC. But also Apple has their M3 out now. It seems pretty robust. Qualcomm has an X Elite new chip. It was rumored NVIDIA might be doing that as well. Would love your expectations for this market. And what does that mean for the TAM for AMD moving forward?
Lisa Su: Yeah. Sure, Chris. Thanks for the question. So look, the way we think about ARM, ARM is a partner in many respects so we use ARM throughout parts of our portfolio. I think as it relates to PCs, x86 is still the majority of the volume in PCs. And if you think about sort of the ecosystem around x86 and Windows, I think it's been a very robust ecosystem. What I'm most excited about in PCs is actually the AI PC. I think the AI PC opportunity is an opportunity to redefine what PCs are in terms of productivity tool and really sort of operating on sort of user data. And so I think we're at the beginning of a wave there. We're investing heavily in Ryzen AI and the opportunity to really broaden sort of the AI capabilities of PCs going forward. And I think that's where the conversation is going to be about. It's going to be less about what instructions that you're using and more about what experience are you delivering to customers. And from that standpoint, I think that we have a very exciting portfolio that I feel good about over the next couple of years.
Christopher Rolland: Thank you, Lisa. And one quick one on FPGA for the Data Center in particular. That was a really cool fintech win. I understand that [Technical Difficulty] AI? And could we even mix in an FPGA into the MI300 tile at some point or is there really, at this point, not an AI market for FPGA?
Lisa Su: Yeah. I mean, Chris, the way I think about sort of FPGAs in the data center, it's another compute element. We do use FPGAs or there are FPGAs in a number of the systems. I would say from a revenue contribution standpoint, it's still relatively small sort of in the near term. We have some design wins going forward that we would see that content grow but that won't be so much in 2024, that it will be beyond that. And part of our value proposition, I think, to our data center partners is, look, whatever compute element you need, whether it's CPUs or GPUs or FPGAs or DPUs or -- we have the ability to sort of bring those components together. And that is a strong point as we think about just how heterogeneous these data centers are going forward. So thank you for that.
Operator: At this time, we have reached the end of the question-and-answer session. Now I’d like to turn the floor back over to Mitch for any closing comments.
Mitch Haws: Great, John. That concludes today's call. Thank you to everyone for joining us today.
Operator: And ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
AMGN | 3 | 2,023 | 2023-10-31 13:15:04 | Operator: My name is Julianne, and I'll be your conference facilitator today for Amgen's Third Quarter 2023 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. There will be a question-and-answer session at the conclusion of the last speaker's prepared remarks. [Operator Instructions] I would now like to introduce Justin Claeys, Vice President of Investor Relations. Mr. Claeys, you may now begin.
Justin Claeys: Thank you, Julianne. Good morning, and welcome to our third quarter 2023 earnings call. Bob Bradway will lead the call and be followed by a broader review of our performance by Murdo Gordon, Vikram Karnani, who joined Amgen from Horizon Therapeutics following the October 6, 2023 acquisition close, Dave Reese and Peter Griffith. Given the timing of these Horizon Therapeutics acquisition close, our third quarter results do not include any contribution from Horizon. Vikram will provide select information from Horizon's third quarter product sales for future context. You should have received a link to our slides that we have posted. Through the course of our discussion today, we will make some forward-looking statements and use non-GAAP financial measures to describe our performance. And just a reminder that actual results can vary materially. I would now like to turn the call over to Bob.
Robert Bradway: Okay. Thank you, Justin and thank all of you for joining our call. It's an exciting time here at Amgen. And we're continuing to execute well this year, serving many more patients around the world with medicines such as Repatha, EVENITY and Tezspire, advancing a number of promising first-in-class medicines rapidly through our pipeline and preparing for our next wave of biosimilar launches. However, as this is our first earnings call following the close of our acquisition of Horizon Therapeutics, I thought we might turn our attention there first. The Horizon acquisition, coupled with our purchase of ChemoCentryx, which we acquired a little more than a year ago, gives Amgen a significant rare disease business that fits squarely within our overall strategy and will be additive to the growth we expect from our base business. At the heart of our strategy of course is innovation. First, our best-in-class medicines that make a big difference for patients suffering from serious diseases. The medicines in our rare disease portfolio like Tavneos, Tepezza, KRYSTEXXA and UPLIZNA fit this description perfectly and they'll benefit from Amgen's decades of experience in inflammatory diseases. These medicines are also early enough in their lifecycles that we can positively impact their growth by leveraging Amgen's capabilities in process development, lifecycle management and manufacturing. Finally, we spent the past decade or so building out our international footprint with Amgen medicines now available in about 100 countries. And today our rare disease sales come almost exclusively from the U.S. So, we'll be able to leverage our global presence to quickly bring these medicines to patients around the world. You'll hear more in a minute from Vikram Karnani, who joined us through the Horizon acquisition and is leading a newly created rare disease business that is now the fourth leg of Amgen's commercial stool, alongside our inflammation, oncology and general medicine businesses. Turning to our financial performance in the quarter. Total revenues were up 4% and earnings per share were up 6% compared with a year ago. Volume increased 11% globally, which represents our fourth consecutive quarter of double-digit volume growth. And we achieved good balance across all of our geographic regions and therapeutic areas. Seven of our medicines generated record sales in the quarter. And I'll highlight one of these, BLINCYTO, which delivered 55% sales growth in the third quarter. We see continued upside potential for BLINCYTO as it is increasingly used in earlier lines of therapy and as practice guidelines are updated to reflect the role this medicine can play in treating a broad range of patients with acute lymphoblastic leukemia. Turning to our pipeline. We had the opportunity to discuss six potential first-in-class oncology assets with you recently following ESMO. Three of these have earned Breakthrough Therapy designations from the FDA; tarlatamab, BLINCYTO and LUMAKRAS in combination with Vectibix in colorectal cancer. We also continue to progress trials for bemarituzumab in gastric cancer, for Xaluritamig in prostate cancer and for AMG 193, our PRMT5 inhibitor, which has generated responses across six solid tumors. I'll just quickly note that AMG 193 was identified through our proprietary DNA encoded library technology which we added through the 2019 acquisition of Nuevolution, and it demonstrates our leadership in the emerging field of multi-specific drugs that can address pathways that have long been recognized but considered inaccessible to traditional drug discovery efforts. In other pipeline news, we've completed enrollment in our Phase 2 obesity study for maridebart cafraglutide, which was formerly known as AMG 133. And finally, the FDA has accepted our BLA for our biosimilar to EYLEA. Looking at our business, we feel we have good momentum across the board. We have everything we need with the portfolio, the pipeline and the people to deliver attractive sales and earnings growth through the end of the decade and beyond. As always, I want to thank Amgen employees around the world, including some 2,000 new colleagues focused on rare diseases for their commitment to strong execution on behalf of the patients we serve. With that, I'll now turn it over to Murdo Gordon. Murdo?
Murdo Gordon: Thanks, Bob. I'm pleased with our performance in the third quarter. Execution is strong across the business with record quarterly sales for seven brands and robust volume growth across our general medicine, inflammation and hematology/oncology portfolios. Product sales increased 5% year-over-year. Volume growth was 11% with strength across our regions. U.S. volume growth was 11% and volume growth in our Europe, Latin America, Middle-East and Canada region was 8%. Consistent with our international expansion strategy, Asia-Pacific continues to be our fastest growing region with 27% volume growth in the quarter. Starting with our general medicine business, which includes Repatha, Prolia, Evenity and Aimovig. Overall revenue for these four products grew 21% year-over-year in the third quarter, driven by 20% volume growth. Repatha sales increased 31% year-over-year in the third quarter, with volume growth of 44%, partially offset by lower net selling price. In the U.S., volume growth of 45% was driven by a record number of new patients starting treatment, more than doubling year-over-year. We saw declining net selling prices in the US, primarily driven by new formulary coverage by CVS in July for commercial patients. Outside the U.S., we saw a 43% volume growth with strength across our regions. There are still many more patients around the world who can benefit from Repatha and we're rising to meet that challenge by investing and executing to drive awareness amongst physicians and patients. In the U.S., we have significantly expanded our primary care sales force and activated more than 15,000 new prescribers this year. We're also increasing promotion to patients through direct-to-consumer media efforts. Transitioning to bone health, Prolia sales grew 14% year-over-year in the third quarter, primarily driven by 7% volume growth and higher net selling price. We expect volumes for Prolia to grow supported by real-world evidence data presented earlier this year that demonstrate Prolia's superiority in reducing fracture risk when compared to alendronate in treatment-naive patients with post-menopausal osteoporosis. EVENITY had record sales of $307 million for the quarter, driven by 48% volume growth. Osteoporosis disproportionately impacts postmenopausal women, and the diagnosis and treatment rates for these patients are low. In 2023, we expect approximately 3 million patients in the U.S. will be treated for post-menopausal osteoporosis, an estimated 40% of treated patients will be at very high risk of fracture. But only 6% of those high risk patients will be treated with a bone-building product. EVENITY plays an important role in the bone builder market with a 58% share in the U.S. and a 44% share in Japan. There's much more work to be done and we'll continue to invest to ensure EVENITY reaches the patients who need it. Otezla sales declined 10% year-over-year, driven by lower net selling price, unfavorable changes to estimated sales deductions, and lower inventory levels, partially offset by 1% volume growth in the U.S. Otezla net price declines were driven by higher rebates to support and expand access for commercial and Medicare Part-D patients. Our U.S. Otezla business has been impacted by free drug programs associated with new treatment options that have entered the psoriasis marketplace. We're beginning to see a reduced impact of these free drug programs as physicians and patients are experiencing barriers to access, given prior authorization requirements for these newer therapies. We have strong conviction in the growth potential of Otezla, with its unique indication for all severities of psoriasis, combined with an established clinical profile, broad payer coverage, a lack of testing required for initiation and convenient oral administration. To realize that potential, we have increased our investment to ensure physician and patients understand both the importance of treating psoriasis systemically and the safety and efficacy profile that Otezla offers. We are already seeing positive results from that increased investment, including significant growth in the number of patients requesting educational information and taking action on the Otezla website that generally indicate preparation for a discussion with the healthcare professional. And also recently increased our dermatology sales force by 20% to educate physicians about the benefits of Otezla for appropriate patients. With these increased investments, we expect to drive a return to growth for Otezla. Enbrel sales decreased 6% year-over-year, primarily driven by an 8% decline from unfavorable changes to estimated sales deductions. Year-over-year volume increased 1% in the third quarter and the number of new patients in the U.S. starting treatment increased by 22% driven by improved payer coverage and Enbrel's 20-plus year track record of safety and efficacy. For the remainder of 2023, we expect our improved coverage will lead to continued growth in new patients and declining net selling price. Tezspire continues to show strong growth with $161 million in sales in the third quarter. Sales increased 21% sequentially, driven by 18% volume growth that benefited from the launch of our self-administered pre-filled single-use pen, which was approved by the U.S. Food and Drug Administration in the first quarter. We've now obtained coverage of the patent with the majority of pharmacy benefit managers, enabling easy access and convenient self-administration for patients in the U.S. with severe uncontrolled asthma. As we expected, Tezspire has both penetrated and helped grow the U.S. asthma biologics market. In 2023, the number of new patients on asthma biologics has increased by over 20% year-over-year and Tezspire's share of this expanded market is approximately 20%. Sales of Tavneos were $37 million in the quarter with 26% quarter-over-quarter volume growth. In the U.S., approximately 2,300 patients have now been treated with Tavneos by over 1,500 healthcare professionals. We continue to see an increase in awareness of Tavneos by rheumatologists and nephrologists. And exiting the quarter, we saw an increase in new patient start forms. Looking forward, we expect to bring Tavneos to even more patients with ANCA-associated vasculitis. Amjevita sales increased 30% year-over-year for the third quarter, driven by 53% volume growth, partially offset by lower net selling price. Ex-U.S. sales increased 10%, driven by 22% volume growth, partially offset by lower net selling price. Moving to our hematology-oncology business, which includes LUMAKRAS, KYPROLIS, XGEVA, Vectibix, Nplate and BLINCYTO . Strong commercial execution and compelling new clinical data drove 15% volume growth year-over-year for these six innovative products. BLINCYTO sales grew 55% year-over-year to a record $220 million for the third quarter. Volume growth of 56% was supported by broad prescribing to acute lymphoblastic leukemia patients following positive data from the registration-enabling E1910 study presented late 2022, and updated NCCN guidelines that were issued in May. Long-term, we see significant additional growth potential for BLINCYTO from earlier lines of therapy. LUMAKRAS reported $52 million in sales for the third quarter, a decline of 31% year-over-year. $22 million of this decline was driven by ongoing reimbursement negotiations in France. We see future growth opportunities for LUMAKRAS, driven by launches in new markets and our comprehensive global clinical development program. Vectibix sales increased 2% year-over-year for the third quarter to a record $252 million, driven by higher net selling price and 4% volume growth, partially offset by unfavorable foreign exchange impact. KYPROLIS grew 10% year-over-year, primarily driven by 8% volume growth. And Nplate sales increased 45% year-over-year for the third quarter, resulting from a $142 million order from the U.S. government. In the fourth quarter, we expect to fulfill an additional $62 million order for Nplate by the U.S. government. Given the strong performance of our hematology-oncology products and the exciting new positive data presented at ESMO on our oncology pipeline, we look forward to helping more patients with their cancer therapy. Overall, our execution is strong across the business, driving growth and demonstrating our dedication to serving patients. And with the expansion of our rare disease portfolio, we're excited to serve many more patients around the world who can benefit from our therapies. And with that, I'll turn it over to Vikram.
Vikram Karnani: Thanks, Murdo. We're excited to bring together Horizon's medicines, pipeline and rare disease expertise with Amgen's history of leadership in inflammatory diseases, global infrastructure and world-class biologic capabilities. For those that are not as familiar with Horizon's portfolio, I will spend the next few minutes providing some background on our rare disease medicines. Horizon's business delivered $945 million of sales in the third quarter, representing 2% year-over-year sales growth with multiple positive leading indicators. Let me describe in more detail. Tepezza, the first and only medicine approved for the treatment of thyroid eye disease, regardless of disease activity or duration, generated $453 million of sales in the third quarter, representing 2% quarter-over-quarter growth. We are confident that now as we have officially joined forces and have on-boarded the full commercial team, we will make significant progress in advancing this important product over time to patients. We are driving several initiatives to continue to build the U.S. thyroid eye disease market. In the third quarter, we saw a greater than 50% year-over-year increase in the number of Tepezza prescribers, supported by the April 2023 FDA label update to treat patients with thyroid eye disease, regardless of disease activity or duration. We are pleased with this progress and are continuing to educate the physician community on new clinical data and updated indication across the full spectrum of TED patients. Second, large national and regional payers are continuing to make favorable policy changes to help eligible patients access Tepezza. To date, we have obtained favorable policy changes for greater than 30% of U.S.-covered lives, which are expected to take effect later this year and early next year. As a reminder, for Tepezza, there is a time lag between a patient being identified for Tepezza treatment and treatment being initiated. It can take up to 90 days for a patient enrollment form to move through the prior authorization process. Once that step is complete, then the patient's infusion needs to be scheduled at an appropriate site of care. This process takes time and we have taken several important steps to minimize the time between patient identification and treatment initiation. Finally, we continue to see approximately 100,000 patients with moderate-to-severe disease in the U.S. that are appropriate for Tepezza, with the majority of these patients in low Clinical Activity Score settings. Therefore, the patients -- the FDA's label update, combined with favorable medical policy changes by payers and supported by the expanding base of prescribing physicians, gives us a significant opportunity to reach more patients. These positive execution trends underpin our confidence in Tepezza's growth potential in the U.S. Moving on to markets outside the U.S. We continue to see international expansion as a meaningful long-term growth opportunity for Tepezza which received its first ex-U.S. approval in Brazil in the second quarter of this year. We are particularly excited about the opportunity to leverage Amgen's long-standing presence in multiple major ex-U.S. markets, including Europe and in Japan, where we have reported positive data from the Phase 3 OPTIC-J trial. We also continue to enroll a Tepezza Phase 3 trial in Japanese patients with chronic or low clinical activity thyroid eye disease. KRYSTEXXA, the first and only medicine approved for uncontrolled gout, delivered a record $253 million of sales in the third quarter, representing 32% year-over-year growth. Sales are now annualizing at a $1 billion run rate. Performance in the third quarter reflected continued strong uptake in both the rheumatology and nephrology segments. Strong results were driven by execution across all phases of the patient journey, demand-generation, stakeholder education and adherence to treatment. The FDA approved KRYSTEXXA's label change for combination with methotrexate in July 2022. We have seen a steady increase in uptake since then. Immunomodulation usage remained above 70% of new patient starts in the third quarter. We see an opportunity to redefine KRYSTEXXA with methotrexate as a standard of care and reach even more of the over 100,000 uncontrolled gout patients in the U.S. UPLIZNA sales increased 54% year-over-year in the third quarter to $67 million. International expansion is also underway with UPLIZNA now launched in multiple ex-U.S. markets, including Germany, France, Italy, Spain and Brazil. Additional indications in development also support UPLIZNA's long-term growth potential with Phase 3 trials underway in both IgG4-related disease, and myasthenia gravis. The rest of Horizon's portfolio generated $173 million of sales in the third quarter, primarily driven by our portfolio of ultra-rare medicines; RAVICTI, PROCYSBI and ACTIMMUNE. We see an opportunity for this basket of products to continue to generate robust sales. Before I turn it over to Dave Reese, I want to take the opportunity to thank all my colleagues in the rare disease business for maintaining their focus on patients throughout a period of distraction over the last several months. Looking ahead, we are excited to work together by leveraging Amgen and Horizon's combined capabilities to ensure our medicines reach more patients even faster who are suffering from serious and rare diseases globally. I'll now turn it over to Dave.
David Reese: Thank you, Vikram. Good morning, everyone. I'd like to begin by welcoming our new colleagues from Horizon. We are excited to be integrating Horizon's R&D capabilities with Amgen's to advance the promising Horizon pipeline. For R&D, the third quarter was one of high quality execution as we progressed our innovative pipeline with important oncology data readouts, the addition of two breakthrough therapy designations and completion of enrollment on key studies. We also advanced our innovative pipeline through rapid enrollment on multiple registration enabling studies. Starting with general medicine, we have completed enrollment in the Phase 2 study of maridebart cafraglutide in patients with obesity with or without diabetes. The goal of this study is to generate data that will provide optionality to design a broad Phase 3 program, leveraging the unique properties of maridebart cafraglutide that could potentially allow us to take a differentiated approach. We anticipate top-line data from this 52-week study towards the end of 2024. The Phase 3 outcomes study of Olpasiran are potentially best-in-class Lp(a) targeting small interfering RNA molecule in atherosclerotic cardiovascular disease is enrolling very well. In inflammation, beyond severe asthma, we are investigating additional indications with Tezspire, including separate Phase 3 studies in chronic rhinosinusitis with nasal polyps, which is fully enrolled and eosinophilic esophagitis. We also have a Phase 2 study in COPD that has been fully enrolled with top-line data anticipated in the first half of 2024. This study has recruited a broad population of COPD patients, including patients with both high and low eosinophil counts. Rocatinlimab, a first-in-class anti-OX40 monoclonal antibody being investigated in patients with moderate-to-severe atopic dermatitis, recruitment is off to a strong start on the ROCKET Phase 3 clinical development program. We have now randomized over 1,500 patients across the program. We are excited to present additional data from our expanded rheumatology portfolio following the acquisition of Horizon, including data from a Phase 2 study of dazodalibep in Sjogren's Syndrome, along with data from KRYSTEXXA, Tavneos, Otezla and other molecules from our broad portfolio at the American College of Rheumatology Convergence 2023 Meeting in November. I'll be brief with my remarks on our oncology portfolio, given the detailed oncology review last week. Based on the E1910 Phase 3 study, the FDA has granted BLINCYTO Breakthrough Therapy designation for the treatment of adult and pediatric patients with CD19-positive Philadelphia chromosome-negative B-cell precursor acute lymphoblastic leukemia during the consolidation phase of multiphase therapy. We see future growth in BLINCYTO from advancements into earlier lines of therapy and subcutaneous administration. BLINCYTO also serves as a blueprint for how we plan to rapidly progress tarlatamab and Xaluritamig into earlier lines of therapy [indiscernible] setting a lower tumor burden. Along with experts in the field, we are very encouraged by tarlatamab, our BiTE molecule, targeting DLL3. At ESMO, we presented data from DeLLphi-301, a Phase 2 study in late-stage small-cell lung cancer, where we saw impressive response rates, durability of response, and overall survival in a setting where patients typically have limited options and a very poor prognosis. We are submitting these data to the FDA and are pleased that the FDA has granted tarlatamab Breakthrough Therapy designation for the treatment of adult patients with extensive-stage small-cell lung cancer with disease progression on or after platinum-based chemotherapy. Given our confidence in these data, we are rapidly advancing tarlatamab into earlier lines of treatment with multiple Phase 3 studies underway or planned. Based on emerging clinical data, we are discontinuing PSMA-targeting bispecific AMG 340, and we will focus our efforts on rapidly advancing Xaluritamig in metastatic castrate-resistant prostate cancer. We expect Xaluritamig dose expansion cohorts to be fully enrolled by the end of the year, and are planning to initiate additional studies in patients with earlier-stage prostate cancer. With AMG 193, a small molecule MTA-cooperative PRMT5 inhibitor, we are encouraged by the responses we've seen across six MTAP-null solid tumors, the manageable safety profile and preclinical evidence of CNS penetrants. We are now rapidly enrolling dose expansion cohorts. And with that, I'll turn things over to Peter for the financial update.
Peter Griffith: Thank you, Dave. I'll review our third quarter results before discussing our updated 2023 guidance. Turning to our third quarter financial results, which are shown on Slide 44, total revenues of $6.9 billion grew 4% year-over-year and non-GAAP earnings per share of $4.96 grew 6% year-over-year. The growth in revenues was due to product sales increasing 5% year-over-year, driven by a 11% volume growth. Third quarter total non-GAAP operating expenses increased 4% year-over-year. We advanced our pipeline and invested in growth opportunities in the quarter, while delivering a non-GAAP operating margin as a percent of product sales of 52%. Non-GAAP cost of sales as a percent of product sales increased 1.3 percentage points on a year-over-year basis to 17.4%, primarily driven by higher profit shares and changes in product mix. Non-GAAP R&D expenses in the quarter decreased 2% year-over-year due to lower spend in research and early pipeline activities, partially offset by higher spend in later-stage clinical programs and marketed products. Year-to-date, non-GAAP R&D expenses increased 5% due to higher spend in later-stage clinical programs and marketed products, partially offset by lower spend in research and early pipeline. Non-GAAP SG&A expenses in the third quarter increased 1% year-over-year. We continue to focus on prioritizing key investments, digitalization, driving productivity and accelerating use cases for artificial intelligence. Non-GAAP OI&E were a net $225 million expense in the third quarter. The year-over-year favorability was driven primarily by higher interest income and the change in Beijing accounting from equity method to a mark-to-market investments, with the impact included only in our GAAP results. Our third quarter non-GAAP tax rate increased 3.2 percentage points to 16.1%, primarily due to the 2022 Puerto Rico tax law change that replaced the excise tax with an income tax beginning in 2023. We continue to execute on our capital allocation priorities. First, we continue to prioritize investments in both internal and external innovation. In the third quarter, we increased investments in programs, including maridebart cafraglutide, I'll call it mari from now on, Rocatinlimab, Tavneos and ABP 206, our biosimilar to OPDIVO. Second, we continue investing in our business for long-term growth, including through simultaneous construction of our state-of-the-art manufacturing facilities in Ohio and North Carolina. We're excited for the anticipated licensure of our Ohio facility in the first half of 2024. Additionally, we're making investments in all parts of our business to leverage the power of Generative AI opportunities. Third, we have a strong track record of returning capital to our shareholders and pay dividends of $2.13 per share in the third quarter, representing a 10% increase over the third quarter in 2022. The company generated $2.5 billion of free cash flow in the third quarter of 2023 compared with $2.8 billion in the third quarter of 2022. We will continue to generate strong cash flows. However, Q4 cash flow will be lower than historical patterns due to the timing of tax payments and Horizon transaction-related expenses. Turning to the outlook for the business for 2023 on Slide 46. We're pleased to have closed the acquisition of Horizon Therapeutics. We're updating our full-year 2023 guidance to include Horizon financial results starting October 6, 2023. So our Q4 results will exclude approximately one week of Horizon's results. We are raising our 2023 revenue guidance to$28.0 billion to $28.4 billion versus previous guidance of $26.6 billion to $27.4 billion. For 2023 non-GAAP earnings per share, we are narrowing the range to $18.20 to $18.80 versus previous guidance of $17.80 to $18.80. We will add Horizon's business into Q4 without material non-GAAP EPS dilution. However, we do expect Q4 non-GAAP EPS to be lower than Q3 non-GAAP EPS because of planned investment increases in our business, including key assets in our innovative pipeline, beginning with mari, Olpasiran and AMG 193, and other strategic business investments, including Generative AI use cases in all parts of our business. This sequential pattern is consistent with historical trends. And in addition, Q4 non-GAAP EPS will begin to include the recognition of interest expense related to the Horizon financing as a non-GAAP expense, important additional points to consider as you model the remainder of 2023. We now expect other revenue for 2023 to be in the range of $1.2 billion to $1.3 billion versus our prior range of $1.1 billion to $1.3 billion. With the Horizon acquisition, we now anticipate full year non-GAAP operating expense for 2023 to increase from our previous estimate of 3% (ph) to approximately 10% versus last year. Horizon represents approximately 5 percentage points of this 10% year-over-year increase. We continue to expect the full year 2023 operating margin as a percentage of product sales to be roughly 50%. We continue to expect non-GAAP cost of sales as a percentage of product sales to be between 16% and 17%. We now expect our non-GAAP R&D expenses to increase from our prior guidance of 5% to about 10% year-over-year. Horizon represents approximately 3 percentage points of this 10% year-over-year increase. The additional 2 percentage points are driven by planned increase in our investments in our innovative pipeline, including mari, Olpasiran, and AMG 193. We continue to expect non-GAAP SG&A to be down year-over-year as a percentage of product sales slightly. We now expect non-GAAP OI&E expenses to be in the range of $1.4 billion to $1.5 billion, up from our prior guidance of $1.1 billion to $1.2 billion. We expect Q4 OI&E to be about $700 million, reflecting interest expense related to the Horizon financing, which will be included in our non-GAAP results effective October 6. And as you begin to model 2024, note that we expect 2024 OI&E to be consistent with this Q4 run rate. This higher interest expense is driven by the $28 billion of debt raised for the Horizon acquisition at a weighted average interest rate of 5.6%. We expect to end 2023 with approximately $65 billion of long-term debt, including the current portion of it, and $11 billion of cash and cash equivalents. For the full year, we anticipate a non-GAAP tax rate of 16.5% to 17%, down from prior guidance of 17.5% to 18.5%. We expect approximately 540 million shares to be outstanding in Q4. This increase from Q3 is driven by the conversion of unvested Horizon equity awards and the Amgen equity awards. Our 2023 capital expenditures are now projected to be approximately $950 million, up from our prior guidance of $925 million. The addition of Horizon's rare disease team further strengthens our confidence in delivering against our long-term growth objectives. We continue to allocate capital to advance innovation at speed and at scale. And I'm incredibly grateful to our now 26,000-plus colleagues for successfully executing our mission of serving patients. This concludes the financial update. And now, I will ask our operator, Julianne, please open the lines for Q&A and remind our participants of the procedure to ask their questions. Julianne?
Operator: Thank you. [Operator Instructions] Our first question comes from Michael Yee from Jefferies. Please go ahead. Your line is open.
Michael Yee: Hey, guys. Good morning. Thanks for all the details around the Horizon transaction. I just wanted to ask a question to David Reese. I mean, David unless we're hiding under a rock, I guess obesity is like the biggest thing ever now and wanted to understand your commentary and confidence around 133 and the profile around what you think that could be relative to leaders and how 786 would fit into that given such a high bar for other orals? Thank you.
David Reese: Yeah. Sure. As we've discussed before, Mike, with 133, we believe we have a potentially differentiated product based on the mechanism of action, it's a bi-functional to remind everyone, that antagonizes GIPR based on a genetic evidence, largely compiled by us, with two GLP-1 peptides stapled to the molecule for that mechanism of action. As I noted in the remarks, we've rapidly enrolled the Phase 2 trial. There are multiple arms to this trial that explore three different doses as well as different dosing intervals that I think will give us broad optionality going forward. We were quite pleased with the Phase 1 data in terms of depth of response, the kinetics of response, as well as persistence, and these are the things that we will be looking at in Phase 2 as we go forward. So it's full steam ahead on this program. And we're looking forward to data from the Phase 2 trial next year which will really inform the breadth of the Phase 3 trial that we're contemplating, which could be quite large. In terms of AMG 186 -- or 786, this is an orthogonal mechanism of action. We're bringing in data. And as we've indicated, after, you know, the first half of next year or so, we anticipate presenting those data in determining the path forward. As you note, it's a high bar in this field and we'd have to see the sort of profile that would, give us the confidence to invest broadly in a molecule like that. I would also note, we've got a suite of preclinical molecules, many of them non-incretin based in terms of mechanisms of action that we will be bringing forward over the next few years. So this is an area where we expect it to be a long-term player. Thanks.
Operator: Thank you, Michael. Our next question comes from Yaron Werber from Cowen. Please go ahead. Your line is open.
Yaron Werber: Great. Thanks for taking my question. Peter, just for you, the $700 million run rate, that was interest expense only, right? That's not including where you're recording sort of the Beijing contribution in the line right above it in terms of other income. And then just secondly, again on your guidance, you also mentioned 3% to 10% increase year-over-year And you mentioned 5% to 10% going to R&D. The 3% to 10% increased -- just remind us what that was, because SG&A is expected to be down, right, slightly year-over-year, so I just missed what that was.
Peter Griffith: Right. Thank you, Yaron. The 700 is everything, so that's the full run rate. And on the question on R&D, as I said in my remarks, we've focused our spending on the later clinical and in-market portfolio that was slightly offset by some decreases in early research. But we continue to spend and invest in the business and we'll continue to do that. As you can see, we're fortunate to have a significant number of opportunities in Phase 3 in the later stages. So that's what we'll stay focused on, will continue to differentially invest in the opportunities in innovation and we're very excited about that.
Operator: Thank you, Yaron. Our next question comes from Terence Flynn from Morgan Stanley. Please go ahead. Your line is open.
Terence Flynn: Great. Thanks for taking the question. Maybe a two-parter from me for Peter as well. Peter, again, I know you went through a lot of numbers there at the end. But in terms of the revenue guidance raise for the year, can you just characterize if that was all coming from the Horizon portfolio or if there was any other contribution from the underlying base business? And then the second part of the question is just any directional help with how to think about 2024 tax rate, as I know there's a number of moving pieces from some legislation, but then you obviously have the Horizon deal close. So just directionally, can you help us out in 2024 tax rate? Thank you.
Peter Griffith: Yeah. So -- excuse me. On the tax rate, let me start with that '24 tax rate. We'll guide on that as we always do at the beginning of the year. I would just say, I think you're thinking about the global minimum tax and Pillar 2, and I would just note, there is no consensus or predictability about how that whole OECD framework is going to be implemented. I know different countries are doing different situations. Rest assured, we look at everything, optimize our position as appropriate on something like that. So we'll give you guidance on that next year at the beginning of the year. First part of the question?
Robert Bradway: Revenues.
Peter Griffith: Yeah. On revenue, look, we don't really break that down. I would just suggest that we continue to see strength in the business and we continue to see our in-line portfolio perform very, very well. I would just note, we had seven products with record sales in the quarter, we had Repatha up 31%, up in the quarter year-over-year. And we've continue to see the hematology-oncology portfolio was up 16%. So everything's, strong in our base business. We're excited about that base business, that continues to perform really well and we're very excited to have the rare disease business now. And looking forward to having that as, as we said, it's kind of the four stool of our commercial thrust forward. So we're seeing good strength around the business in different areas and we'll just continue to get more and more medicines to patients. I'd note, the 11% volume growth is really important. Underneath that 12% volume growth outside the United States. And underneath that 27% volume growth in JPAC, our fastest-growing region. So that's how we're looking at that. We're pleased with the momentum and we're pleased to be able to raise the 28.0 to 28.4.
Operator: Thank you, Terence. Our next question comes from Salveen Richter from Goldman Sachs. Please go ahead. Your line is open.
Salveen Richter: Good morning. Thanks for taking my question. With regard to the Horizon transaction, now that it's closed, could you just walk through the outlook for Tepezza and the other assets as we look to 2024 here? You talked about initiatives that you have to expand the patient population in ex-U.S. being a growth lever. Just maybe walk us through that and when we might get updated long-term guidance, including Horizon. Thank you.
Robert Bradway: Yeah. Maybe we'll take this in two parts, Salveen, it's Bob. Obviously, we're not going to provide '24 guidance here this morning. But we'll see whether we can give you a clear sense of the things that are exciting us when we look at those products for -- heading into next year. And just generally on the question of long-term guidance, as you've heard us say on a number of occasions, we remain confident that we're on track to meet or beat the objectives that we established for 2030, in some ways now frankly, we're more focused on what we can deliver through 2031 and soon to be 2032 as well. So we reviewed -- in-depth review of the oncology portfolio a couple of weeks ago and gave you a good sense for the moving pieces through the end of the decade. And we may seek to present a picture of the business in that way now heading into next year, so that you can get a more comprehensive deep-dive into the different segments of the business that are driving growth. But let's turn to first question, which is the outlook for Horizon and the initiatives that are underway, in particular, with respect to Tepezza, and KRYSTEXXA and UPLIZNA. So Vikram, why don't you fire away?
Vikram Karnani: Yeah. Thanks for the question. I think as I said in my prepared remarks, we have a lot of positive leading indicators as we look at the business. I'll start with Tepezza. We're continuing to build that U.S. TED market following the FDA's April 2023 label updates. And that really helps us get the medicine to TED patients regardless of disease activity or duration. And what we've seen following that label update is that the payers are continuing to update their medical policies and make them more favorable so that more of these patients, more in the low CAS setting or the low Clinical Activity Score setting can now access Tepezza. And I think, finally, from an execution standpoint, we see newer prescribers from both ophthalmologists, as well as endocrinologists increasing 50% year-over-year in this third quarter. So all of these indicators for Tepezza are positive and we feel good about the execution of the team. And as I said, we have now combined forces with Amgen and together we should be able to drive business in a positive way moving forward. Think -- talking about -- the story around Tepezza also is one of international growth. While we see a lot of positive trends in the U.S., we're pretty excited about what we can do as a combined company for patients outside the U.S. as well. We've talked about Brazil getting approval recently. We've got [indiscernible] OPTIC-J as our trial in Japan. We've talked about the chronic trial that's enrolling. And finally, we're getting ready for other markets and we hope to bring the medicines to many more markets now as part of the combined company than we were talking about previously. So Tepezza, both signs very positive in the US as well as globally. And as we've talked about the results for KRYSTEXXA and UPLIZNA, both those medicines performed really, really well. We have immunomodulation with KRYSTEXXA being a major driver since the label update last year. That has continued to drive uptake since that time. We see that continuing into the future. And with UPLIZNA, it is the fastest-growing biologics in neuromyelitis optica spectrum disorders or NMOSD, and we see that momentum continue both in the U.S. as well as outside the U.S. So I think when I look at the overall portfolio we have, we're operating from a position of strength and now we can expand that even further with the combination with Amgen.
Salveen Richter: Thank you, Vikram.
Operator: Thank you, Salveen. Our next question comes from Jay Olson from Oppenheimer. Please go ahead. Your line is open.
Jay Olson: Hey, congrats on all the progress on so many fronts. Could you talk about your investments in AI technology and how that may influence your drug discovery and development over the next five to 10 years? Thank you.
Robert Bradway: Sure. I'll ask Dave Reese to address that, Jay.
David Reese: Yeah. Thanks, Jay. This is an area where we're very excited. You know, I'd like to characterize it as the hinge moment where we're seeing the coming together or the unification of technology and biotechnology. I really think this is going to affect over time a qualitative change in how we do drug discovery and drug development. So everything from protein structure prediction, protein-protein interaction, prediction at the molecular level, to multiomic analysis on extraordinarily large datasets which can -- which is only tractable through AI or machine learning, dense clinical trials data and then real-world evidence and real-world data. When you look across that spectrum, I believe we probably have the largest datasets in the industry. And so we are putting the tools in place and the foundation or models to really mine those data for deeper insights in the biology and then all the way out into the market. We'll talk about this more over time. But this is going to be an area of investment and it can be overhyped. It's not a panacea, but it is absolutely going to be the most powerful tool we've seen in a long, long time.
Operator: Thank you, Jay. Our next question comes from Umer Raffat from Evercore ISI. Please go ahead. Your line is open.
Umer Raffat: Hi, guys. Thanks for taking my question. Dave, I have a two-part question on AMG 786, the oral for obesity. First, I noticed you guys dropped a cohort in your SAD portion of the trial. Is that because you ran into MTD? And then also, I noticed the exclusion criteria around suicide ideation were intensified and I can't tell if we could be reading into that or not, would love to get any color. Thank you
David Reese: Yeah. Thanks. On the latter, I wouldn't overthink that at all. I don't think there's anything there. In terms of the dosing that we do, this is always adjusted as we move through Phase 1 trials. As I've indicated, we're bringing in the data now, we're taking a look at that. And the constellation of clinical data -- updated preclinical data, and I think we'll have that all together as we go into next year and that will determine the potential path forward for AMG 786. And just to remind everyone, this is a target that is not an incretin-based target.
Operator: Thank you, Umar. Our next question comes from Robyn Karnauskas from Truist Securities. Please go ahead. Your line is open.
Robyn Karnauskas: All right. Thanks for taking my question. I do have a follow-up to Salveen's question actually. So Tezspire has gotten a lot of market share, there is so much room to grow in the TED space. Can you walk me through, like how Amgen can actually help grow that business because I'm confused by whether it's the hearing loss or reimbursement or what are really the levers that will actually grow that company -- grow that business -- Tepezza, sorry, Tepezza, that I think that there's a lot of room to grow. And given your strength, you could probably make that work. So, how do you intend to do that?
Robert Bradway: Okay. Thank you, Robyn. So I think it's a two-part question there on Tepezza. We may tackle it in two parts with the combination of Vikram and Murdo. So go ahead, Vikram, why don't you start?
Vikram Karnani: Yeah. Thanks for the question. Like I said earlier, the -- I think one of the areas that has -- something that happened this year was the FDA update. Now when the label updates to patients that are treated regardless of disease activity or duration, many of these patients, in fact, I would say more of these patients are being treated by prescribers, such as endocrinologists and ophthalmologists. And that's what the team has been focused on working through, making sure that our educational program is available to these physicians, so that we can widen our prescriber base from the original set of prescribers that started treating patients at launch. So it's really important to understand that expanding the prescriber base is a critical driver for that success going forward. And as we've seen new prescribers have increased 50% year-over-year. As we continue to work through these new -- this low CAS or low clinical activity patients, we also have to remember that when they are prescribed the medicine, payers need to open up access to the medicine. So our market access team has been working pretty diligently to make sure that payers continue to update their medical policies. And what we have seen is more than 30% of U.S. covered lives are now eligible patients that can access Tepezza with more open or more favorable policies. This has to continue and both of these are areas that we will continue to work on as we go into early next year and beyond. And maybe I'll turn it over to Murdo to add his comments as well.
Murdo Gordon: Yes. Thanks, Vikram. Hi, Robyn. I would add, much the same way when we acquired ChemoCentryx and Tavneos, we realized that there was a low level of awareness of Tavneos. What we did there was we added reminder messaging to some of our broader rheumatology-covered sales forces to increase awareness of the data associated with Tavneos in ANCA-associated vasculitis patients. We've seen a corresponding increase in utilization, of course, driven by awareness of that product. So the core team is still promoting the attributes of the product and educating physicians, but there is a broader group of field personnel building general awareness of that product. What I think Vikram and I are talking about is the Amgen teams that cover endocrinologists were involved in the diagnosing and treatment of Thyroid Eye Disease, would be an ideal opportunity for us to broaden the awareness amongst that community of endocrinologists who are diagnosing and treating thyroid eye disease today to augment the great work that is happening with the rare disease teams under Vikram's leadership. So there's a number of things like that where we can scale and speed up the building of awareness, for example, of the new data that Vikram was just describing and the broadening of the label language. Vikram also mentioned the international expansion. The original plan was quite ambitious for Horizon. We've actually increased the number of markets that we intend to file and launch in, in a shorter period of time. So that would be an additional opportunity for growth given the strength of the two companies now combined.
Robert Bradway: Might just add also, Robyn, that in terms of the time course of events here, I think now that we flip back on a year of ownership of ChemoCentryx, we can really start to see the benefit of what Murdo just described kicking in, over the last few weeks and months. So it takes a little bit of while, but I think our confidence is that over that period of time, we've been able to find ways that we can add distinctive value to that product and we're hoping a similar thing will happen with respect to the new rare disease molecules that we brought on board. So it's not like walk in, flip a light switch and suddenly things are performing on a different track, but rather you come in, work together, identify the ways in which we can be additive in the marketplace. And I'm hopeful that we'll see during the course of '24, the momentum build for the combined organization on these products.
Operator: Thank you, Robyn. Our next question comes from David Risinger from Leerink Partners. Please go ahead. Your line is open.
David Risinger: Yes. Thanks very much. And so my question is on oral obesity development. Regarding Phase 1 candidate 786, management has consistently emphasized that it also has a suite of oral preclinical product. And so should we take away that we should be viewing 786 as more of a wild card, rather than something that Amgen has conviction in at this point? And when do you expect to be able to start Phase 1 for another oral preclinical candidate? Might that happen in '24 or not until '25? And then separately, just I wanted to squeeze in a quick financial question. Do you expect Horizon product channel inventory work down in the fourth quarter to significantly constrain reported net Horizon sales in the fourth quarter? Thank you.
David Reese: Yeah. Thanks, David. Dave Reese, I'll start and then turn things over to Murdo, and Vikram. In terms of oral obesity molecule 786, as I've said, it has a novel mechanism of action, it's a Phase 1 molecule. So you should view it as a Phase 1 molecule. And we're bringing in the data I said, and we'll take a look at that as we get into the new year and make a determination on potential path forward for that molecule. I wouldn't view it as anything more or less than a Phase 1 asset with a novel mechanism of action. In terms of additional molecules and when we might file INDs and launch our first in human trials, we'll give guidance as that portfolio advances over time. Again, many of those molecules are targets that we emanated from deCODE Genetics, our colleagues in Iceland. And I'll provide further information as we get ready to move towards the clinic. But this is playing a long game. If you step back, look, this field is in its infancy. We are just beginning to understand the complex metabolic arrangements that occur with obesity and there are clearly different forms of obesity. There's a lot of work to do. And as I've indicated, our intent here is to play the long game given that this is one of the major public health challenges of the 21st Century. So let me now hand it over to Vikram and Murdo for additional commentary on your second question.
Murdo Gordon: Yeah, David. I just want to make sure that I heard your question right, it was about inventory and product wind-down. Look, I don't think we are going to comment on that specific aspect. I think the -- our team remains focused on driving demand and working with physicians to educate them and expanding the use of Tepezza for appropriate patients and that's where we're really focused too as a primary driver of net sales growth.
Operator: Thank you, David. Our next question comes from Chris Raymond from Piper Sandler. Please go ahead. Your line is open.
Chris Raymond: Hey, thanks for taking the question. I just -- maybe a commercial question on your dermatology strategy and specifically on Otezla, just on the dynamic that you guys talked about with free competitor drug, presumably that's SOTYKTU scenario. And I think I heard you guys, you know, you've been calling this issue out for some time, but also with the investment that you're making in the dermatology sales force, I think I heard you say today that you're increasing that sales force sort of 20% or so. Is the implication that once the competitor free drug program runs its course, that Otezla volume should increase or what's your sense of what happens to volume? And maybe I'll ask it another way, if that volume increase doesn't materialize, do you need additional derm portfolio offerings to support that added effort? Thanks.
Murdo Gordon: Thanks for the question, Chris. This is Murdo. So let's just recapitulate what's happening in this market. At the beginning of the year, you had a number of new launches, not just SOTYKTU, with novel topicals coming into the market as well as a novel oral and every one of those products had very generous free drug programs and that had two effects on Otezla. There were topical patients who would have normally moved to their first systemic option who tried the new topical treatments on a free drug basis. And at the same time, there was a launch of a new oral that had a very generous free drug program. And so, Otezla, which sources the majority of its growth from topical patients for systemic, in other words, biologic naive patients. Otezla got squeezed in the first and second quarter on the basis of those new programs coming into the market. What we've seen since those two events in the market is that the novel topicals have flattened out in their growth and have pulled back to some extent on their free drug offering. The other oral therapy SOTYKTU continues to provide free drug, and so continues to have some effect on Otezla. What we think will happen and we're already seeing the very early signals of this is that we will continue to source our new growth from the topical patients, bio-naive patients. Given that Otezla is the ideal for a systemic agent, we have established ourselves with really strong access in the market. So we don't need to provide free drug programs to the extent that everybody else is. And then as the contracting cycle for 2024 matures and we see what the actual access is for some of the other competitors in the market, including the new oral, we should be able to give better guidance on our growth prospects for the future. But we almost certainly expect the impact of the free goods program to continue to reduce and that will help us grow Otezla. The investments we've made are really just kicking in this quarter. So the expansion in the field force, and your number was right, by 20%, the derm team was just deployed at the beginning of Q4. So they are only in-field as of a few weeks. So that impact is not in the historical performance of the brand. And our direct-to-consumer spend has been increased for the fourth quarter as well. So we will be able to tell you more as we go forward, but we feel given the very large number of patients here who continue to persist on topicals, when they really are better candidates for a systemic agent, will convert to Otezla as we build into that market. And just a reminder, we're the only product in the market that has a broad label regardless of severity of psoriasis. So we're optimistic and we're enthusiastic and that's why we've made these investments and we'll continue to look to add to our dermatology portfolio as we go forward.
Operator: [Technical Difficulty] Chris. Our next question comes from Mohit Bansal from Wells Fargo. Please go ahead. Your line is open.
Mohit Bansal: Hey. Thank you very much for taking my question and thank you for changing the time to make sure people can enjoy Halloween. So maybe one question on sequential growth. If I look at second quarter from third quarter, it seems like pretty much every product, even including Nplate accounts for the government budget, seems to be down. I know that you warned about this in the second quarter call regarding Medicare donut hole, but can you talk a little bit about the dynamics there and how should we be thinking about this going forward?
Robert Bradway: Yeah, Mohit. I don't think every product is down. I think we had a number of products posting pretty significant double-digit growth in the quarter. And those are products that we continue to expect long-term growth from products like Repatha, EVENITY, Prolia, our hemo portfolio, BLINCYTO in particular. So, we're seeing some strength in our priority growth brands that we expect to continue to drive. What we did have in the quarter were a number of adjustments from prior period on net sales. So there was one particular adjustment on LUMAKRAS, which was based on a year-over-year change in the negotiations that we have on reimbursement. So in France, for example, we have an early temporary access program, and ATU program. Since 2021 LUMAKRAS has been available in France and we took a $22 million accrual in the quarter for those sales on the basis of price negotiations we are having in France. So we had a number of events like that related to price in the quarter. And as you mentioned, we are entering the donut hole for some of our products. So overall, I think unit volume growth is very strong. A few price effects on select products in the portfolio and a little bit of donut hole impact.
Operator: Thank you, Mohit. Our next question comes from Gregory Renza from RBC Capital Markets. Please go ahead your line is open.
Gregory Renza: Great. Good morning, Bob and team and congrats on the progress, and thanks for taking my question. Bob, just circling back to the obesity market again, and as you and the team focused on really being first or -- and/or best in class across markets, I'm just curious how you and the team view and anticipate how different the obesity market can look and how you see the unmet need morphing by the time a program from Amgen is ready for prime time. But would there be a need to look not just internally but externally to accelerate those efforts, especially if things are evolving so quickly? Thanks again and congrats on the progress.
Robert Bradway: Now, we're very excited about what we see so far emerging from our early work in obesity. I think over time you've got the sense of this from Dave Reese. This is likely to be a heterogeneous disease, they're probably going to be a number of different ways to have to go at it. But what encourages us right now is, what we think as an emerging differentiated profile for our approach versus the competition. And maybe, Murdo, you want to just jump in and remind Gregory about the basis of differentiation that we see so far in our data from the competition and why we think that gives us a good foothold for entering the markets.
Murdo Gordon: Yeah. Thanks, Bob. I like the way the question was framed. It sometimes gets framed as, what are you going to do when the -- with these entrenched products in the market. And I'd just like [Technical Difficulty] people how young this market is and how much more is left to unfold. What we're seeing in the early days is, we're seeing a lot of patients trying these products, losing weight, but then not persisting with their treatment and regaining weight. So we think that there is an opportunity in the market long term for a product that can bring about very strong weight loss, both rapid and sustained over time with convenient dosing. And I think that that's where 133 or maridebart cafraglutide really has an opportunity to differentiate itself from what is available in the market today. We've seen the durability of that product between doses, and we think based on the Phase 2 in a number of different dosing cohorts we have being explored in that trial, we will be able to find the right balance of efficacy and the ability, based on convenient dosing to sustain that weight-loss over time. And, of course, the goal here is not just to lose weight, but to improve a number of sequelae or outcomes from people who carry extra weight over the course of their life, and that's what we're starting to see with others reading out in event trials. We will see more data as the medical congress has passed these next few months. But our hope is to bring about real improvement in outcomes with a highly efficacious and highly convenient product, like 133.
Operator: Thank you, Gregory. Our next question comes from Geoff Meacham from Bank of America. Please go ahead. Your line is open.
Geoff Meacham: Good morning, guys. Thanks so much for the question. Murdo, it's been a long time coming for Repatha in submission. Are you guys finally hitting a commercial tipping point with payers, or do you think there is an increasing interest among cardiologists? I guess, I wasn't sure how, you know, the current market is and looking forward, how about the impact? How do you guys see it from a couple of the ongoing Phase 3s and 4s? Thank you.
Murdo Gordon: Thanks for the question, Geoff. Yes, it's been a bit of a journey. And the COVID pandemic didn't help us in our efforts to educate and convince cardiologists that they needed to do more to be more aggressive in treating their patients; LDL, cholesterol. I do think we've reached a tipping point in cardiology and I do think we've reached a tipping point with payers. We now have over 90% commercial lives covered. We anticipate being able to continue to progress our Medicare Part-D coverage, and we're seeing, you know, the PCSK9 category driven primarily by our 80% share of that category. Really, really starting to move now. Our new patient volume growth is good, not just in the US, but around the world. We are now seeing more and more primary care physicians using PCSK9s in combination with other drugs to more aggressively lower LDL in high-risk ASCVD patients. So the phases are pretty clear, payer coverage established, affordability for patients established, cardiologists are now prescribing with frequency and now moving into primary care. And we'll be adding direct-to-consumer campaign investment to that mix. So, yeah, I think we've reached a tipping point on Repatha Geoff and I'm bullish on what we can do to further expand that product, both from a volume and net sales perspective.
Operator: Thank you, Geoff. Our next question comes from Chris Schott from JPMorgan. Please go ahead. Your line is open.
Chris Schott: Great. Thanks so much for the question. Just a question on longer-term margins. So I guess post Horizon and I guess with the ramp of your pipeline, including some potentially very large obesity studies over time, I guess, just directionally, how should we be thinking about margins from here? I guess is this kind of 50% or slightly above 50% range a reasonable target for the company, or just any considerations we should keep in mind as we kind of balance, I guess, Horizon versus investment? Thank you
Robert Bradway: Well, we're not going to give updated margin guidance on this call, Chris, but I think we've been pretty clear about what the trail should look like. We're focused on remaining a leading efficient player in our industry. We've been able to achieve leading operating margins over time. There is nothing that we see in the Horizon business specifically that would lead us to conclude differently from that. So we expect that at a full run rate, capitalizing on our in-place infrastructure internationally and manufacturing and process development that the margins in that business would be attractive in our hands. And the reference that Peter made to R&D spend earlier, obviously, to the extent that we get into a number of Phase 3 trials in the middle years here of the decade for Lp(a) and for obesity products, that may have an effect on overall margins, but we'll have plenty of time to talk about that in advance so that nobody is surprised if the margin starts moving around. So again, we've demonstrated a pretty consistent ability to manage the cost structure of the business and that's something that we're determined to maintain.
Operator: Thank you, Chris. Our next question comes from Evan Seigerman from BMO. Please go ahead. Your line is open.
Evan Seigerman: Hi, guys. Thank you so much for the color on the call today. So the growth in perspective is pretty impressive. Just wondering how the mentioned $1 billion run rate compares with your expectations going into the deal. And then taking a step back, we saw on a JAMA article about the use of type 2 diabetes and then for gout. How are you seeing that in the broader gout space? Is this something we should be concerned about when it comes to KRYSTEXXA? Thank you.
Robert Bradway: Maybe we'll take this in two-parts. First, with respect to KRYSTEXXA, I'd say KRYSTEXXA is performing very well and we believed it would. Again, we think there is a tremendously large unmet medical need here and that KRYSTEXXA with methotrexate is serving the marketplace well. So we're looking forward to working with our colleagues on it. And overall, I'd say that the business is proceeding as we thought it would to this point. The things that we were -- that we thought were important to have in hand, like the chronic indication for Tepezza, like, international datasets that were made available with the OPTIC-J trial, like the progress we've made in Brazil, et cetera. Those were things that we wanted to have in hand and now do. And, again, UPLIZNA also performing very much in line as we expected it would. So we see three growth opportunities there and we see ways for the Amgen-based business to add value to what Vikram will be running now in our rare business area. And then, with respect to the question on diabetes, I’ll ask Dave, [Multiple Speakers]
David Reese: I mean, I think, the broader context here is important. These patients have severe uncontrolled gout. They are often facing amputations, for example, because of the severity of the disease. And so there are large number of these patients that are currently not being served in the market in clinical practice. And so our focus is on reaching those patients where the quality-of-life impediments are quite significant, and the effects of the drug can be quite dramatic in improving the disease course and improving that sort of quality of life. So that's the focus right now. I wouldn't get distracted by some of the other potential associations.
Robert Bradway: Now, operator, I think we have two more calls in the log here. So why don't we take two more and then we'll thank our colleagues and let them get on with the day.
Operator: Certainly. Thank you, Evan. Our next question comes from Tim Anderson from Wolfe Research. Please go ahead. Your line is open.
Tim Anderson: Thank you. On AMG 133, maybe this is a silly question, but is it at all possible that you can start Phase 3 in 2024? The main way to do this would be to do an early or interim look of sorts at the Phase 2 trial before the primary completion date. And I know you're guiding for top-line on that in late '24. Thank you.
David Reese: Yeah. I mean, as we go through '24, we will give guidance on when we expect, you know, the Phase 3 program to launch. You know, as is customary in these programs, we will take an interim look. That will remain blinded, we will not release that externally, because this is a 52-week study, but that will help at least guide our thinking. Also recall that the FDA requires a certain safety database before you launch Phase 3 trials here. And so as we get into next year and start to have those conversations, we will be able to give more definitive guidance as to when you can expect the launch of the Phase 3 program and what that suite of studies might look like.
Robert Bradway: And let's take our last question.
Operator: Thank you, Tim. Our last question will come from Colin Bristow from UBS. Please go ahead. Your line is open.
Colin Bristow: Hi. Good morning, and thanks for taking the questions. Maybe just a quick follow-up on 133. Just as we think about this from a commercial perspective, this is obviously an antibody backbone. It's going to be an injectable. Just in light of margin that's achievable with this, just help us think through that. Thanks.
Vikram Karnani: Well, Colin, you rightly point out that this is an antibody backbone. The properties of that, obviously, as I was alluding to earlier, could be that you can dose it much less frequently than you have to with the current therapies on the market. We also think, given the potential differentiation on efficacy and possibly tolerability, that we will be able to establish a very strong position in the market for people who need rapid, deep, and sustained weight-loss that they can manage over time, so that they can gain the benefits, the reduction in cardiovascular risk, the improvement in outcomes from that treatment. But we expect, as Dave said, to develop this product across a suite of Phase 3 experiments, and we expect to be able to take a decent share of the market, which will drive a good return on our investment in that product.
Operator: Thank you, Colin. I would now like to turn the call back over to Bob Bradway for closing remarks.
Robert Bradway: Okay. Well, let me thank all of you for joining us this morning. And we hope that the choice of doing this in the morning frees you up to go enjoy the afternoon and evening of trick-or-treating wherever you are. But we again, appreciate your support. It's been an eventful few months at Amgen. And we'll look forward to having an opportunity to regather with you and report on the fourth quarter when we get to the new year. Many thanks.
Operator: This concludes our 2023 Q3 earnings call. You may now disconnect. |
CHTR | 3 | 2,023 | 2023-10-27 12:37:03 | Operator: Hello, and welcome to the Charter Communications Q3 Conference Call. We ask that you please hold all questions until the completion of the formal remarks, at which time you’ll be given instructions for the question-and-answer session. Also, as a reminder, this conference call is being recorded today. If you have any objections, please disconnect at this time. I'll now pass you over to Stefan Anninger.
Stefan Anninger: Thanks, operator, and welcome, everyone. The presentation that accompanies this call can be found on our website at ir.charter.com. I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, which we encourage you to read carefully. Various remarks that we make on this call, concerning expectations, predictions, plans and prospects, constitute forward-looking statements, which are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only, and Charter undertakes no obligation to revise or update such statements. On today's call, we have Chris Winfrey, our President and CEO; and Jessica Fischer, our CFO. With that, let's turn the call over to Chris.
Chris Winfrey: Thanks, Stefan. During the third quarter, we added 63,000 Internet customers, as we continue to benefit from growth in both our existing footprint and new subsidized rural footprint. We also added nearly 600,000 Spectrum mobile lines, benefiting from our Spectrum One offering. At the end of the third quarter, we had over 7 million total mobile lines, and over 12% of our Internet customers now have mobile service. We expect mobile penetration to meaningfully grow over the next several years as the quality and the value of our converged connectivity service gains wider recognition. Revenue was essentially flat year-over-year, with some temporary headwinds within the quarter. And adjusted EBITDA grew at 0.7% year-over-year, moving past the low point last quarter. We expect that upward trend to continue as we realize the benefit of our operating investments. More importantly, we're making significant progress against the multiyear strategic initiatives we outlined late last year. Our footprint expansion initiative remains on track. We expect to add approximately 300,000 new subsidized rural passings in 2023 and to accelerate that pace in 2024. Our penetration gains in subsidized rural passings continues to grow at a better-than-expected pace. At the 12-month mark, our rural builds are achieving nearly 50% penetration, faster than our initial expectations. Our execution initiative also continues to progress, and we remain committed to prioritizing the customer experience. We continue to see the benefits of our investments in employee tenure and training, including better employee retention, higher quality service transactions and better sales yields. Additionally, the increasing digitization of our service platforms for both customers and employees will further reduce transactions, driving higher levels of customer satisfaction and employee satisfaction, driving tenure and quality. And finally, our evolution initiative, which is comprised of our network evolution project, our convergence efforts and our video product transformation, all of which remain on track. Our network evolution project continues to progress well and will allow us to maintain our fastest Internet and WiFi service claims in front of customers and competitors everywhere we operate. Unlike the telcos, which prioritize the most attractive footprints for upgrades, our multi-gig speed offerings will be available across our entire footprint. Our network evolution is good for the communities we serve, and it's good for Charter. And excluding the benefit of any savings that result from the project, we continue to expect our network evolution to cost a very low $100 per passing. We're very much on target. Whether we finish our network evolution initiative by the end of 2025 or mid-2026 will really depend on the supply chain for distributed access architecture components and managing annual capital spend, given the larger customer growth opportunity and construction speed of RDOF, where we're ahead of the build requirements and we'll end up with more passings than originally expected, state grants, and hopefully, beat passings. However, I want to reiterate and be very clear that where state BEAD rules are not conducive to private investment, we will not participate in those states. Our converged product offering also continues to evolve and succeed. Spectrum One is performing well and offers the fastest connectivity, with differentiated features like mobile Speed Boost and the Spectrum Mobile Network. Spectrum One also offers significant savings for customers, with market-leading pricing at both promotion and retail. Finally, turning to the evolution of our video product. Earlier this month, we launched our Xumo platform across our entire footprint. This industry-leading video platform allows our customers to access their linear and direct-to-consumer video content with unified search and discovery within one easy-to-use interface. Combined with our Spectrum TV app, the most viewed linear and VPD streaming service in the US, Xumo is now our go-to-market platform for new video sales. In September, we announced an agreement to carry Disney's linear networks and direct-to-consumer services for our customers. This new hybrid distribution model is good for consumers and we believe a significant step forward for the video ecosystem. For Charter, the agreement adds value to our video packages and better aligns linear content and DTC apps, which will be included for free in our video products. We also maintained flexibility to offer lower cost packages. Disney gets broader distribution of its DTC products with ad revenues from our video customers and upgrade subscriptions to ad free. We'll also sell Disney's DTC apps to our Internet customers, including via Xumo over time. Together with Disney, we created a glide path to bridge from linear video into new growth with both linear and DTC services. Disney and ESPN were a key first step to repairing the video ecosystem, but our goal is to have a product that is valuable and that we're proud to sell. We plan to modernize all of our distribution agreements upon renewal in a way that works for customers. That means packaging flexibility, value and not asking customers or us to pay twice for similar DTC and linear programming. If programmers insist on customers paying twice, we just won't carry those channels. But we'd still be happy to sell their content in an à la carte app, same way as they do. Our goal is to modernize these agreements quietly and seamlessly for our mutual customer base. Our new hybrid distribution model, combined with Xumo's content forward interface, provides a clear path to solve key customer issues of choice, value, and utility, with seamless linear DTC and SVOD integration in advanced search and discovery functionality. For Charter and programmers, this creates a state-of-the-art video marketplace, supported by our scaled distribution, sales, and service infrastructure, and we believe a glide path to broader distribution, better economics, and more choice for everyone. Through expansion, network evolution, convergence, video transformation, and investing in quality, we are executing successfully the strategy we laid out last December. Our strategy remains to provide the highest quality products, which we then priced and packaged in customer-friendly ways to drive higher penetration of our services across our footprint. We then combined that with investments in high-quality service, which also increases our competitiveness to acquire more customers. Ultimately, continued execution of our strategy will drive significant long-term value for shareholders, and we continue to make good progress. Before handing the call over to Jessica, I want to note that earlier this week, we announced Ton Rutledge's plan of retirement, and that Eric Zinterhofer is reassuming the non-Executive Chairman role at Charter. I'm pleased that Tom will remain as Director Emeritus, and grateful to Tom, Eric and our full Board, including two of the most successful cable investors in Liberty Media and Advanced New House, for their work to achieve a smooth CEO transition for Charter. Jessica?
Jessica Fischer: Thanks, Chris. Let's turn to our customer results on Slide 5. Including residential and SMB, we added 63,000 Internet customers in the third quarter. We estimate that approximately 15,000 third quarter Internet disconnects were driven by the temporary loss of ESPN in September. Video customers declined by 327,000 in the third quarter, with about 100,000 video disconnects driven by the Disney programming dispute. The overall impact to customer relationships was less than we expected, facilitated in part by the wide availability of over-the-top alternative. The loss of Disney programming occurred both at the beginning of football season and in the midst of a programming cost pass-through and the launch of our new Auto Pay discount incentive on Internet. Nonetheless, operationally, we handled the Disney dispute very well. But our billing and retention call centers were not fully back to normal until early October, so there was lingering customer net add impact early in the fourth quarter. Turning to mobile. We added 594,000 mobile lines in the third quarter. Wireline voice customers declined by 286,000 in the third quarter. Overall market activity, churn and gross adds, remained well below pre-COVID levels, partly driven by persistently low move rates. We continue to compete well in a portion of our footprint that is overlapped by fiber, but we also continue to see some impact from fixed wireless access competitors in the lower usage and price-sensitive customer segments of our residential and SMB businesses. That product remains slower and less reliable than what we can deliver, and will be additionally constrained as consumers demand more and more data. In fact, high data usage customers that switched to fixed wireless have a higher propensity to return to our Internet service. Despite our Disney dispute, third quarter residential Internet churn was at a new record low for the third quarter. Our Spectrum Mobile product also continued to perform well in the quarter. The majority of new lines continue to come from existing Internet customers, though the percentage of lines coming from new customers has continued to increase. Boarding from other carriers as a portion of our gross additions grew year-over-year, despite much higher mobile sales. We also continue to see healthy data usage on our Spectrum One promotional lines and remain confident that these lines should perform well as long-term customers. In the third quarter of last year, we launched Spectrum One pilot programs in a handful of markets. The pilot program customers reached their 12-month anniversary during the third quarter of this year, and incremental churn on those lines was small and even less than we expected. Turning to rural. Subsidized rural passings growth accelerated in the third quarter, with 78,000 passings activated. And we continue to expect approximately 300,000 new subsidized rural passings this year. As our RDOF build has progressed, we have identified roughly 300,000 adjacent passings along the way that are not in the sense of slot groups we want, but we will add to our network as we complete the RDOF build. Because of these adjacent passings, we now expect that our RDOF initiative will yield a total of 1.3 million passings to be constructed over a multiyear period. And while labor and equipment costs have both increased, we expect the average net cost per passing of these 1.3 million passings to be similar to our original RDOF net cost per passing estimate. We don't expect any potential BEAD build, subject to what Chris mentioned, to begin until 2025. Moving to financial results, starting on slide 6. Over the last year, residential customers grew by 0.2%, with new customer growth driven by Internet, partly offset by video-only customer churn. Residential revenue per customer relationship declined by 0.6% year-over-year, given a higher mix of non-video customers, growth of lower-priced video packages within our base and $63 million of residential customer credits related to the Disney lockout, partly offset by promotional rate step-ups, rate adjustments and the accelerated growth of Spectrum Mobile. Excluding Disney-related credits, residential revenue per customer relationship was flat year-over-year. As slide 6 shows, in total, residential revenue declined by 0.3% year-over-year. Excluding Disney-related credits, residential revenue grew by 0.3% year-over-year. Turning to commercial. SMB revenue declined by 0.9% year-over-year, reflecting lower monthly SMB revenue per SMB customer, primarily due to a higher mix of lower-priced video packages and a lower number of voice lines per SMB customer. These factors were partly offset by SMB customer growth of 1.3% year-over-year. Enterprise revenue grew by 3.7% year-over-year, driven by enterprise PSU growth of 5.9% year-over-year. Excluding all wholesale revenue, enterprise revenue grew by 5.5%. Third quarter advertising revenue declined by 20.3% or $97 million year-over-year due to less political revenue. Core ad revenue was down 1.8%, due to a more challenged advertising market, partly offset by our growing advanced advertising capabilities. Other revenue grew by 28.8% year-over-year, driven by higher mobile device sales. In total, consolidated third quarter revenue was up 0.2% year-over-year, and up 1.5% year-over-year when excluding advertising and the impact of the $68 million in total Disney-related customer credits. Moving to operating expenses and adjusted EBITDA on slide 7. In the third quarter, total operating expenses were approximately flat year-over-year. Programming costs declined by 9.6% year-over-year due to a decline in video customers of 6% year-over-year, a higher mix of lighter video packages and a $61 million benefit related to the temporary loss of Disney programming in early September. These factors were partly offset by higher programming rates. We now expect that for the full year 2023, programming cost per video customer will decline by approximately 3% year-over-year. Other cost of revenue increased by 15.2%, primarily driven by higher mobile device sales and other mobile direct costs, partly offset by lower regulatory and franchise fees and lower ad sales costs. Cost to service customers increased by 3.7% year-over-year, driven by previous adjustments to job structure, pay and benefits to build a more skilled and longer tenured workforce, resulting in lower frontline employee attrition compared to 2022 and additional activity to support the accelerated growth of Spectrum Mobile. Those were partly offset by productivity improvements, including from tenure investments, lower service transactions per customer and lower bad debt. Sales and marketing costs declined by 1.4%, primarily driven by lower labor costs, as we've lapped our prior year employee investments in sales and marketing. Overall, while we certainly had some additional overtime in our call centers, given the Disney dispute, it was not a material expense driver this quarter. Finally, other expenses grew by 2.5%, driven by labor costs. Adjusted EBITDA grew by 0.7% year-over-year in the quarter. Turning to net income on slide 8. We generated $1.3 billion of net income attributable to Charter shareholders in the third quarter, up from $1.2 billion last year, driven by higher adjusted EBITDA and lower other operating expense, partly offset by higher interest expense. Turning to slide 9. Capital expenditures totaled $3 billion in the third quarter, above last year's third quarter spend of $2.4 billion. The increase was primarily driven by higher spend on upgrade rebuild due to our network evolution initiative, higher spend on line extensions driven by Charter's subsidized rural construction initiative and continued network expansion across residential and commercial greenfield and market selling opportunities, and higher CPE, driven by the purchase of Xumo devices for our launch earlier this month. For the full year 2023, we now expect capital expenditures to total approximately $11.2 billion. Capital expenditures, excluding line extensions, should total approximately $7.2 billion, higher than our previous expectation. The increase reflects additional Xumo CPE purchases and an acceleration of network spend related to future high split markets, including inventory accumulation and other preparation activities like walk-out and design and proactive equipment swap-outs of both DTAs and MPEG2 boxes. As Chris noted, we continue to expect to spend approximately $100 per passing to evolve the network to offer multiple gigabit speeds. There has been no change to our longer-term network evolution CapEx outlook. We also continue to expect 2023 line extension capital expenditures to total approximately $4 billion. We are working through our 2024 operating plan right now. Given the greater subsidized rural passings and construction opportunity we currently see, we may partially fund that opportunity by very modestly slowing our network evolution plan, as Chris mentioned. And as we complete our 2024 plans, we will provide a more detailed outlook on our fourth quarter 2023 call in January. I want to highlight that capital expenditures, excluding line extensions and network evolution as a percentage of total revenue, have remained consistent since 2021. And following the completion of our network evolution initiative, capital expenditures, excluding line extensions as a percentage of revenue, should decline to below 2022 level, which has important long-term cash flow implications. As Slide 10 shows, we generated $1.1 billion of free cash flow this quarter versus $1.5 billion in the third quarter of last year. The decline was primarily driven by higher CapEx, mostly driven by our network evolution and expansion initiatives. A couple of brief comments on working capital and cash taxes before turning to the balance sheet. Excluding the impact of mobile devices, we now expect our full year 2023 change in working capital to be negative by a few hundred million dollars, given the timing of capital expenditures and lower-than-expected accrued programming at year-end. On cash taxes, we did have a lower cash tax payment in the third quarter, which is just a timing difference. The full year cash tax outlook, which I provided during our fourth quarter 2022 call, still stand. We finished the quarter with $97.6 billion in debt principal. Our current run rate annualized cash interest is $5.2 billion. As of the end of the third quarter, our ratio of net debt to last 12-month adjusted EBITDA was 4.45 times, and we intend to stay at or just below the high end of our four to 4.5 times target leverage range. During the quarter, we repurchased two million Charter shares and Charter Holdings common units, totaling $854 million, at an average price of $421 per share. Our 2023 EBITDA growth has been pressured by significant investments we've made in the future growth of our business. As we move toward 2024, pressure on our EBITDA growth will begin to abate, with growing transaction efficiency as we benefit from building employee tenure and easier comps as we have now lapped the impact of those employee investments. Lower transactions in our mobile business, which drove down -- which drive down our per customer cost of service and building as we move into next year, revenue growth acceleration from the roll-off of our mobile free line offers and positive impact from political advertising. In addition, faster pacing of our rural build should bring additional positive impact to customer net additions next year. In the longer term, the competitive impact in operational efficiencies from our network evolution will drive a stronger broadband business. Convergence momentum will improve our churn and generate financial growth for both broadband and mobile, and transformational changes to the video business can enhance the value of our product for our connectivity customers. The investments we have been making and will continue to make are set to drive the growth of our business going forward. Operator, we're now ready for Q&A
Operator: [Operator Instructions] Thank you. Our first question will come from Jonathan Chaplin with New Street Research. Your line is now open.
Jonathan Chaplin: Thanks. Two quick questions. Starting with broadband, it looks like your -- the progress in the new markets, the rural markets that you're pushing into is great. The 12-month penetration there is accelerating, which is fantastic. But it seems like the core markets are progressing a little bit more slowly than you expected. And I'm wondering, Chris, if you can give us some context for what was different from what you may be expecting in the core markets as sort of function of just slower pull-through from Spectrum One, or greater pressures from fixed wireless broadband or something else? And then I'm wondering, sort of, taking a step back, whether you can give us a view of what you think the video business ultimately looks like five years down the line? I can imagine an environment, a world where you're collecting a platform fee, this lower ARPU, but very high margin from a large number of your customers, and it becomes a much more valuable business for you than the sort of the distribution business that you have today. But I would love to get your thoughts on like how that business evolves? And when we sort of hit the point where it starts to become a growth driver for you as opposed to a drag on growth? Thanks.
Chris Winfrey: Sure. And there's a lot in what you just asked, broadband. So, as you mentioned, our subsidized rural construction is going very well and it's pacing well. We're getting faster penetration than we anticipated, probably are used for higher terminal penetration. As Jessica mentioned, as we get into next year, not only do we have the accelerated pace of construction that we get into Q4 and then into next year, but also the tailwind of the construction that we've already completed. So, as a standalone investment, the transparency around that is actually pretty high. The core markets, I think similar to what you've heard probably from others, both in the second quarter as well as third quarter, the back-to-school and dynamics, both at disconnect in Q2 and reconnected Q3 is not gotten back to where it was several years ago. Some of that could tie into the low end of the market where you have some incremental fixed wireless access. I think importantly for us we're continuing well in fiber markets and as it relates to fixed wireless access where you have a lower quality, lower throughput, lower capacity product, that's really not even lower priced when you combine mobile and Internet together. But on the increment, it appears to be that way. We feel pretty good about that space, just given the amount of bandwidth usage that increases over time and the natural capacity constraints that we've all spoken about in the past. So, I think some combination of that, as well as Jessica mentioned, we had a relatively modest, but small impact on the Disney programming dispute, which drove an additional 15,000 units. But just if you step back, for all the reasons that we know, the broadband market has been temporarily stunted for growth. But we are growing in both our existing footprint as well as in the rural subsidized footprint as well and we're providing that so people can evaluate where both pieces are. In terms of video, five years from now, I think there'll still be a traditional video business that exists. And then I'll talk a little bit about where it could evolve to. But a traditional video business that exists, hopefully with additional value in it with DTCs, bundled in, in a way that increases the stickiness of the linear business, is just to the benefit of our ourselves and programmers, we can do that through these renovated agreements with the programmers and the combination of Xumo that creates utility for customers to find content in an easier way and have a deeper library and availability of that content. I do think, as you mentioned and as I mentioned in the prepared remarks, we have an opportunity to evolve to a state-of-the-art video marketplace where we can provide that type of traditional linear integrated DTC and SVOD product for customers who can afford it. It's a value. But when you get that, it's a very valuable product, and it's something that we'd be proud of. And for those customers who are going to be coming more in and out of the video market with different packages because of affordability, that's been driven by the programmers and because of the availability of DTC's à la carte, that Xumo, for us, can provide a really good marketplace to sell those products, again, for the benefit of the programmers as well and gives customers options wherever they want to go. And to your point, not only do we have the traditional video business delivered by Spectrum, but we also have the ability to monetize, from an advertising revenue perspective, the platform through our equity investment in the 50-50 joint venture of Xumo. So nobody sitting here forecasting that traditional linear video is going to grow. But I do think it still remains very important to our connectivity relationships. I think we have a strategic advantage in the marketplace because of our capabilities as a broadband provider with a scaled video platform with the programming relationships that we have and the ability to package together a hybrid model that creates value for customers and is also a distribution engine for these DTC apps, either on a standalone or a bundled basis, for customers and programmers in the future. So if I step back from a video perspective, again, I'm not forecasting growth, but the past 15 years, there's been very little to be optimistic about, either from a customer perspective because of what the programmers have done or for ourselves as a distributor. And for the first time, I see a path where we can create value for customers and create utility and that ultimately will enhance the value of the connectivity services that we provide through our seamless connectivity in Spectrum One, which we're beginning to market now as part of Xumo.
Stefan Anninger: Thanks, Jonathan. We’ll take our next question, please.
Operator: Our next question will come from Craig Moffett with MoffettNathanson. You may unmute and ask your question.
Craig Moffett: Hi, thank you. I wonder, maybe for Jessica, if we could drill down a little bit on the ARPU impact of Spectrum One? And how we should expect, as you start to see the first cohorts roll off, how should we expect ARPU to track for both broadband and for wireless, I guess, over the next not just the next quarter or so, but maybe a little bit longer term as you start to roll off those cohorts?
Jessica Fischer: Sure. Thanks, Craig. So I'm going to start on the wireless side, and then I'll come back and hit the Internet side. On the wireless side, our rate of net additions, it's been not perfectly steady, but fairly steady over the last four quarters now, with Spectrum One in place. And so as you lap and have the roll-off of those free lines that were in the fourth quarter of last year, and you create new free lines in the fourth quarter of this year, what I would say is that the impact that the free lines have on overall ARPU, it ceases to become a pressure on ARPU. And as the free lines as a portion make up a smaller and smaller percentage of the total lines, over time, because the base is growing underneath them and the number of free lines sort of stabilizes, I think that you do have a little bit of remaining -- or you could have a little bit of positive pressure on ARPU. The other side of that, we do still have some legacy pricing in the mix that has to roll off. So probably on wireless, more stabilized next year. If you think about what the impact is that it's having on Internet, so Internet ARPU growth, if you sort of look at it at a product ARPU level, gap growth in the year-over-year was 2.6%. Without the Spectrum One mobile allocation in there, it would have been 3.7%. So you have about a 1.1% difference in product line ARPU growth that relates to that allocation from the fee line. As those free lines start to roll off, I think actually, the dynamic is the same. The total free lines in the system become sort of steady in the year-over-year. So that mobile allocation becomes steady as you get into Q4. So, there is the potential then that what you see from a GAAP reporting perspective is better ARPU growth on the sort of Internet component, but it's related to just not having the building of that GAAP allocation inside of the Internet product.
Craig Moffett: That’s helpful. Thank you.
Stefan Anninger: Thanks, Craig. We will go take our next question, please.
Operator: Our next question comes from Ben Swinburne with Morgan Stanley. You may ask your question.
Ben Swinburne: Thank you. Good morning, everyone. I'm hoping you could spend a little more time talking about the CapEx outlook and strategy around sort of three buckets: the digital evolution, the line extensions and then Xumo or, I guess, video. It sounds like we should continue to assume about $5.5 billion for the network evolution spend, but it sounds like the timing of that may have moved, maybe some -- maybe less more this year, but less next couple of years, and then more maybe in 2026. I wonder if you could help us there. Is there a change in the $4 billion a year of line extensions from the higher RDOF opportunity that you talked about? And then I don't think you've been spending much at all, I would guess, on video CPE, given recycling of set-tops, et cetera. So, can you fill us in a little bit on the Xumo plan? Because I'm trying to think about whether you're sort of going to be slowly moving your video sub base over time to a whole new equipment fleet, so to speak, and trying to understand what that might look like from a CapEx point of view. So I know that's a lot, but you guys give us a lot to chew on, but I'd ask for some help.
Chris Winfrey: It was our fault, Ben. That's true. Why don't I take two of those, being network evolution -- or start off with two of those network evolution video CPE, and let Jessica take expansion and any gaps that I missed on the first two. On network evolution, we -- I mentioned that we could potentially slow down by, call it, six months. And then the counter to that, obviously, is wait a second, I thought this is improving your competitive standpoint, it is. But I would flag that we're competing. One, it's not that material at a time difference. And two, we're competing well against fiber today. And our goal remains to have a superior speed claims across everywhere we operate in our footprint. That being said, we've always said that we'll accelerate investments wherever we can. And the trade-off to that is we also recognize there is value in showing some discipline to shareholders in terms of the overall envelope capital and these rural investments, which continue to expand both in terms of size and our capabilities to deploy quickly. They produce immediate gains. So when you step back and think about trying to balance both our traditional approach, which is if there's capital returns, capital that can be deployed that has great ROI go as fast as you can, at the same time, balance investor expectations and show discipline there in terms of the overall envelope, a six-month time line, it's not going to make that much difference long-term. There is an additional benefit operationally, which is that an extended time line allows some of our DAA or distributed access architecture suppliers to catch up with the latest technology at full scale so that we can deploy the most advanced gear as part of this wave of high split and DOCSIS -- eventually DOCSIS 4.0 implementation. So, that's my thoughts on network evolution. Jessica can come back in a second and clean up on that, if I missed something. On video CPE, it's -- we have, over time, spent less on video CPE because we've been able to recycle World Box at the initial beginning of deployment for Xumo, we needed to get a starting state inventory of Xumo Boxes, and that's captured in capital. On the increment, we will be deploying more new boxes than we have in the past because we're essentially using Xumo as our go-to-market deployment for video CPE, and that's going very well right now. And -- now the boxes are less expensive than what traditional boxes have been over the past, and we expect the cost of those boxes to continue to decline significantly. So, you'll have a combination of volume, which will be determined by our success, and a lower price point over time as well as lower need to build up inventory through all of our channels and throughout the country. So it's -- there's a step-up there. But long term, I don't expect it to be that material.
Jessica Fischer: Yes. So maybe I'll try to help you with some numbers around network evolution and rural. I'm going to caveat it that we're still working through our operating plan for next year. So, I'm not going to give a 2024 guide. But just to help you frame the issue. If you think about where our run rate for rural passings will be in Q4 to reach our 300,000, you have to have 110,000 passings in Q4, which we're actually pretty confident that we will meet. If you take that run rate and sort of push it into four quarters of next year, we would build the 440,000 passing, which is 140,000 more rural patents than what we built this year. We've told you before, and it's true that passings timing isn't perfectly aligned with spend. So it's not a perfect guide. But if you put that at the net cost per passing, the $3,800 that we've talked about for RDOF, it would put the run rate next year on the order of $500 million higher than where we are inside of this year, assuming that all of the other components of line extensions remain the same, which there is a little variability there. But I think it's a good way to think about the issue overall. I think you have to couple that on the other side, with an understanding that network evolution spend sort of like our rural construction, is front loaded. There's a lot of costly preparation and inventory building work that needs to be done before you make it into the field to actually do the high slip or to replace equipment. We expect that we're going to spend a little over $1 billion this year in 2023 on high split, which leaves a substantial a substantial amount of spend in the project and a large portion of which if we continue at our current pace would hit inside of next year. So adjusting the timing of high split won't be enough probably to fully offset the additional line extension spend, but it can help. And as Chris said, we are looking at it sort of in the context of a total package to say, what's an appropriate amount of capital expense load to put against the business given where we sit. No, you're right. I want to say one more thing about it, though. So as we think about all of this investment that we're making in rural, I think it's probably -- we need to drive additional visibility around sort of the value that's related to having sort of unique one-time capital investments like that. We're taking a look at a lot of different ways we could think about that. We consider it a JV, but the returns are so strong. I don't think we want to share them. We've considered a tracking stock. I think structurally, it's complicated, but it does sort of do what I'm thinking about and kind of trying to create focus on the spending on rural as really acquiring passing is more like M&A, instead of thinking about it the way that you would think about CapEx. Absent doing one of those things, I am looking at additional disclosures to create more transparency. And so I think you should look for us to be trying to bring some of those disclosures early next year. And the other way that you can think about it with what's already been built, which I think is easier to sort of wrap your mind around as to what value has been created. Jonathan at New Street actually laid out a nice way to think about sort of what's the value of overall passing once it's built. His number came in around $9,000. And I'm not going to argue with him because I think it's a good space to think about it. So we built 315,000 rural passings so far. At $9,000 per passing, it's around $2.8 billion. Our average net cost per passing on the subsidized rural build is around $3,800. So, you can assume something like $1.6 billion of capital has been spent against those completed passings. And what that means is that we've created value, the current value of the passings at $2.8 billion versus the $1.6 billion that we've spent. We've already created value of $1.8 billion or $1.2 billion related to the building of those passings. And as we continue to accelerate the pace of the build, the pace at which we add that value to our business will increase. So we are looking at additional transparency there and trying to help as we sort of think about what our total capital spend might look like for next year, also making sure that we pair it with good disclosure and help from a valuation perspective so that you can see the value that those are adding to the business as we get them built.
Chris Winfrey: So Ben, you got probably more than you asked for. But Jessica was talking and I step back -- if you step it up one level from that, I think it's important just to reiterate that this company has a very strong focus on long-term capital allocation, long-term shareholder value creation. But we also understand the value of shareholder confidence along the way. And so we're going to go outside of our comfort zone here before we finish our operating plan, try to provide some of that additional disclosure and transparency, and make sure that we've got the full buy-in of our shareholders along the way and demonstrate what we've always been, I think, is really good allocators of capital.
Ben Swinburne: Appreciate it. Thanks so much.
Stefan Anninger: Thanks, Ben. Luke, we’ll take our next question please.
Operator: Our next question will come from Vijay Jayant with Evercore. Your line is now open.
Vijay Jayant: Thanks. Two, if I could. Jessica, you previously talked about cost items, cost to serve and sales and marketing sort of exiting this year close to zero. Obviously, cost of services elevated in the quarter. Can you just talk about where we are on the cost cycle, given you should be comping against some of your labor cost increases? And sort of what it sort of means sort of into 2024? And then Chris, you started mentioned, I think now two quarters in a row, about the BEAD process and the state process and how that may sort of play out and you may not participate kind of thing. Can you sort of talk about really what are the issues there? And if that is the case, are we still too optimistic on your line extension spend over the next few years, which I think is about $4 billion a year?
Jessica Fischer: Yes. So Vijay, first on the cost items, I don't have any change in my expectation relative to cost to serve in sales and marketing, exiting the year at close to zero. And I think we've talked in our remarks, and it is our expectation that as our -- as the tenure in those areas mature, and as we -- because now, as of the end of Q3, we've really lapped the one-time increase related to the investments that we made on the employee side.
Chris Winfrey: For sales and marketing.
Jessica Fischer: Well, as of the end of the quarter, I think you also lapped in cost to serve for the most part. And so the rate of increase -- why I'd say that? So, we should expect to be more efficient across those areas going forward, whether that's sort of every quarter mix. I'm not going to be specific about where we'll be inside of next year and the quarters. But I do think our overall expectation is that from this point, we drive efficiency in those spaces.
Chris Winfrey: Vijay, on BEAD, you talked about pipeline, the BEAD has always been very difficult to forecast exactly what it will be because there's state allocations now, but how much of that is near our footprint. We're working through all of that. It's going to take a long time for that. So, -- and -- but in the meantime, RDOF and the state grants, they're going well. And there's a very large pipeline, as we've talked about, absent BEAD. I think it's fair to say that we were somewhat disappointed in the potential guidelines that came out from NTIA. And all I'm trying to say, without getting too much in the detail, NTIA states are all aware of the issues that we have. But to be clear, the states that adopt the NTIA's proposed guidelines on things such as Internet tiers, dictating Internet tiers, dictating pricing, labor practices, those just won't be attractive state for us to bid in. And so what we will do is we'll focus our investments on the states that allow us to retain flexibility to run the business, properly respond to market demand and ultimately, earn a healthy return. So, that's our focus. And so it's very difficult to forecast what, if any, BEAD investments will occur at this stage. And it's going to take us some time, I think, to figure that out as well as everybody else for that matter. So, we're not unique.
Jessica Fischer: And as we have said all along in rural, we've been extremely disciplined from a financial perspective and looking at the specific passing that we're bidding on to make sure that we're comfortable that it will generate financial returns and all things factor into that, including the limitations that you have under the regulatory environment.
Stefan Anninger: Thanks Vijay. Thank you. We'll take our next question please.
Operator: Our next question will come from Phil Cusick with JPMorgan. You may unmute and ask question.
Phil Cusick: Thank you. I guess a couple of follow-ups. Jessica, I heard your comment, on October customer addition drag, do you think it's still a reasonable goal for 2023 to add more broadband subs year-over-year? And if not, do you think 4Q of last year is a reasonable proxy for this year? I know you love guidance. And then second, as I'm thinking about your cost commentary as well as maybe some revenue pick up, what is the outlook for EBITDA acceleration from here? We've talked about EBITDA accelerating in the back half, but I'm also thinking about what your Disney content costs are going to do for the fourth quarter. Just how should we think about that from here? Thank you.
Chris Winfrey: Phil, on the -- let me take the customer one. The -- our goal has been to increase net adds for Internet year-over-year. I think given some of what we've seen just in early October for the reasons that we talked about before, I think it would require a very successful November and December. So I think we're going to be hard-pressed to hit that. I think the underlying trends in the business we've talked about where that sets us up for 2024. And so we're really optimistic about that. But I think it requires a pretty -- a very healthy November and December in order to achieve what was our original goal.
Jessica Fischer: On the EBITDA side, so thinking about what the components are, as you go into Q4 and next year, in Q4, you do still have an advertising headwind and actually the most significant advertising headwind of the year because of political advertising. But as you go into next year, then that turns around where you're back in a political year and you have the benefit of political advertising. As I said earlier, we've sort of lapped the last of our 2022 labor adjustments as at the end of Q3. So I think the trajectory from a cost perspective on cost to serve and sales and marketing is -- it gives -- you have easier comps and you have growing efficiencies sort of going into next year. In the fourth quarter, we'll start gaining revenue from the mobile free line roll-off. It's relatively small inside of Q4, but the impact builds as you go through next year. So we expect to have a good tailwind from that. And then we continue to expect to have just overall efficiency from our 10-year investments across the business. So, as we said, I think that we recognized that EBITDA was challenged in 2023, by both the investments that we're making, doing it in a nonpolitical year. But as we get into Q4 and going into next year, our expectation is that we've pushed through most of that headwind and that we'll be in a better position.
Phil Cusick: Thanks very much.
Stefan Anninger: Thanks, Phil. Luke, we'll take our next question, please.
Operator: Our next question will come from Steven Cahall with Wells Fargo. Your line is open.
Steven Cahall: Thank you. So, you said that some of your initial Spectrum One roll-to-pay results were a little better than expected. Could you just expand on the tools you're employing to drive those retention rates? And what kind of targets you might have in mind for the Spectrum One mobile roll-to-pay as we think about how that retention could look going forward? And is it right to assume that it's about 300,000 lines per quarter that are up for grabs? And then additionally, we've received a lot of questions on the ACP program and what it means for Charter. Could you maybe just help us frame how you see that exposure? Do you think you require any contingency plans in case there's any changes to the political outlook for that? And is there a lot of overlap between ACP customers and Spectrum One customers? Or is that quite a different customer set? Thank you very much.
Chris Winfrey: I'll do my best to answer as much of that as I can. The mobile retention, we're not having to do much of anything at all, simply because these lines are being actively used. They have similar port in rates to what we have elsewhere. They also have similar -- nearly similar device purchase rate. So they are real customers, they are looking very much like any other existing customer. When they roll tier from a $0 price point for the first line, many of them are paying for a second line. But they go from a first line at $0 to $30, and that product is the fastest mobile product in the country, and it's providing it at the lowest rate relative to that speed. So, at $30, you can't replicate that mobile product anywhere else in the country that's producing that speed. And then all-in, when you think about it from a convergence standpoint, it's a product that has a structural advantage that's difficult for anyone else to replicate. So, we do have some small tactics around the edge that we can do to retain customers under different circumstances, but that's not being heavily used at this point, simply because it's sticking. On ACP, for the benefit of the broader audience, that's the affordable connectivity program. This program, federal program, it's brought Internet connectivity to customers who really wouldn't have access to broadband otherwise. And -- it's also allow existing customers who would have been coming in and out of the broadband marketplace really given the affordability issues, to remain connected consistently. So, I think we think it's been a really effective program. We're proud to be the largest ACP provider in the country. Just this week, I understand the White House has asked Congress to authorize more money for ACP earlier. And I hope that Congress will fund it before running out next year. Now, you asked the question, what happens to the extent it's not funded? Just as I mentioned, most of these customers receive -- that received ACP support today were Internet customers before the program was founded. We have low-income broadband programs that existed before ACP began and because of the value we provide in that connectivity, I do think that we'll continue to retain these customers. We have ways where they're moving them into the lower speed products that we have to be able to save the money more importantly, if you think about the mobile build the vast majority of these customers have inside their home, we can save them hundreds or even thousands of dollars every year, even though ACP disappeared simply by moving them over to our mobile. So, we have a lot of tools available to us for these customers to make sure that they stay. I hope is that we don't need to go down that path. I hope is that we can still save them that money by kind of getting them on to Spectrum Mobile and Spectrum One. But I'm hopeful that the program, which has been very successful, gets successfully renewed.
Stefan Anninger: And that concludes our call. Thanks very much, everybody.
Chris Winfrey: Thank you all. Appreciate it.
Jessica Fischer: Thanks. |
AMZN | 3 | 2,023 | 2023-10-26 22:20:26 | Operator: Thank you for standing by. Good day everyone and welcome to the Amazon.com Third Quarter 2023 Financial Results Teleconference. [Operator Instructions] Today's call is being recorded. And for opening remarks, I will be turning the call over to the Vice President of Investor Relations, Dave Fildes. Thank you, sir. Please go ahead.
Dave Fildes: Hello and welcome to our Q3 2023 financial results conference call. Joining us today to answer your questions is Andy Jassy, our CEO; and Brian Olsavsky, our CFO. As you listen to today's conference call, we encourage you to have our press release in front of you which includes our financial results as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2022. Our comments and responses to your questions reflect management's views as of today, October 26, 2023, only and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K and subsequent filings. During this call, we may discuss certain non-GAAP financial measures in our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website. You will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures. Our guidance incorporates the order trends that we've seen to date and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic and geopolitical conditions and customer demand and spending, including the impact of recessionary fears, inflation, interest rates, regional labor market constraints, world events, the rate of growth of the Internet, online commerce, cloud services and new and emerging technologies and the various factors detailed in our filings with the SEC. Our guidance assumes, among other things, that we don't conclude any additional business acquisitions, restructurings or legal settlements. It's not possible to accurately predict demand for our goods and services and therefore, our actual results could differ materially from our guidance. And now, I'll turn the call over to Andy.
Andrew Jassy: Thanks, Dave. Today, we're reporting $143.1 billion in revenue, up 11% year-over-year; $11.2 billion in operating income, up 343% year-over-year or $8.7 billion; and $20.2 billion in trailing 12-month free cash flow adjusted for equipment finance leases which is up $41.7 billion versus the comparable period last year. We continue to be encouraged by the progress we're making in lowering our cost to serve, improving our customer experiences and investing for future growth. I'll start with our stores business. Our move earlier this year from a single national fulfillment network in the U.S. to 8 distinct regions represented one of the most significant changes to our fulfillment network in our history. This change has gone more smoothly and made more impact than we optimistically expected. And you can see the benefits in many forms. Regional fulfillment clusters with higher local in-stock levels and optimized connections between fulfillment centers and delivery stations mean shorter distances and fewer touches to get items to customers. Shorter travel distances and fewer touches mean lower cost to serve. But perhaps most importantly, shorter distances and fewer touches mean that customers are getting their shipments faster. We remain on pace to deliver the fastest delivery speeds for Prime customers in our 29-year history. And as I talked about last quarter, we know how important speed of delivery is to customer satisfaction and buying behavior. A good example is the significant growth we're seeing in consumables and everyday essentials. When customers are getting items as quickly and conveniently as they are now from Amazon, they're going to consider us more frequently for more of their shopping needs. As we've shared the last few quarters, we've re-evaluated every part of our fulfillment network over the last year. The first substantial rearchitecture centered on the regionalization change. We obviously like the results but don't think we fully realize all the benefits yet and we continue to make steady improvements in fine-tuning the placement algorithms to enable even more in-region fulfillment and to further increase consolidation into fewer shipments. We've also identified several substantial changes to our inbound processes that we believe could have a significant impact on our cost to serve and speed of delivery. We have a long way before being out of ideas to improve cost and speed. The team is really humming on this and I'm proud of the way they're inventing and executing together. Moving to AWS and our investments in generative AI. AWS revenue grew 12% year-over-year in Q3, with $919 million of incremental quarter-over-quarter revenue and now has the annualized revenue run rate of $92 billion. AWS' year-over-year growth rate continued to stabilize in Q3. And while we still saw elevated cost optimization relative to a year ago, it's continued to attenuate as more companies transition to deploying net new workloads. Companies have moved more slowly in an uncertain economy in 2023 to complete deals. But we're seeing the pace and volume of closed deals pick up and we're encouraged by the strong last couple of months of new deals signed. For perspective, we signed several new deals in September with an effective date in October that won't show up in any GAAP reported number for Q3 but the collection of which is higher than our total reported deal volume for all of Q3. Deal signings are always lumpy and the revenue happens over several years but we like the recent deal momentum we're seeing. Top of mind for most companies continues to be generative AI. As I mentioned last quarter, we think about generative AI as having 3 macro layers, each of which is very large in each of which we're investing. A few updates there. At the lowest layer is the compute to train large language models, or LLMs and produce inferences or predictions. The key to this compute is the chip inside it. As we've shared, we've been working on custom silicon for training and inference with our Trainium and Inferentia chips, respectively. Recently, we announced that leading LLM maker Anthropic chose AWS as its primary cloud provider and will use Trainium and Inferentia to build, train and deploy its future LLMs. As part of this partnership, AWS and Anthropic will collaborate on the future development of Trainium and Inferentia technology. We believe this collaboration will be helpful in continuing to accelerate the price performance advantages that Trainium and Inferentia deliver for customers. In the middle layer which we think of as large language models as a service, we recently introduced general availability for Amazon Bedrock which offers customers access to leading LLMs from third-party providers like Anthropic, Stability AI, coherent AI 21 as well as from Amazon's own LLMs called Titan, where customers can take those models, customize them using their own data but without leaking that data back into the generalized LLM, have access to the same security, access control and features that they run the rest of their applications within AWS all through a managed service. In the last couple of months, we've announced the imminent addition of Meta's Llama 2 model to Bedrock, the first time it's being made available through a fully managed service. Also through our expanded collaboration with Anthropic, customers will gain access to future Anthropic models through Bedrock with exclusive early access to unique features, model customization and the ability to fine-tune the models. And Bedrock has added several new compelling features, including the ability to create agents which can be programmed to accomplish tasks like answering questions or automating workflows. In these early days of generative AI, companies are still learning which models they want to use which models they use for what purposes and which model sizes they should use to get the latency and cost characteristics they desire. In our opinion, the only certainty is that there will continue to be a high rate of change. Bedrock helps customers with this fluidity, allowing them to rapidly experiment with move between model types and sizes and enabling them to pick the right tool for the right job. The customer reaction to Bedrock has been very positive and the general availability is buoyed that further. Bedrock is the easiest way to build and scale enterprise-ready generative AI applications and a real game changer for developers and companies trying to get value out of this new technology. And the top layer which are the applications that run the LLMs, our generative AI coding companion Amazon CodeWhisperer has gotten a lot of early traction and got a lot more powerful recently with the launch of its new customization capability. The number one enterprise request for coding companions has been wanting these companions to be familiar with customers' proprietary code bases. It's not just having code companions trained in open source code, companies want the equivalent of a long-time senior engineer who knows their code base well. That's what CodeWhisperer just launched, another first of its kind out there in its current form and customers are excited about it. A few last comments on AWS's generative AI work. As you can tell, we're focused on doing what we've always done for customers, taking technology that can transform customer experiences and businesses but they can be complex and expensive and democratizing it for customers of all sizes and technical abilities. It's also worth remembering that customers want to bring the models to their data, not the other way around. And much of that data resides in AWS as the clear market segment leader in cloud infrastructure. We're innovating and delivering at a rapid rate and our approach is resonating with customers. The number of companies building generative AI apps in AWS is substantial and growing very quickly, including Adidas, Booking.com, Bridgewater, Clariant, GoDaddy, LexisNexis, Merck, Royal Philips and United Airlines, to name a few. We are also seeing success with generative AI start-ups like Perplexity.ai who chose to go all in with AWS, including running future models in Trainium and Inferentia. And the AWS team has a lot of new capabilities to share with its customers at its upcoming AWS re:Invent conference. Beyond AWS, all of our significant businesses are working on generative AI applications to transform their customer experiences. There are too many for me to name on this call but a few examples include, in our stores business, we're using generative AI to help people better discover products they want to more easily access the information needed to make decisions. We use generative AI models to forecast inventory we need in our various locations and to derive optimal last mile transportation routes for drivers to employ. We're also making it much easier for our third-party sellers to create new product pages by entering much less information and letting the models to the rest. In advertising, we just launched a generative AI image generation tool, where all brands need to do is upload a product photo and description to quickly create unique lifestyle images that will help customers discover products they love. And in Alexa, we built a much more expansive LLM and previewed the early version of this. Apart from being a more intelligent version of herself, Alexa's new conversational AI capabilities include the ability to make multiple requests at once as well as more natural and conversational requests without having to use specific phrases. We continue to be convicted that the vision of being the world's best personal assistant is a compelling and viable one and that Alexa has a good chance to be one of the long-term winners in this arena. Every one of our businesses is building generative AI applications to change what's possible for customers and we have a lot more to come. We're also encouraged by the progress we're making in our newer initiatives. Just to name a few, we're pleased with what we're seeing in Prime Video. Prime Video continues to be an integral part of the Prime value proposition where it's often one of the top 2 drivers of customers signing up for Prime. We also have increasing conviction that Prime Video can be a large and profitable business in its own right as we continue to invest in compelling exclusive content for prime members but also offer the best selection of premium streaming video content anywhere with our marketplace offering, including channels for customers who can subscribe to channels like Max, Paramount+, BET Plus and MGM+, as well as our broad transaction video-on-demand selection. As we continue to invest in compelling content, beginning in early 2024, Prime Video shows and movies will include limited advertisements. We aim to have meaningfully fewer ads than linear TV and other streaming TV providers. If customers prefer and add free option, we plan to offer that for an additional $2.99 per month for U.S. members. There is still a lot of work to be done in innovation ahead but we're excited about our future on Prime Video. We're seeing progress on a number of our investments that expand our ability to serve more consumers and sellers in their e-commerce missions. Our emerging international stores continue to improve their customer experiences and profitability and are on a strong trajectory. Both consumers and sellers are excited about Buy with Prime which enables third-party sellers with direct-to-consumer websites to offer Amazon Prime members the same fast payments and delivery options they receive on Amazon.com. We recently announced the capability for sellers to integrate Buy with Prime with their Shopify account, making it easier for Shopify merchants to manage their businesses with inventory pricing and promotions automatically synced in one place. And we're seeing very positive early response from sellers to Supply Chain by Amazon, a fully automated set of supply chain services where Amazon can pick up inventory from manufacturing facilities around the world, ship it across borders, handle customs clearance and ground transportation, store inventory in bulk, manage replenishment across Amazon and other sales channels and deliver directly to customers, all without sellers having to worry about managing their supply chain. Our health care team is continuing to make health care easier for people to access. The Amazon Pharmacy customer experience has significantly evolved this year and customers are responding that both in their purchasing behavior and qualitative feedback. We built RXPass for customers to get unlimited supply of eligible medications for $5 per month, meaningfully reduce the cost for customers to get insulin and diabetes products and partnered with Blue Shield of California to offer a first-of-its-kind model to provide more affordable pharmacy care to its 4.8 million members, providing fast and free delivery of prescription medications and 24/7 access to pharmacists. We remain convinced that we can be part of the solution of making health care a better customer experience. And our low Earth orbit satellite initiative Project Kuiper which aims to bring fast, affordable broadband to underserved communities around the world, took a meaningful step forward in the last few weeks with the successful launch of 2 prototype satellites. We will use this multi-month mission to test our satellites and network from space and collect data ahead of the planned start of satellite production later this year. I'd like to close by thanking our teams around the world who are gearing up for 2 of our most significant events across the company. First, our annual AWS re:Invent conference that begins on November 27. The team is excited to share a lot of new capabilities with customers and provide an array of opportunities for builders to learn and connect with one another. And on the stores side, we've already kicked off what will be our 29th holiday shopping season. Prime Big Deal Days held earlier this month was our most successful October holiday kick-off event ever, with Prime members saving more than $1 billion across hundreds and millions of items sold. Just as we do all year long, we aim to make our customers' lives easier and better every day and there's no time where it's more important to us that we deliver on this mission than during the busy holiday shopping season. With that, I'll turn it over to Brian.
Brian Olsavsky: Thanks, Andy. Overall, we saw a strong performance in the third quarter. Worldwide revenue was $143.1 billion, representing an increase of 11% year-over-year, excluding the impact of foreign exchange and approximately $100 million above the top end of our guidance range. We saw our highest quarterly worldwide operating income ever which was $11.2 billion for the quarter, an increase of $8.7 billion year-over-year from $2.7 billion above the high end of our guidance range. North America revenue was $87.9 billion, an increase of 11% year-over-year. And international revenue was $32.1 billion, an increase of 11% year-over-year, excluding foreign exchange. During the quarter, we held our biggest Prime Day event ever with prime members purchasing more than 375 million items worldwide and saving more than $2.5 billion on millions of deals across the Amazon store. Outside of Prime Day, we continue to see strong demand across everyday essentials, including categories like beauty and health and personal care. From a customer behavior standpoint, we still see customers remaining cautious about price, trading down where they can and seeking out deals, coupled with lower spending on discretionary items. Building on the momentum from last quarter, we set another record for delivery speed. For the year-to-date period through the third quarter, we have delivered at the fastest speeds ever in the United States. These improvements in delivery speeds have been a key driver of growth and are resulting in increased purchase frequency by our Prime members. Third-party sellers grew at 18% year-over-year, excluding foreign exchange, primarily driven by selection expansion and growing adoption of our optional services for sellers, including Fulfillment by Amazon and paid account management and more. During the quarter, we hosted Amazon Accelerate, our annual seller conference, where we launched a number of new innovations and product developments for our sellers, including Supply Chain by Amazon. We also continue to see durable growth in advertising which grew 25% year-over-year, excluding foreign exchange, primarily driven by sponsored products as we lean into machine learning to improve the relevancy of the ads we show our customers and enhance our measurement capabilities on behalf of advertisers. We have seen strong improvement in our profitability. North America operating income was $4.3 billion, an increase of $4.7 billion year-over-year, resulting in an operating margin of 4.9%, up 100 basis points quarter-over-quarter. Since North America operating margins bottomed out in Q1 of 2022, we have now seen 6 consecutive quarters of improvement, resulting in a cumulative improvement of over 700 basis points over these past 6 quarters. The third quarter marked the second full quarter of regionalization within the U.S. and we're pleased with the early results. Regionalization has allowed us to simplify the network by reducing the number of line-haul lanes, increasing volume within existing line-haul lanes and adding more direct fulfillment center to delivery station connections. We have also been focused on optimizing inventory placement in a new regionalized network which when coupled with the simplification mentioned earlier, is helping contribute to an overall reduction in cost to serve. Additionally, in the quarter, we saw benefits from lower inflation, primarily within line haul, ocean and rail shipping rates which were partially offset by higher fuel prices. While we are encouraged by the improvements in operating profit, we still see a lot of opportunity in front of us. In international, we were closer to breakeven during the quarter with an operating loss of $95 million. This was an improvement of $2.4 billion year-over-year. This improvement was primarily driven by lowering our cost to serve through higher productivity, decreased inflationary pressures and improvements in leverage across our established and emerging international countries as we continue to focus on customer inputs and improve efficiencies within our operations. Moving to AWS; revenues were $23.1 billion, an increase of 12% year-over-year. On a quarter-over-quarter basis, we added more than $900 million of revenue in AWS as customers are continuing to shift their focus towards driving innovation and bringing new workloads to the cloud. Similar to what we shared last quarter, while optimization still remain a headwind, we've seen the rate of new cost optimization slowdown in AWS and we are encouraged by the strength of our customer pipeline. Customers are excited about our approach to generative AI, with several new announcements made during the quarter, including a strategic collaboration with Anthropic, opening Amazon Bedrock up to general availability, adding Meta's Llama 2 model to Bedrock in the near future and new customization capabilities of CodeWhisperer. AWS remains a clear cloud infrastructure leader with a significant leadership position in the number of customers, the size of our partner ecosystem, our breadth of functionality and the strongest operational performance in the industry. When we look at the fundamentals of the business, we believe we are in good position to drive future growth as the rates of cost optimization slow down. AWS operating income was $7 billion, an increase of $1.6 billion year-over-year. Our operating margin for the quarter was 30.3%. This is an improvement of approximately 600 basis points quarter-over-quarter, primarily driven by increased leverage on our head count costs. Shifting to free cash flow. On a trailing 12-month basis, free cash flow adjusted for finance leases was $20.2 billion, an improvement of $41.7 billion year-over-year. The largest driver of the improvement in free cash flow is our increased operating income which we're seeing across all 3 of our segments. Key drivers of this improvement include reductions in our cost to serve, continued advertising growth and improved leverage on our fixed costs. We are also seeing improvements in working capital, notably with our inventory efficiency as we improve our inventory placement. Now, let's turn to our capital investments. We define our capital investments as a combination of CapEx plus equipment finance leases. These investments were $50 billion for the trailing 12-month period ended September 30, down from $60 billion in the comparable prior year period. For the full year 2023, we expect capital investments to be approximately $50 billion compared to $59 billion in 2022. We expect fulfillment and transportation CapEx to be down year-over-year, partially offset by increased infrastructure CapEx to support growth of our AWS business, including additional investments related to generative AI and large language model efforts. As we head into the fourth quarter, we are ready to make this a great holiday season for our customers. Looking at our operations network, our inventory is the best position it's ever been heading into the holiday season, enabling us to serve customers with fast delivery speeds from their local regions. We continue to believe putting customers first is the only reliable way to create lasting value for our shareholders. With that, let's move on to questions.
Operator: [Operator Instructions] And the first question comes from the line of Justin Post with Bank of America. Justin, your line is live.
Justin Post: I'll ask about AWS. I guess the first question is, as you look forward in the fourth quarter, you mentioned you've signed some new deals. Are you seeing less cost optimization as you look forward? Or do you think it will be similar to Q3? And then second, you couldn't help but notice the big margin improvement in AWS all the way back to where you were 7 quarters ago. Could you talk about the drivers and sustainability of those margins?
Andrew Jassy: Yes, Justin. Sure. This is Andy. I think if you look at AWS, we grew 12% year-over-year. And I think that you saw a continued stabilization of our year-over-year growth rate. And included $919 million of incremental quarter-over-quarter revenue which it's hard to compare and do the math across different players because not everyone discloses them clearly. But as far as we can tell, that also looks like the most absolute growth of any of the players out there. We're still seeing elevated customer optimization levels than we've seen in the last year or year before this, I should say. So if you look at the optimization, it's more than a year ago but it's meaningfully attenuating from where we've seen in the last few quarters. And if you look at the optimization too, what's interesting is it's not all customers deciding to shut down workloads. A very significant portion of the optimization are customers taking advantage of enhanced price performance capabilities in AWS and making use of it. So for example, if you look at the growth of customers using EC2 instances that are Graviton based which is our custom chip that we built for generalized CPUs, the number of people and the percentage of instances launched their Graviton base as opposed to Intel or AMD base is very substantially higher than it was before. And one of the things that customers love about Graviton is that it provides 40% better price performance than the other leading x86 processors. So you see a lot of growth in Graviton. You also see a lot of customers who are moving from the hourly on demand rates for significant portions of their workloads to 1- to 3-year commitments which we call savings plans. So those are just good examples of some of the cost optimization that customers are making in less certain economies where it's really good for customers short and long term and I think it's also good for us. But we're starting to see -- as I said, we're seeing that optimization attenuate. I expect that to continue over time. I remain very optimistic about AWS in the medium to long term. And it's because we have the most functionality by a large amount. We have a much larger partner ecosystem than you'll find elsewhere. We have stronger security and operational performance than you can find elsewhere. I think we're the most customer-focused. Even if you look during optimization times in this difficult economy, customers have really noticed how AWS leaned in with them for the long term. And I think that matters to customers. And then we have a $92 billion revenue run rate business where 90% of the global IT spend still resides on premises. And if you believe like we do, that equation is going to flip. There's a lot more there for us. And then you look at the very substantial gigantic new generative AI opportunity which I believe will be tens of billions of dollars of revenue for AWS over the next several years, I think we have a unique and broad approach that's really resonating with customers. And you can see it with the array of customers I mentioned that are using us and starting to build workloads for generative AI who have already on top of us. I could see it also. Just the growth rate for us in generative AI is very fast. Again, I have seen a lot of different numbers publicly. It's real hard to measure an apples-to-apples. But in our best estimation, our -- the amount of growth we're seeing and the absolute amount of generative AI business we're seeing compares very favorably with anything else I've seen externally. So I think that you can see that in the deals that we're doing, too. I spoke about the significant number of deals that we've closed over the last couple of months. A lot of those conversations, it's -- a big piece of it is what I mentioned earlier, the functionality, the ecosystem, the operational performance, the security, how you take care of customers but also whether or not they like your vision and set of products that you're building in this brand-new technology space, generative AI which I think has been very effective so far. So to me, I think there's a lot of growth in front of AWS. I'm very optimistic about it.
Brian Olsavsky: And Justin, on your comment about -- a question about AWS margins. So yes, the margin improved 600 basis points quarter-over-quarter, an increase of income of $1.6 billion quarter-over-quarter for AWS, is driven by -- primarily by our headcount reductions in Q2 and also continued slowness in hiring, rehiring open positions. There's been also a lot of cost control in non-people categories, things like infrastructure costs and also discretionary costs. Natural gas prices and other energy costs have come down a bit in Q3 as well. So as we've said historically, the margins on -- the operating margin for AWS is going to fluctuate quarter-to-quarter and this is a good example of that.
Operator: Our next question is from Doug Anmuth with JPMorgan.
Doug Anmuth: Can you just talk more about how the regional fulfillment network is exceeding your expectations? And then also, how does that support your confidence in moving North America beyond mid-single-digit margin levels? And then just perhaps on generative AI, obviously, a lot of innovation here. You talked about a number of different customers running early workloads. How should we think about the timing, just to drive some tangible monetization there?
Brian Olsavsky: Well, I'll start. The -- on regionalization, I think it was such a significant change for us in the network. It's hard to really appreciate with a big change across so many dimensions it was that first to make such a change has all sorts of risk. And I think the team did a great job planning around it being very thorough. I think that we were able, with our placement algorithms, to get more regional local in-stock levels than we anticipated. And then I think until you actually put all the connections together, we changed a lot of the connections from a lot of these middle connections going from fulfillment centers to sortation centers and then to delivery stations to connecting the fulfillment centers and delivery stations more directly which, of course, is easier to do when you have more local in stock in a region. But I think that we were able -- the connections that we made and the optimization that we made there allowed us to get shorter transportation distances than we even anticipated in items to people a lot quicker. And then always one of the issues you got to worry about when you make a change that big is whether or not you end up splitting shipments and having more -- fewer items per box and per shipment. And that was also something that we really had to work through in the design and in the early stages and we've gotten a lot better on. So we're just across the board, we're seeing shorter transportation distances and much faster delivery to customers. And when you deliver faster delivery to customers, they actually start to consider you for a lot more items than they otherwise would. I think it's part of what -- if you look at our very significant growth rates right now in everyday essentials and consumables, a lot of it is when you -- if you're going to order something which you need in the same day or next day, you're not going to consider it if it's coming in 3 or 4 days. But when you're consistently getting it in same day or the next day, just changes what you're willing to do. I think the second question was on gen AI and the timing of monetization. What I would tell you is that we have been surprised at the pace of growth in generative AI. Our generative AI business is growing very, very quickly, as I mentioned earlier. And almost by any measure, it's a pretty significant business for us already. And yet I would also say that companies are still in the relatively early stages. I mean now you have to get perspective. My perspective is that the cloud is still in the early stages. If you think about 90% plus of the global IT spend being on-premises, where I think that equation is going to flip in 10 years. I think cloud is early. So if you -- with that lens on, I still think we're very early in generative AI. And what's interesting, too, around generative AI because we have so many companies who are doing all sorts of prototypes and it's really accelerating very rapidly on the training side with Trainium and Inferentia and then on the application building and running side with Bedrock, is that companies are still trying to sort out for themselves what they're going to run at large-scale production in all of these areas. Because what happens is you try a model, you test the model, you like the results of the model and then you plug it into your application. And what a lot of companies figure out quickly is that using the really large -- the large models and the large sizes ends up often being more expensive than what they anticipated and what they want to spend on that application. And sometimes too much latency in getting the answers as it shovels through the really large models. And so customers are experimenting with lots of different types of models and then different model sizes to get the cost and latency characteristics that they need for different use cases. And it's one of the things that I think is so useful about Bedrock is that customers are trying so many variants right now but to have a service that not only lets you leverage lots of third party as well as Amazon large language miles but also lots of different sizes and then makes the transition of moving those workloads easy between them is very advantageous.
Operator: Our next question is from Brian Nowak with Morgan Stanley.
Brian Nowak: Thanks for taking my question, I have two, one on AWS, one on the retail business. On AWS AI Andy, I recognize you have a pretty multipronged AI approach. But just could you talk us through sort of one or two of the early generative AI products where you're seeing the most early demand and interest? And as you talk to customers, are there still hurdles or pain points that you're not quite serving in your product suite you look to solve and innovate on over the next couple of years in AI? And then the second one, you made a lot of steps on the regionalization of warehouses and making it more efficient. Where are you on robotics in the warehouses? And how should we think about the potential impact of that to drive profitability even higher?
Andrew Jassy: On the AI side, I think that if you're looking for some of the products that we're offering that are -- that have a lot of early resonance and traction, I would -- I'd start with Bedrock. These customers are -- they're very excited about Bedrock. And it's making it so much easier to get applications, generative AI applications built. And again, it's machine learning and AI has been something that people have been excited about for 25 years. In my opinion, about a half dozen years ago, it took a pretty significant leap forward where it was much easier given the economics and scalability of compute and storage and then some of the tools that we built like SageMaker, it was much easier for everyday developers to start to interact with AI. But it just -- it took another meaningful step forward with generative AI but still it's complicated to actually figure out which models you want to work, you want to use and how you actually want to employ them and trying to make sure you have the right results, trying to make sure you get safe results, trying to make sure you end up with a cost structure and a customer experience that you want. And so it's hard. And customers will like -- there's a certain number of customers who have very deep AI expert practitioners but most companies don't. And so Bedrock just takes so much of the difficulty out of those decisions and those variables that people are very excited about Bedrock. They're using it in a very broad way. They're extremely excited about not just the set of models in there but if you look at a leader like Anthropic and the ability for our customers in Bedrock to have exclusive early access to models and customization tools and fine-tuning which gives them more control, there's just -- there's a lot of buzz and a lot of usage and a lot of traction around Bedrock. I would also say our chips, Trainium and Inferentia, as most people know, there's a real shortage right now in the industry in chips. It's really hard to get the amount of GPUs that everybody wants. And so it's just another reason why Trainium and Inferentia are so attractive to people. They have better price performance characteristics than the other options out there but also the fact that you can get access to them. And we've done, I think, a pretty good job providing supply there and ordering meaningfully in advance as well. And so you're seeing very large LLM providers make big bets on those chips. I think Anthropic deciding to train their future LLM model on Trainium and using Inferentia as well is really a statement. And then you look at the really hot start-up Perplexity.ai, who also just made a decision to do all their training and inference on top of Trainium and Inferentia. So those are 2 examples. I'd say CodeWhisperer, too, is just, again, it's just a game changer if you can allow your engineers not to have to do the more repetitive work of cutting and pasting and building certain functions that really, if somebody knew your code base better, could do. And so it's a real -- it's a productivity game changer for developers. And then actually launching that customization vehicle so that they actually understand your own proprietary code base, that is something that customers are quite excited about. So those are ultimately early traction AI. There's so much more to provide, Brian. I mean there's -- I think people -- even though Bedrock is so much easier to use than people trying to build models themselves and build the applications, I think people are still looking to find ways to make it easier to look at a big corpus of data and run an agent on top of it or maybe they don't have to do all that work themselves. I think people are looking for automated ways to understand developer environments and be able to ask any question on the developer environment. So there's a lot more. It's going to be a long time before we run out of services. And yes, I think it's a good thing to look toward the next few months in re:Invent to see the additional things that team launches. I think on the robotics piece, it's a very significant investment for us. It has been for several years. It's made a huge difference for us. It's made a big difference for us both on the productivity side, on the cost side as well as importantly on the safety side where we can have our teammates working on things that are even safer than what they get to work on today. We have a very substantial investment of additional robotics initiatives, I would say many of which are coming to fruition in 2024 and 2025 that we think will make a further additional impact on the cost and productivity and safety and our fulfillment service.
Operator: Our next question comes from the line of Eric Sheridan with Goldman Sachs.
Eric Sheridan: Maybe one follow-up on AWS and one on the ads business. Andy, would love your perspective. The cloud optimization theme started in the second half of '22 when there were a lot of macro concerns. And then the AI theme really only sort of came to the forefront in the last 8 or 9 months. What's your perspective on how turning the calendar into 2024 and there being a new IT budget cycle could possibly lead us to put the optimization theme in the background and some of the AI theme come more to the forefront when there might be more distinct budgeting around AI as a theme? That would be number one. And then in your ads business, you're approaching $50 billion run rate and it's compounding in the mid-20s. What are you most excited about on the initiative front to continue to build scale both on Amazon properties and possibly off Amazon as a broader digital advertising player?
Andrew Jassy: On the AWS side, my perspective, we'll obviously all have to wait and see to some extent. But my perspective is that in 2024, you're going to -- I think a lot of the relatively low-hanging fruit on optimization has happened in 2023. It's not to say there won't be any more optimization. It's just that there's more low-hanging fruit when you have very large footprints and you've built a lot of applications on a platform for you to go decide to optimize if that's what you want to go do. And so I think 2020 -- we're already seeing it now with the attenuation of optimization over the last several months. But I think you'll continue to see the attenuation continue and we're already seeing more and more companies that are turning their attention to newer initiatives. And I think what you will see in '24 and '25 as well, I think -- I don't think it's a 1-year deal, I think that's going to be a several-year trajectory, is that you're going to just see a lot of companies not just looking at the new generative AI workloads but also there was a significant number of new customer transformations where companies were going to largely move from being on-premises to being in the cloud. That got stalled in 2023 because companies were being more conservative with their spend and wary of an uncertain economy. And so I think that what you'll see increasingly is that companies will both go back to those transformations they were planning on making and working with a lot of systems integrator partners as well as ourselves as well as start to see the production in large scale of the generative AI applications that they're all working on and prototyping and starting to deploy into production. I think on the ad front, well, there's a lot I'm excited about on the ad side as well. I think that it's interesting what's happened in our ads business as if you look around the industry, most advertising-heavy companies have struggled growth-wise as the economy has been difficult. And while we see companies being more cautious on the ad side and the top-of-funnel products, things like display and a little bit of video, we're still seeing a lot of strength in the lower-funnel ad products like sponsored products. And I think in these types of economies, we have fared pretty well in part because we have a number of owned and operated properties that have very large volumes that advertisers and brands want to get in front of. Even in a harder economy, there's going to be a lot of e-commerce purchasing. So people want to be in front of our customers in our marketplace. Or take Thursday Night Football which is we're in our second season of Thursday Night Football and off to a great start, the ratings are 25% higher than they were a year ago through 6 weeks. But also, we're doing much better on the advertising side than we did in our first year and that's a property that's really valuable. It's the one game that week and advertisers want to be in front of customers because there's 13 million customers a week watching. So I think part of it is because we have owned and operated properties that have a lot of volume. And then I think the other piece is that most of our resource in the advertising side is spent on machine learning expert practitioners who are owning algorithms to make sure that the sponsor results people get when they search on something are relevant. And because of that, those ads perform better for advertisers. So when they have to think about budget decisions, they're going to choose the ones that have large volume and perform better. I think both of those are real advantages in our advertising area right now. In terms of additional things we're excited about. I think that we have barely scraped the surface with respect to figuring out how to intelligently integrate advertising into video, into audio and into grocery. So I think we're early days in that. I think that we also started externalizing some of our products like sponsored products to third-party websites. And you see that with what we've done with Pinterest, Hearst Newspapers and BuzzFeed, so I think there's -- again, we're still pretty early in that area but it's growing well and we're very focused on continuing to in a great customer experience.
Operator: And our final question comes from the line of Mark Mahaney with Evercore ISI.
Mark Mahaney: Okay. On those AWS deals Andy, that you talked about in the September quarter, was there something different about those deals, different industry, different verticals, different geographic markets? Or is it just kind of a resumption of kind of the deal flow that you've had in years past? So that's the first question. And secondly, Brian, international. Is international finally at a point where it can be sustainably profitable going forwards, maybe except for the seasonally challenged March quarter? Have you wrung out enough efficiencies and gotten enough scales? And the oldest markets there are big enough and scalable enough and profitable enough that it offsets the newer countries? Have you finally reached that point?
Brian Olsavsky: First, just to give Andy a break. On international, thanks for your question. Yes, the quarter was just short of breakeven. And as you pointed out, that's a departure from kind of prior trends. I would answer that question this way. There's multiple things going on internationally. In our established countries, U.K., Germany, Japan, France, those countries are profitable and have been profitable. And we continue to work on price selection and convenience. And all that retail base is essentially adding sellers, adding vendors and selection, scaling advertising and improving the cost structure of our ops network. So many of the ops productivity initiatives, probably with the exception of regionalization, is more of a U.S. side right now. But we're working on all those productivity elements and speed concurrently globally. And you're seeing that internationally and customers are responding. On the emerging side, over the last 6 years, we've launched 10 new countries. History has shown us that those all take time to grow into profitability. The U.S. took 10 years -- excuse me, 9 years originally. And they're all on their own journey there with growth and scale and profitability and selection and a number of other variables. So that's -- those are all going well as well. We continue -- we're going to continue to invest internationally in things like Prime and expanding Prime benefits and we're going to continue to build out the fulfillment and transportation networks to better serve customers. So I can't say it's permanently we've reached a breakeven threshold for profitability. I think the trend lines are clear, though and we'll continue to work on accelerating that journey in all countries, especially the emerging ones.
Andrew Jassy: On the AWS deals, it's a really broad mix of industries and geographies. So it's not comped up in one. Some are kind of first really big deals from customers. Some of them are very large expansions of existing agreements where they've gone from call it, 20% of their workloads to 50% of their workloads moving to AWS in the cloud. It's also -- I'm not even really including in that number, a number of really big public sector deals that we've done over the last chunk of time that won't hit for a period of time; and so all these deals don't hit in a month. They happen over a period of time as you help those customers safely transition and migrate their workloads to AWS. But it hasn't been any one piece. And I wish I could tell you we knew exactly why they're starting to happen in faster numbers. I do think, in general, historically, deal volume tends to be lumpy and it doesn't perfectly distribute over a calendar year. I do think though that we've seen this in '23, for sure, that the time to close deals lengthened. And I think it's all reflective of what most companies in the world have been thinking about the last year which is just in the face of uncertain economy, you're going to be more conservative. There are going to be more people involved. You're going to spend more time on how you can save on your existing cost instead of migrating new workloads or thinking about signing new deals. And so I think what you're just starting to see along with some of the optimization attenuation is that companies are starting to look forward again. And so we've just seen a collection of those the last couple of months that had been -- being discussed for several months where I think, frankly, both sides thought they would close faster but just went slower than they did. So I just think you're starting to see companies look forward more.
Dave Fildes: Thanks for joining us today for the call and for your questions. A replay will be available on our Investor Relations website for at least 3 months. We appreciate your interest in Amazon and look forward to talking with you again next quarter.
Operator: Ladies and gentlemen, that does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. |
CMCSA | 3 | 2,023 | 2023-10-26 13:05:28 | Operator: Operator: Good morning, ladies and gentlemen, and welcome to Comcast's Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Please note this conference call is being recorded. I will now turn the call over to Executive Vice President, Investor Relations, Ms. Marci Ryvicker. Please go ahead, Ms. Ryvicker.
Marci Ryvicker: Thank you, operator. And welcome, everyone. Joining me on today's call are Brian Roberts, Mike Cavanagh, Jason Armstrong, and Dave Watson. I will now refer you to slide 2 of the presentation accompanying this call which can also be found on our Investor Relations website and which contains our Safe Harbor disclaimer. This conference call may include forward-looking statements subject to certain risks and uncertainties. In addition, during this call, we will refer to certain non-GAAP financial measures. Please see our 8-K and trending schedule issued earlier this morning for the reconciliations of these non-GAAP financial measures to GAAP. With that, I'll turn the call over to Mike.
Michael Cavanagh: Good morning, everyone. And thanks for joining our third quarter earnings call. It was another strong quarter for us, with adjusted EBITDA up 5% and adjusted EPS up 13%. We generated $4 billion in free cash flow, which, combined with our expectation of Hulu proceeds in the near future, contributed to a pick-up in our share repurchases to $3.5 billion in the quarter. Our steady performance has been a direct result of how we've always run our company, which is with a focus on industry-leading performance, both operationally and financially, in each of our businesses, combined with a long-term, customer-centric approach to decision-making that ensures each business is positioned to win in the future. This has all been facilitated by a philosophy of investment in our businesses that has remained consistent through different economic and credit cycles, and particularly through the recent global pandemic. Now, I'd like to highlight four areas in the quarter that show how this strategy is playing out before handing it over to Jason to review this quarter's results in full. The first area I'd like to highlight is residential domestic connectivity, where we are very pleased with our performance and strategy as we navigate a highly competitive broadband marketplace. The customer experience provided by our broadband network, which has ubiquitously available gig speeds today and is on a path to ubiquitous multi-gigabit symmetrical speeds, combined with our wireless offering through our MVNO with Verizon and our own network of over 20 million Wi-Fi hotspots, enables us to provide world-class connectivity both in and out of the home to all of our customers everywhere in the most cost effective and capital efficient manner versus our competition. Our broadband network and product leadership continue to drive strong residential revenue growth, which was up nearly 4% this quarter, fueled by very strong ARPU growth of 3.9%. We're confident in our ability to drive continued ARPU growth because of our focus on constantly improving the product experience through investment and innovation, thus delivering more value to our customers. Having a truly excellent Internet experience as reflected in speed, reliability, coverage, security, and latency is constantly increasing in importance to all households as a result of the consumer experiences it enables. One of the biggest catalysts for recent growth in data usage is the accelerating transition of sports viewership to streaming platforms. The switch of a single Thursday night NFL game to streaming moved peak data usage on our broadband network from Sunday night to Thursday night, and that game comprises roughly 25% of all Internet traffic on Thursday nights. Every internet service provider, fixed wireless in particular, will really be put to the test as this transition of sports to streaming continues, especially come January, when for the first time ever, an NFL playoff game will be aired exclusively on a streaming platform which will be our very own Peacock. The second item I'll highlight is Peacock, which added 4 million paying subscribers during the quarter, saw greater than 60% revenue growth versus a year ago, and had the first year-over-year improvement in EBITDA since our launch in 2020. While we report standalone Peacock metrics given the significance of this initiative, we manage it as part of the broader NBCU media segment which includes the broadcast and cable networks to best leverage the advantages we bring to the streaming landscape. We continue to be pleased with our progress in the few short years since we've pivoted our streaming strategy as a result of the ownership changes at Hulu. Looking ahead, we are sticking to our plans and still expect 2023 to be the peak year of EBITDA losses for Peacock, though we are now expecting 2023 Peacock losses to come in around $2.8 billion versus our original $3 billion loss outlook. And for 2024, we expect to show meaningful EBITDA improvement over 2023. The third area to highlight is our parks business, which generated a record high level of EBITDA, surpassing the previous record that we'd just set in second quarter. The reaction to Nintendo and Hollywood in Japan continues to be fantastic, and we are very excited about bringing the experience to Florida soon. I was just in Orlando with the parks leadership team last week, reviewing our plans for the new Halloween Horror experience in Las Vegas and kids theme park in Frisco, Texas. I also spent a few hours on a site tour of the Epic Universe park, which is deep in construction and is simply breathtaking. So thanks to the momentum of our third quarter results and what we have in the pipeline, I could not be more excited about our parks business. The final area to highlight is our studios business, which is having a great year with three of the top five box office hits for the year so far in Super Mario Bros., Fast X, and now Oppenheimer, which grossed more than $900 million in worldwide box office in the third quarter and became the highest grossing biopic of all time. This is a continuation of our solid track record where, since 2020, we've had at least two of the top five movies in worldwide box office. We believe that success in this business is not formulaic. It's a craft rooted in creativity and originality. We've long focused on assembling a team of the most innovative filmmakers, Chris Nolan, Chris Meledandri, Steven Spielberg, Jason Blum, and Jordan Peele, to name a few, which positions us very well for the future in the studios business. More broadly, it is our consistent investment approach through past business cycles and the pandemic that is the reason for much of the success we're experiencing today. We remain steadfast in supporting our businesses, even those that were hit hard during that time period. For example, in studios, we never stopped believing that people want to experience great films in theaters, and that conviction enabled us to attract new partners like Chris Nolan who made a masterpiece in Oppenheimer. Similarly, while our parks business was closed or at limited capacity, we continued to invest heavily in our existing parks, including the VelociCoaster in Orlando, Secret Life of Pets in Hollywood, and the Nintendo Lands I had mentioned earlier in Los Angeles and Osaka, and we will be bringing Epic Universe to life in 2025. Our strong investment-grade balance sheet enabled these investments and puts us in strong and enviable position today. Now the business world must deal with pressures of much higher interest rates, which I believe will asymmetrically advantage us, given our low leverage and the long duration of our debt. Since the end of 2018, we have refinanced over $40 billion or nearly 40% of our debt obligations, reduced net debt from $108 billion to $88 billion today, lowered net leverage by a full turn from 3.3 times to 2.3 times, increased the average life of our debt by more than four years to 17 years, while reducing the weighted average cost of our debt to 3.6% from 3.8%. Today, 97% of our debt is at fixed rates compared to just 82% at the end of 2018. We accomplished this while at the same time returning $45 billion to shareholders, including $24 billion via share repurchases and $21 billion in dividends. To sum up, we're in a great place, especially given how the competitive dynamics in our industry might evolve in this higher-for-longer interest rate environment. I expect that our focus on building businesses that are market leaders for the long term through strong execution, investment, and innovation will keep us in one of the strongest positions to perform for our customers, employees, and shareholders. Jason, over to you.
Jason Armstrong: Thanks, Mike. And good morning, everyone. I'll take you through our strong third quarter and we'll begin with our consolidated financials on slide 4. Revenue increased 1% to $30.1 billion, while adjusted EBITDA grew 5% to $10 billion. Our results were driven by six key growth areas we have highlighted this year: our connectivity businesses, including residential broadband, wireless, and business services connectivity; our theme parks; streaming and premium content; and our studios. Together, these growth areas generated more than half of our total company revenue in the quarter and grew at a high-single digit rate over the past 12 months. The growth in these areas, which on the whole are margin accretive, coupled with disciplined cost management drove our EBITDA growth and contributed to our adjusted earnings per share increasing 13% to $1.08. Last, we generated $4 billion of free cash flow, while returning $4.7 billion of capital to shareholders in the quarter. Now let's turn to our individual business results, starting on slide 5 with Connectivity & Platforms. As a reminder, our largest foreign exchange exposure is the British pound, which was up nearly 8% year-over-year. So in order to highlight the underlying performance of the business, I will refer to year-over-year growth on a constant currency basis. Revenue for total Connectivity & Platforms was flat at $20.3 billion. Our core connectivity businesses – domestic broadband, domestic wireless, international connectivity, and business services connectivity – increased 7% to $11 billion in revenue, while video, advertising, and other revenue declined 6% to $10 billion in revenue. We're focused on investing in and driving growth in high margin businesses, while protecting profitability in businesses with secular headwinds through disciplined cost management. And it's working, underscored by the 100 basis points of margin expansion for Connectivity & Platforms in the third quarter, while margins for our domestic legacy cable business improved 160 basis points to 46.6%. Getting more into the details, residential connectivity revenue was up 7.5%, reflecting 4% growth in domestic broadband, 16% growth in domestic wireless, and 25% growth in international connectivity. Business services connectivity revenue was up 5%. Domestic broadband revenue growth continued to be driven by very strong ARPU, which grew 3.9%. Our commitment to network leadership and delivering it ubiquitously across our footprint enables customers to do more on our network. They're using more data and connecting more devices at faster speeds, which provides them with increasing value and underpins our ability to drive ARPU higher this year and beyond. At the same time, our residential broadband base remained stable, both on a year-over-year and sequential basis, with voluntary churn at record low levels for the third quarter. While back-to-school was a tailwind as expected, the broadband market remains highly competitive, particularly at the lower end. During the quarter, we recalibrated by pulling back on some of our promotional offers targeting this segment to remain consistent with our strategy of competing aggressively, but in a financially disciplined way. This means striking what we believe to be the appropriate balance between broadband subscriber growth and ARPU growth. And as we continue to manage this balance, we expect ARPU growth to remain strong and our primary driver of broadband revenue growth with somewhat higher subscribers losses expected the fourth quarter compared to the 18,000 loss we just reported in the third quarter. We expect subscriber trends to improve over time as we remain focused on network and product leadership and also as we see the benefits of greater footprint expansion. We've grown our homes and businesses passed by 1.5% year-over-year to 62 million and we're on of pace to meet or exceed our goal of 1 million new homes and businesses passed for 2023. This is a material step-up from 2022, and we should accelerate this again in 2024. Domestic wireless revenue increased due to higher service revenue, driven by strong momentum in customer lines which were up 1.3 million or 27% year-over-year to over 6 million in total. This includes 294,000 lines we just added in the quarter. We continue to test some new converged offers, which along with the new iPhone launch should translate into accelerated line additions in the fourth quarter. With still only about 10% penetration of our domestic residential broadband customer accounts, we have a big opportunity and long runway ahead for growth in wireless. International connectivity revenue increased 25% to another record high, driven by steady mid-teens growth in broadband with the remainder driven by wireless, reflecting healthy growth in services and a particularly strong quarter of device sales. The 5% growth in business services connectivity revenue reflects stronger growth in enterprise and mid-market. The strong revenue growth in our connectivity businesses was offset by declines in video, advertising, and other revenue. Video revenue decline was driven by continued customer losses. The lower other revenue reflects similar dynamics in wireline voice, and advertising was impacted by lower political revenue in our domestic markets, which in the fourth quarter will face an even more challenging comparison to last year. Connectivity & Platforms total EBITDA increased 3% to $8.2 billion, with adjusted margin up 100 basis points, again, driven by the mix shift to our high margin connectivity businesses, coupled with expense management. Continuing the trends seen in the first half of the year, every line item of expense improved year-over-year except for direct product costs. These are success based and tied to the growth in our connectivity businesses. In terms of the breakout in our Connectivity & Platforms EBITDA results, residential EBITDA grew 2.4%, with margin improving 110 basis points to reach 38.4%, driven by our favorable mix shift. While business EBITDA increased 3.6%, EBITDA margin declined 60 basis points to 57.5%, reflecting investments we're making in sales capacity to drive growth in the mid-market and enterprise segments. Now let's turn to Content & Experiences on slide 6. Content & Experiences revenue increased 1% to $10.6 billion and EBITDA increased 10% to $2 billion, driven by record results at parks as well as an improvement in year-over-year Peacock EBITDA losses. Looking at the results of each segment. I'll start with media, which combines our TV networks and Peacock, given we manage this as one portfolio. Revenue was slightly higher as strong growth in Peacock offset the challenging performance at our linear networks. Unpacking that further, domestic advertising declined 8%, reflecting softness in the linear market, partially offset by growth at Peacock, which increased nearly 40%. Domestic distribution increased 4%, driven by Peacock subscription revenue growth of nearly 90% as we continue to grow our paid subscriber base. We ended the quarter with 28 million Peacock paid subscribers compared to 16 million a year ago, with 4 million net additions in the quarter. This result was driven by continued success in converting free Comcast bundled subscribers to a paid relationship as well as organic growth driven by programming, including the start of the NFL season and having the Big Ten for the first time as well as Super Mario Bros. landing exclusively on Peacock in our Pay-One window. Media expenses were slightly lower, reflecting effective cost management in our linear networks and the timing of Premier League costs, partially offset by higher Peacock expenses. This resulted in a 6.5% increase in media EBITDA, with consistent EBITDA at our TV networks and improved year-over-year Peacock losses for the first time. As Mike noted, we believe Peacock's financial performance will continue to improve and now expect full year 2023 losses will come in at around $2.8 billion, better than our previous outlook of $3 billion. However, keep in mind that, in the fourth quarter, we expect our overall media EBITDA results to be impacted by higher sports costs, reflecting a full quarter of the contractual rate increase in our NFL programming, the addition of Big Ten to our sports programming lineup, and higher Premier League costs compared to last year when games were paused for four weeks to accommodate the timing of the World Cup. Turning to studios, Oppenheimer had a strong theatrical performance, delivering over $900 million at the box office. This success, coupled with the positive benefits from carryover titles from our strong film slate this year, resulted in EBITDA of $429 million. While this is a tough comparison to last year's third quarter, which was driven by the strong performance of both Minions: The Rise of Gru and Jurassic World: Dominion, it still ranks as one of the highest EBITDA quarters in the history of studios. At theme parks, revenue increased 17% and EBITDA increased 20% to $983 million, our highest level of EBITDA on record. Our international parks continued to experience nice rebounds post-COVID. Leading this growths was Osaka, which benefited from strong demand from Super Nintendo World, and our park in Beijing achieved another EBITDA record, driven by increases in attendance and per capita spending. In Hollywood, the positive consumer reaction to Super Nintendo World, which we opened earlier this year, drove strong attendance and per cap growth, helping Hollywood to deliver its best quarterly EBITDA in its history. In Orlando, our results were also strong, with attendance relatively in line with 2019 pre-pandemic levels and revenue substantially ahead. I'll now wrap up with free cash flow and capital allocation on slide 7. As I mentioned previously, we generated $4 billion in free cash flow this quarter and achieved this while absorbing meaningful investments, concentrated in our domestic broadband network, footprint expansion, streaming, and theme parks. Total capital spending increased 16%, driven by higher CapEx, which remains within the envelope of the guidance we gave at the beginning of this year, including Connectivity & Platforms CapEx intensity to remain at around 10% and parks CapEx to increase by around $1.2 billion for the full year compared to 2022. At Connectivity & Platforms, CapEx in the quarter decreased slightly to $2.1 billion, with CapEx intensity coming in at 10.3%. The year-over-year decline was due to lower spending in customer premise equipment and support capital, which more than offset the investments we are making to accelerate our growth in homes passed as well as to transition our US network to DOCSIS 4.0. Content & Experiences' CapEx increased by $270 million, driven by parks, with Epic accounting for the majority of this quarter's increase in spend. Working capital was fairly neutral in the quarter and improved by nearly $1 billion year-over-year, with more than half of this improvement reflecting the pause in production during the work stoppages associated with the writers and actors strikes. We expect this benefit in working capital to reverse as we ramp up to our normal levels of production in the coming quarters. Turning to return of capital and our balance sheet, we repurchased $3.5 billion worth of our shares in the quarter, a step-up in our quarterly run rate relative to the first half of the year. In addition, dividend payments totaled $1.2 billion in the quarter for a total return of capital in the third quarter of $4.7 billion. We ended the quarter with net leverage of 2.3 times, in line with our target leverage. With that, let me turn it over to Marci for Q&A.
Marci Ryvicker: Thanks, Jason. Operator, let's open the call for Q&A, please.
Operator: Operator: [Operator Instructions] Our first question comes from Ben Swinburne from Morgan Stanley.
Ben Swinburne: Two questions for the team on the cable business or connectivity business. Jason, as you mentioned, expenses continue to be a nice tailwind for growth. I think investors are focused on your ability to sustain that. You've been delivering kind of low to mid-single digit EBITDA growth in connectivity. Can you keep this up with expenses as a driver over the next couple of years or do you need revenue to accelerate? Maybe just talk about the opportunity you see ahead for the company. And then, I'm just wondering, you teased it a little bit with the iPhone commentary, but what's the thought process around getting more aggressive in wireless? Do you want to avoid pressuring financials at all? Because it would seem like wireless and the ability – the potential for wireless to bring broadband growth up to higher levels has got to be something you guys are thinking about. So, love to just hear your considerations on that front. Thank you.
Jason Armstrong: It's Jason. Let me start with the margin and expense question on the connectivity side. I think you're right, we've been sort of consistently expanding margins. A large part of that is we had yet another quarter, as we mentioned in the upfront remarks, where every expense line item went backwards or declined year-over-year, which is a positive outside of direct network costs. And just as a reminder, those are costs that directly feed into our key growth businesses like broadband and wireless. So as we look forward, I think the construct is, and you sort of laid this out appropriately, we've got several revenue growth drivers within our connectivity business, namely residential broadband, wireless, and business services, and those are the higher margin businesses within all of Connectivity & Platforms. So the mix shift that we're seeing and undergoing, where those are the businesses that are growing against businesses that are not growing, has been a favorable mix shift for us and we expect it to continue to be a favorable mix shift. So I would look for continued opportunities in both expense and margin.
Michael Cavanagh: And I would just add – it's Mike, Ben – that on the other part – as Jason has pointed out, the six growth driver businesses, the cable – components of that are all high incremental margin next dollar revenue, very high incremental margin, but there's also the businesses that are – as we've talked about, are not in the six growth drivers that are being managed pretty aggressively, frankly, for continued ways to find efficiencies to offset the pressures on the top line. So we've got multiple things going on that I think are the tailwinds for continued ability to drive margins.
David Watson: Ben, this is Dave. So – and as both Jason and Mike said, it does start when you talk about margins with the top line, and so a real focus around healthy ARPU, total revenue growth in connectivity, so all of those things really I think are sustainable. And you go through a competitive phase like we are, but you've still got to keep your eye on the ball and we believe that, over time, in addition to driving good, healthy, making financially disciplined calls along the way, we will return to subscriber growth over time. And so, I think you add all that up, it's – that's the beginning part. Then your question on mobile, it's such an important part of our strategy and it has been. We've built up the business, had consistent performance, and believe strongly we've got a long runway ahead. And one of the things that we're doing just to showcase kind of the focus for us is we are rolling out a buy one, get one offer. It's scaled up at the very end of Q3. It's really kicking off in earnest in Q4. It's a straightforward, good, solid offer that will be accretive and will drive broadband benefits in doing so. We're starting with the base and that's – but it's just an example that in both residential and in small business, we'll continue to be very – I think very aggressive in mobile over time. So a lot more to come on mobile, but we're encouraged and really like the runway ahead. Operator: Thank you. Next question is coming from Craig Moffett from MoffettNathanson.
Craig Moffett: I'm going to go to a different place, actually. Xumo, and maybe, Brian, if you could talk a little about this from a high level kind of strategic point of view. There's been a lot of talk about the prospect for streaming services being rebundled into something that maybe is in some ways closer to what we used to have in the video world. I wonder if you could just talk about that a little bit and talk about how Xumo might fit into that and whether you think Xumo has the potential to actually become a meaningful part of your Connectivity & Platforms business.
Brian Roberts: Great question. We're really excited about Xumo and the progress that we've made – we're making together now with Charter, and it's an amazing platform that started with X1, but now will be in televisions, it will be in devices, and it will be all over the nation and frankly all over the world. The heart and soul of it is our entertainment operating system which is global that includes Sky, all of Canada, Cox, and a number of other distributors that we now gradually build up to, all be helping to finance and help the innovation roadmap. So what is that innovation roadmap? It's really like you're suggesting, what do customers really want? They want a great platform, a great pipe. There want world-class content that they customize. And they want someone to make it really simple for them and do the heavy lifting as you bounce in between services, and that is what we really built our company on all these years and this industry on. So it is somewhat ironic that we've unbundled to rebundle to unbundle to rebundle and everybody has a different version of that and we're at a moment in time, but a lot of it is having one great platform that now the entire industry has and thankfully all of you on this phone who do not live in a Comcast market, which is many, are now soon going to be able to get these products, talk to your voice remote, and see how fantastic the experience is, whether you buy the cable bundle or not. And that's a big point. As most of our sales now are broadband only, we want to make sure we are the best aggregator for streaming. And then a logical next step will be us or others beginning to try to make it even easier for consumers to purchase and to switch packages. So it's an important part of the roadmap and this was a big week in the Charter announcement. And I'm sure, in their call, they'll talk about their commitment to the JV as well. Operator: Next question is coming from Phil Cusick from JPMorgan.
Phil Cusick: A couple for Dave. Dave, I think you said that you expect to get back to broadband growth over time, and as you expand the number of houses that you're building, as Jason mentioned, I expect that that's probably part of it. But can you talk about the contribution of that low end effort that you started? You mentioned on the first quarter call and the level of reversal that you're doing here as well as recent competition from fiber and fixed wireless. And then second, if you can just talk about where wireless is right now, how the CBRS trials are going in Philadelphia, and any thoughts on timing to expand that. Thanks very much.
David Watson: You got it, Phil. So as we've said, and it's – everybody has seen, it's a pretty competitive environment. And so, when you – we have some continuation of some of the macro issues that we talked about, but we've also – as you brought up, we've also continued to see the expansion of both fiber and fixed wireless footprint. So we've gone through several competitive cycles where there's – it's really noted by a lot of new footprint that's been added, and so we did start in the beginning of the year, made some adjustments in terms of offers that were really focused more on the lower end of the market, but part of our game plan is to – we're going to continue to invest in a better network, better products, and compete aggressively, but we're going to maintain financial discipline, and that means making certain decisions when it comes to balancing rate and volume. And so, after the first half, we did make the decision to pull back on some of our more aggressive offers which resulted in lower connect activity. So that is the changes that we've had. I think our voluntary churn rate is very healthy. A key part of that that's continued and the real issue that we see at this point is, as we manage things, is just lower connect volume. So – but, net-net, we're growing revenue as we talked about earlier, Jason did and I did, and we're going to focus on multiple drivers of revenue growth. And we'll make our playbook, we make changes throughout. So – and then to wireless, your point, we are continuing to test in terms of the CBRS roll-offs where we've picked up the pace on that, staying close to what Charter is doing. We've seen good progress in the ability to off-load traffic and encouraged by the opportunity in terms of just such a small geographic part of your footprint contributes so much volume of wireless traffic. So we are in position, if we so choose to do it, but we like where we're at with that, no new news in terms of scaling up on that point, but we're in a good position. Operator: Our next question is coming from Jessica Reif Ehrlich from Bank of America Securities.
Jessica Reif Ehrlich: I have two topics. One is sports and one's advertising. On sports, it's such a key differentiator in content. Can you just talk about your longer term sports strategy and how you believe sports will be distributed in the future? You talked about more going direct-to-consumer. What role will linear play as we look ahead three to five years, and how would you respond to the leagues, whether NBA or NFL, et cetera, investing in ESPN? And then on advertising, there seems to be weakness across the board, cable and media, which is in line I'm sure with the rest of the industry. But there seems to be strength in the industry in digital whether it's Google or Meta. How are you as a company/industry addressing that? How do you get dollars back?
Brian Roberts: Okay. Well, this is Brian. Let me start and kick it over to Mike because I think your industry question on sports is really profound and important. I think our company has had a long, deep, rich history in sports, both parts of the company. The best way to consume an NFL game or the Olympics is to have our entertainment operating system I just talked about in Craig's question, and you'll see that in the Olympics. There will be nothing like it. The same goes for I think NBC Sports which is the number one show in television on Sunday Night Football. We've got a great team and a culture of big events, whether it goes from the Kentucky Derby, which the ratings are much higher when it's been on NBC than any previous platform, and then on and on. And with Peacock now, we have the most live sports of any of the streaming services. And I believe that that's a surprise to many people when they learn that and believe that to be the case, and that's a commitment we made when we had things like English Premier League or Tour de France or golf or events that went on for longer periods of time than were typically on a network where you wanted more camera angles or more feeds and more games, and that sets us up for being relevant in the transition that we're all talking about. How do we go from analog to digital in a way that helps the leagues? And so, yeah, I can't speculate on what might happen to ESPN, but what I could speculate is we meet with the leagues which we do frequently, we think we present a somewhat unique ability to help get the maximum engagement now with broadcast and cable, particularly our broadcast platform, as well as having a robust streaming service and a super quarter here regarding the kind of momentum that we've garnered. A lot of that is driven by sports on Peacock. And that sets you up to answer your advertising question, which I'll let Mike go into a bit, but at the highest level, we're creating the digital capability on Peacock in the most relevant content. That looks like a very winning combination for us as a strategy.
Michael Cavanagh: And I'll just add on that. It's Mike. I'll just add that the importance and the significance of us being committed to sports in the streaming context of Peacock is for us combined with the ability to bring the big reach that our broadcaster NBC brings to the party, which I think is an important element of – while sports over the long term I think are going to be experienced significantly through streaming, I think for a long time, the economics of the sports rights that you see is going to be substantially supported by broadcast reach that I think for a long time is going to continue to be a significant part of the picture. In terms of advertising, I'd say, Jessica, that overall it's not a big difference in story than last quarter. I'd say the ad market has remained soft. It hasn't necessarily gotten worse despite a little bit of sequential decline, but it hasn't gotten better at the same time. And we still continue to think it's due to the general uncertainty about economic conditions that are out there. The kind of weakness that we're talking about or the softness is particularly on the linear side, while Peacock has remained very strong. Picking at this quarter a little bit, the deceleration from 5% to 8%, contributing factor there which is a little idiosyncratic is, while the retail and tech sectors were down a little bit, whereas auto and pharma and consumer products were up. The one that was down that's a little unique and idiosyncratic is entertainment where you had streamers spending a little less together with advertisers, given the strikes, looking at what the lineups were in the recent past and putting some money in other places. So some of that will revert we believe once strikes are over. And as we look to the fourth [Technical Difficulty] last year's World Cup as well as political that underlying ad sales will be an improvement in this fourth quarter versus last year's fourth quarter. And as far as digital, I think that's why there is definitely the opportunity that some tech competitors are capturing to get premium video monetized in digital platforms, and I think that speaks to why we consider Peacock to be an important initiative for us. And we're pleased again with the progress we're making in Peacock which is now north of 28 million subs and strong overall 60% revenue growth year-over-year.
Brian Roberts: One last point I just wanted to add that one of the great things about sports that we're very excited about is streaming sports and what that means for our broadband network strategy that Dave was just talking about. Dave and the team I think have found a great balance in how we're running the operation, but a big part of that is a commitment and a belief that we see all sports finding a way over the next many years or maybe not so many years to be more and more streamed, and that's going to require more bandwidth and that's going to require and create an opportunity for us to have the superior product in the market. So that's our strategy, and so sports really, back to your first question, Jessica, is at the heart and soul of a lot of what we do. Operator: Our next question is coming from Brett Feldman from Goldman Sachs.
Brett Feldman: I've got two questions about your business connectivity segment. The first is you made some comments about investments you're making to better address the enterprise customer demographic. I think the assumption has been, historically, it's not been a focus for you because serving that demo generally requires you to serve customers with locations outside of your footprint. So I was curious to hear a little more about your strategy for scaling up there, and I'm wondering whether that might involve making incremental investments in your connectivity platform outside of your region, either organically or potentially making some acquisitions. And then second, I was hoping you could give us an update on the extent to which the business segment is contributing to your success in wireless. Is it kind of pacing what you're seeing in the residential space, or do you think you have more opportunity there? Thank you.
David Watson: Hey, Brett, Dave. So let me start. Overall, business services had a very good quarter. Revenue accelerated a little, reflecting stronger growth in enterprise and mid-market, so we've been very focused on growing all categories. So your point on the sales investment, let me provide some context. We have been for some time working with partners. And most certainly, with the acquisition of Masergy, we've been expanding our capability to go into other areas and now we have global opportunity to be able to handle customers. The key here is to be able to take care of customers' needs wherever they are, so this particular investment is just adding some folks, it's not infrastructure that we're building out there. We will leverage the partnerships that we have, but certainly we'll deliver products that meets the customers' needs out. But it's sales force and adding some people that can drive mid-market and enterprise where the customers' locations are. But we'll continue to partner, we have great partnerships with Charter, Cox, many others, and we'll continue to do that. It's not really an infrastructure moment. And in terms of wireless, it's a very important part of business services and it's – clearly, this phase is centered on SMB and we're getting going on that. We've picked up the pace on that. It's not a major driver yet in overall mobile activity at this point, but we expect that pace to pick up. That is an important one for us. And let me – just one last point, if I could, Brett. While you're talking about business services, I'd be remiss if I didn't thank Bill Stemper as he transitions to Chairman Emeritus. Bill has been a spectacular teammate and driver of this business over a long stretch, really. And one of the great things that Bill did is build a world class team. I think they've set the bar in terms of performance. We continue to do that. And part of that team is a wonderful executive, Ed Zimmerman, who has now taken over the – running business services for us, so congratulations to both. Operator: Our next question is coming from John Hodulik from UBS.
John Hodulik: Two, if I could. First of all, and maybe for Dave, can I just get your thoughts on the Charter approach to the Disney renewal? Do you see Comcast heading in that direction, or do you see benefits for the industry and for linear TV if the industry does move in that direction? And then following up on some of your comments on the broadband side, you guys are rolling out DOCSIS 4.0, you're starting to sign up customers. I guess, one, could you just update us on the timing of that rollout? And two, do you see it more as an ARPU opportunity or a sub opportunity, subscriber growth opportunity? I guess lastly on that, you said there's more competition at the low end of the broadband market. Is there any way you could quantify either Comcast's exposure to the low end or how big the low end of the market in broadband is? Thanks.
David Watson: I think Mike and Brian talked about Charter Disney, so that to me – I think that is the – they provided the point of view. From my perspective, I think every situation is unique. I think we are in a very unique position because of the platform that we have and the fact that we are in the streaming business as a company, that we have great relationships with content providers and we have a way of figuring things out. But it will be case by case as they come up and we'll see – but a big part of it, one of the things we talked about is value, value of the content and how that model evolves, we'll figure it out. But I think we are in a good position to be a bridge builder as we go, consider each one of these options in the marketplace. In terms of the network and DOCSIS, let me give you a sense, John, where we're at. So we're about 30% in terms of mid-splits and really focused on this seamless integration that connects HFC to fiber. And we'll be at 40% next year. So – and then we started – you've seen the announcement and we talked about the deployment of DOCSIS 4.0 [Technical Difficulty] and so we're going to continue to drive the mid-split upgrade areas. DOCSIS 4.0 follows that mid-split trajectory. And that is our focus, continued focus is just providing leadership of where the market's going. The reason why, to answer your question, in terms of where do we see the benefits, it's that point, that the market is going to continue, whether it's the sports discussion we talked about earlier, as more and more things start to perhaps go to streaming, there will be more simultaneous contention at peak moments and we're in a great position with the networks. So having that, the ability to have faster speeds, ubiquitous network coverage at scale, the most efficient network and effectively delivering, we've got [Technical Difficulty] customers that are 1 gig today, 70% of our customers are 400 megabits or higher, and we see where things are going. So I think the answer is both. I think, over time, it's customer relationship as it's going to become increasingly harder for some of the competition to keep up in terms of – they have to make network trade-offs in fixed wireless, in particular, and so that to me is both rate and volume. And on – the last point is just on the lower end, it was a lot of activity in the lower end. We did respond in the first quarter but made adjustments for the second half, so that – I talked about that.
Brian Roberts: I would just say on the Charter and Disney, what I think it was in sort of the first question I answered, we think there's a – echo what Dave said, not one size fits all, very glad, happy for both companies that they figured something out. Good for consumers. Each situation is slightly different. What I think is important for us is finding a way to help our customers have a great network, aggregate that content, and have access to the great content, and I think we're really well positioned to do that and we're looking forward to executing upon that. Operator: Thank you. Next question is coming from Jonathan Chaplin from New Street. Your line is now live.
Jonathan Chaplin: Maybe for Dave, just a small question following on from Phil's. In terms of the CBRS trials, is the benefit that you're seeing there that you're sort of more enthusiastic about primarily on the cost side from being able to off-load traffic, or is there a product benefit as well? And then with the sale of the 600 megahertz spectrum, does that sort of suggest that you're not really interested in owning any spectrum besides 600 megahertz, or was there some sort of something – sorry, besides CBRS, was there something specific about 600 megahertz in the portfolio that you had that made it non-strategic? And then if you can give us just a quick update on where your sort of average usage is on broadband, that would be helpful as well. Thanks.
David Watson: So in terms of CBRS, it's what I said before that we're in position – it's an option for us. We're in a good position and we like our – where we're at with our current deal, the MVNO, capital light approach, everything that we talked about is consistent. But we've always been very interested – and the benefit of CBRS is on the cost side, and that if you have – again, 3% of your geographic footprint that's delivering 60% of the traffic, that's a good option and if we can figure out how to do that. So we're – that's what's really driving it. And – but we've always been very focused on how to build a better overall wireless experience. We have I think great Wi-Fi capability in addition to CBRS if that's something we want to do. But the key for CBRS is that we just want to be in position and doing it without a massive amount of CapEx to be able to deliver that smaller geographic area. And in regards to 600 megahertz, it's just a – it was an opportunity to get value for areas of the country outside of our areas and it just made sense to – it was a good transaction for us and not something that we're going to build outside of our footprint. Operator: Our final question today is coming from Steven Cahall from Wells Fargo. Your line is now live.
Steven Cahall: So just first on the residential broadband ARPU, wondering if you could unpack a little bit of the sequential change? I know the big components are double play going to single play from cord cutting as well as just tiering and pricing, so with a little bit of slowdown sequentially. Should we attribute a lot of that to the slowdown in video losses that you saw, or anything else going on in there? And then, Brian, you talked a lot about how effectively you've deleveraged the balance sheet, taking down by a full turn over the last couple of years. Also that a lot of your competitors, especially on the media side, are going to be more challenged. So I know you'll be disciplined in anything that you do, but as you look ahead and think about competing against some companies that aren't challenged, like Netflix and Apple and Amazon, how do you think about some of the availability of some of those distressed content creators that might be out there at some future point? Thank you.
David Watson: Let me start, Steven. This is Dave. The biggest driver in terms of ARPU was that, the first half of the year, our focus – we did make adjustments in that first part of the year about being a little bit more aggressive in the lower end. This resulted in a mix shift among new customers that were coming on and this caused the deceleration in ARPU growth from where we were before at 4.5% to 3.9%. The 3.9% is still very strong ARPU growth and consistent with our planning and what we were talking about. So that was really the biggest driver. Some certainly benefit over time to a little bit better performance in the video business with NOW TV, which is beginning to pick up the pace. So pleased with that. But it was mostly that refinement of the lower end offers, and you're not going to see that, by the way, that level of deceleration from Q3 to Q4 as we made those adjustments. So that – it's mostly the tier mix change that I talked about.
Jason Armstrong: Steven, I would add on to that, just if you look at the historical context here, we've typically grown broadband ARPU 3% to 4% in any given year. We've been operating at the very high end of that for the first three-quarters this year. Things that contribute to that over the long term, you mentioned sort of the tactical components of that that really, really – we want to see broadband usage growth, we want to see customers hanging more devices off their network, we want to see them taking higher speeds, and that's exactly what they're doing. So those are sort of the foundational pillars for driving ARPU growth over time, and that's exactly what we're seeing.
Brian Roberts: This is Brian. I actually will let Mike answer because he did such a great job in his old job as CFO in helping put our balance sheet in this enviable position that he described in his opening or comments about how long the debt is and some of the interest rates. We have a great business this quarter, another demonstration of it. The start to the year is fantastic. But, Mike, why don't you – so therefore, the bar is very high to do anything other than the plan we've got and we like the company but, Mike, why don't you go into your thoughts on that content question specifically.
Michael Cavanagh: So I think if you zoom out, it's much of what I said earlier, Steven, which is I think the strength of our financial position broadly, if you think about across all the businesses we're in, I think of us as having leading positions for the customer but also strong margins benchmarked against any period you can look at, that together with the strong balance sheet, I think the company couldn't be in better shape financially. And I think on the execution side, Dave and his team and the NBC team that works with me are – they know what they're doing and I think we're not giving anybody any quarter in terms of operating the businesses we have. Our priorities, though, in how to use that financial strength is very strategic. So I think we think about the businesses we're in and investing in them appropriately for return and growth and drive growth in those businesses over the long term, hence the way Jason talks about the half the company that's got strong revenue growth. We're trying to find ways to put resources into our own businesses. So that's the priority. As Brian said, the bar is really high for us to consider anything inorganic, but it's our job to look at these things. But if you think about – what you call the potentially distressed media assets, I'm not sure which ones you're referring to, but many of them are pretty small and wouldn't change the arc of what our company's all about. So I think our focus is on the total picture what Comcast looks like and we're proud of the company we have.
Marci Ryvicker: Thanks, Steve. That concludes our call. I want to thank everyone for joining us. Operator: Thank you. That does conclude today's question-and-answer session and today's conference call. A replay of the call will be available starting at 11:30 am Eastern Time today on Comcast's Investor Relations website. Thank you for participating. You may now all disconnect. |
META | 3 | 2,023 | 2023-10-25 21:10:25 | Operator: Good afternoon. My name is Dave and I will be your conference operator today. At this time, I would like to welcome everyone to the Meta Third Quarter 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] This call will be recorded. Thank you very much. Ken Dorell, Meta's Director of Investor Relations, you may begin.
Ken Dorell: Thank you. Good afternoon and welcome to Meta Platforms’ third quarter 2023 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO, and Susan Li, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. And now, I'd like to turn the call over to Mark.
Mark Zuckerberg: All right. Thanks, Ken. Thanks, everyone, for joining today. This was a good quarter for our community and our business. We estimate that there are now more than 3.9 billion people who use at least one of our apps every month. The big product news this quarter is that we just held our annual Connect conference and we discussed Quest 3, which is the first mainstream mixed reality device, and the next generation of Ray-Ban Meta smart glasses, which are the first smart glasses with our Meta AI built in. There continues to be a ton of innovation in AI. And we used Connect to describe and start launching a lot of the new consumer AI experiences that we expect to become meaningful parts of all of our apps and our business over the coming years. We started rolling out Meta AI, our new assistant that you can access across all our messaging experiences and smart glasses to answer questions, get access to real-time information, and generate photorealistic images. We started launching our AI Studio platform that enables people to create and interact with lots of different AIs for help getting things done and just having fun. We rolled out Emu, our image creation model that produces high quality images and stickers fast. We launched an early alpha of business AIs so that eventually every business can have an AI to interface with customers to do sales and support. And we let out the plan to launch creator AIs next year, so every creator can have an AI their fans can engage with to help them build out their community. And that's just a snapshot of some of the AI work that we're doing. The experiences that we start rolling out at Connect are going to transform the way that people use all our services, feeds, messaging, hardware, advertising, business messaging, interacting with creators and more. But it's going to take time to tune all these experiences before hundreds of millions or billions of people are going to use them. And I expect that dialing in these products and the vision that we articulated at Connect is going to be our theme for much of the next year. And I think that it's going to be a very exciting 2024. As we are looking ahead and planning for next year, I want to share a few thoughts on what I'm expecting. I've been happy with our results this year so far, and we are planning to continue focusing on operating efficiently going forward, both because it creates a more disciplined and lean culture and also because it provides stability to see our long-term initiatives through in a very volatile world. Now, in terms of investment priorities, AI will be our biggest investment area in 2024, both in engineering and compute resources. But I want to avoid allocating a lot of new headcount. So we're going to continue deprioritizing a number of non-AI projects across the company to shift people towards working with AI instead. On the recruiting front, one dynamic that I want to flag is that we have a sizable hiring backlog right now since part of our layoffs earlier this year included teams swapping out certain skill sets for being able to hire others. And we're still going to be hiring those roles into 2024. So that means that even though we're going -- even though we're planning to grow headcount at a much slower rate going forward, the actual rate next year may temporarily be faster as we work through this hiring backlog. All right. Now, let's get into our product updates. Let's start with Reels, which continues to do very well. We estimate that with all the ranking and product improvements that we've made, Reels has now driven more than 40% increase in time spent on Instagram since launch. We also reached a monetization milestone earlier than expected. And we estimate that Reels is now net neutral to overall company ad revenue. In many ways, Reels has now graduated from being an early initiative to now being a core part of our apps. So going forward, and we're going to continue focusing on Reels, but we'll also look at growing it as part of our overall portfolio of video services, which make up more than half of the time that is spent on Facebook and Instagram. And There's a lot more to do across all of these. All right, AI. AI advances are driving a lot of our product and business performance. Generative AI will increasingly be important going forward. I outlined our product roadmap earlier. And on top of that, we're also building foundation models like Llama 2, which we believe is now the leading open source model with more than 30 million Llama downloads last month. Beyond that, there was also a different set of sophisticated recommendation AI systems that powers our feeds, Reels, ads, and integrity systems. And this technology has less hype right now than generative AI, but it is also very important in improving very quickly. AI-driven feed recommendations continue to grow their impact on incremental engagement. This year alone, we've seen a 7% increase in time spent on Facebook and a 6% increase on Instagram as a result of recommendation improvements. Our AI tools for advertisers are also driving results with Advantage+ shopping campaigns, reaching a $10 billion run rate and more than half of our advertisers using our Advantage+ creative tools to optimize images and text in their ads creative. Business messaging also continues to grow across our services and I believe will be the next major pillar of our business. There are more than 600 million conversations between people and businesses every day on our platforms. To give you a sense of what this could look like when it's scaled globally, every week now, more than 60% of people on WhatsApp in India message a business app account. A revenue from click to message ads in India has doubled year-over-year. Now I think that this is going to be a really big opportunity for new business AIs that I talked about earlier that we hope will enable any business to easily set up an AI that people can message to help with commerce and support. Today, most commerce and messaging is in countries where the cost of labor is low enough that it makes sense for businesses to have people corresponding with customers over text. And in those countries like Thailand or Vietnam, there's a huge amount of commerce that happens in this way. But in lots of parts of the world, the cost of labor is too expensive for this to be viable. But with business AIs, we have the opportunity to bring down that cost and expand commerce and messaging into larger economies across the world. So making business AIs work for more businesses is going to be an important focus for us into 2024. I want to give a quick update on Threads. We're three months in now, and I'm very happy with the trajectory. There are just under 100 million monthly actives at this point. And we're now getting to the point where we're going to be focusing on growing the community further. From what we can tell, people love it so far. I've thought for a long time that there should be a billion person public conversations app that is a bit more positive. And I think that if we keep at this for a few more years, then I think we have a good chance of achieving our vision there. Now finally, in addition to AI, our other major long-term focus is the metaverse. And we just launched Quest 3, our most powerful headset yet, at a very competitive price. We packed a lot of improvements in there, including a next generation chipset with 2x the graphics performance, our best display as yet, and a form factor that's 40% thinner than Quest 2. But the most important breakthrough for Quest 3 is that it's the first mainstream mixed reality device. And that means that when you put on the device, you see your physical room around you, and you can bring digital objects and games into your physical space, whether that's a ping pong table, your workstation, a big screen TV to play Xbox games on, or your friends as holograms. The early reviews have been great, and it's been fun to see how people respond to this. We also launched the next generation of Ray-Ban Meta smart glasses. They're upgraded from the first generation in basically every way. Better camera, clearer audio, they're lighter, they have more styles, and you can now even live stream video from them. But most importantly, these are the first smart glasses shipping with Meta AI built in. So you can ask your glasses questions throughout the day. It'll answer them right in your ear. And in many ways, glasses are the ideal form factor for an AI device because they enable your AI assistant to see what you see and hear what you hear. Again, it's good to see the early reviews, they're so positive, and I'm looking forward to this space evolving quickly over the coming years. We are also making progress on software for the metaverse too. Horizon is now growing faster. There's more new worlds like Super Rumble and Citadel come online. We also started testing Horizon for phones, tablets, and PCs, which is going to be an important part of how we build out the metaverse across devices. And we've had a couple of important milestones with avatars as well, both for our expressive avatars and the latest codec avatars that I showed off recently. Now, as I said at Connect, I think one of the most interesting questions for our industry over the coming decades is going to be how we bring together our physical and digital worlds into a coherent and good experience. I think we're starting to see some of the building blocks come together between mixed reality for bringing digital objects into the physical world, our AI studio work for enabling interactions with all kinds of different AIs, and eventually smart glasses to bring all this together into a stylish form factor. So I am very excited about the roadmap ahead. All right. That is my update for today. This was a good quarter. I'm pleased with our progress on efficiency this year. We're a leaner organization, shipping faster and advancing the state-of-the-art in all of our long-term initiatives. And while investing heavily for the future, we also just recorded our highest operating margin in two years. So I'm looking forward to carrying this product momentum and operating discipline forward. As always, thank you to everyone on our team and all of you who are on this journey with us. And now, here's Susan.
Susan Li: Thanks, Mark, and good afternoon, everyone. Let's begin with our consolidated results. All comparisons are on a year-over-year basis unless otherwise noted. Q3 total revenue was $34.1 billion, up 23% or 21% on a constant currency basis. Q3 total expenses were $20.4 billion, down 7% compared to last year. In terms of the specific line items, cost of revenue increased 9%, as higher infrastructure-related costs were partially offset by lower content costs. R&D increased 1%, as higher headcount-related costs from Family of Apps and Reality Labs were partially offset by lower non-headcount related Reality Labs operating expenses. Marketing & Sales decreased 24%, due primarily to lower marketing spend and headcount-related costs. G&A decreased 39%, due primarily to lower legal-related expenses. We ended the quarter with over 66,100 employees, down 7% from the second quarter. Our third quarter headcount no longer included the substantial majority of the employees impacted by the previously announced layoffs. Third quarter operating income was $13.7 billion, representing a 40% operating margin. Our tax rate for the quarter was 17%. Net income was $11.6 billion or $4.39 per share. Capital expenditures, including principal payments on finance leases, were $6.8 billion, driven by investments in servers, data centers and network infrastructure. Capital expenditures were below the prior year levels primarily due to lower server and data center construction spend as we prepared to shift to our new data center design, as well as payment timing. Free cash flow was $13.6 billion, benefitting from a deferral of income taxes which was paid in the fourth quarter. We repurchased $3.7 billion of our Class A common stock in the third quarter and ended the quarter with $61.1 billion in cash and marketable securities and $18.4 billion in debt. Moving now to our segment results. I’ll begin with our Family of Apps segment. Our community across the Family of Apps continues to grow. We estimate that approximately 3.14 billion people used at least one of our Family of Apps on a daily basis in September, and that approximately 3.96 billion people used at least one on a monthly basis. Facebook continues to grow globally and engagement remains strong. Facebook daily active users were 2.09 billion, up 5% or 101 million compared to last year. DAUs represented approximately 68% of the 3.05 billion monthly active users in September. MAUs grew by 91 million or 3% compared to last year. Q3 Total Family of Apps revenue was $33.9 billion, up 24% year-over-year. Q3 Family of Apps ad revenue was $33.6 billion, up 24% or 21% on a constant currency basis. Within ad revenue, the online commerce vertical was the largest contributor to year-over-year growth, followed by CPG and gaming. Online commerce and gaming benefited from strong spend among advertisers in China reaching customers in other markets. On a user geography basis, ad revenue growth was strongest in Rest of World and Europe at 36% and 35%, respectively, followed by Asia Pacific at 19% and North America at 17%. Foreign currency was a tailwind to advertising revenue growth in all international regions. In Q3, the total number of ad impressions served across our services increased 31% and the average price per ad decreased 6%. Impression growth was mainly driven by Asia-Pacific and Rest of World. The year-over-year decline in pricing was driven by strong impression growth, especially from lower monetizing surfaces and regions. While overall pricing remains under pressure from these factors, we believe our ongoing improvements to ad targeting and measurement are continuing to drive improved results for advertisers. Family of Apps other revenue was $293 million in Q3, up 53%, driven by strong business messaging revenue growth from our WhatsApp Business Platform. We continue to direct the majority of our investments toward the development and operation of our Family of Apps. In Q3, Family of Apps expenses were $16.4 billion, representing approximately 81% of our overall expenses. FoA expenses were down 9% as growth in infrastructure-related costs was more than offset by lower legal-related expenses, marketing, and headcount-related costs. Family of Apps operating income was $17.5 billion, representing a 52% operating margin. Within our Reality Labs segment, Q3 revenue was $210 million, down 26% due primarily to lower Quest 2 sales. Reality Labs expenses were $4.0 billion, flat year-over-year as higher headcount-related expenses were offset by lower non-headcount related operating expenses. Reality Labs operating loss was $3.7 billion. Turning now to the business outlook. There are two primary factors that drive our revenue performance. Our ability to deliver engaging experiences for our community, and our effectiveness at monetizing that engagement over time. On the first, overall engagement on Facebook and Instagram remains strong. Reels, and video content more broadly, continues to grow and drive incremental engagement. AI- recommended content from unconnected accounts in Feed continues to become increasingly incremental to engagement, including in the US & Canada. These gains are being driven by improvements to our recommendation systems and we see additional opportunities to advance our systems even further in the future as we deploy more advanced models. We’re also developing entirely new experiences for our community. Our investments in AI capacity in recent years have enabled us to support leading Generative AI research and we’re meaningfully accelerating the pace of bringing that research into our products. We launched our first consumer Gen AI experiences last month that are built on top of our foundation models and are excited to learn from how people use these tools to make them increasingly valuable over time. Aside from Generative AI, Threads also remains a compelling long-term opportunity and we’re excited to build on the strong product momentum we have going into next year. Turning to the second driver, improving monetization. Here, our focus is on continuing to drive marketing performance for businesses, including through business messaging. There are four areas of this work, improving Reels monetization; creating engaging on-platform ad experiences; making it easier for advertisers to connect their marketing data, and increasingly leveraging AI across our ads systems and products. On Reels, we have continued to improve monetization and are now at a level where Reels is neutral to overall revenue. We’ve made tremendous progress over the last year building and scaling Reels as a consumer product, and it has now become part of the core experience on Instagram and Facebook. As such, we don’t anticipate quantifying the net revenue contribution from Reels going forward. We will still work to further improve Reels ads performance through ranking improvements and making Reels ads increasingly interactive, while also growing supply to give businesses more opportunities to get in front of people. We anticipate this ongoing work will help Reels be a modest tailwind to revenue in 2024 while we continue to strike the right balance between engagement and revenue growth. But our focus going forward will be on growing revenue and engagement on overall video, and more holistically across our product lines within Instagram and Facebook. Next, onsite experiences. We’re seeing sustained momentum with Click-to-Message ads. Click-to-WhatsApp ad revenue continues to grow very quickly in particular and is already at a multi-billion dollar annual run-rate. We’re progressing on our work to enable further down the funnel conversions, and longer-term, we’re excited about the potential of AI to help businesses message with customers more efficiently at scale. We’ve recently started testing AI capabilities with a few partners and will take our time to get the experience right, but we believe this will be a big unlock for business messaging in the future. We’re also excited about the potential for paid messaging, which serves as a nice complement to click-to-messaging ads by helping businesses develop ongoing relationships with customers once they’re in a messaging thread. Outside of business messaging, we’re seeing good early traction with Shops ads and in the third quarter we announced expanded commerce integrations with third party services to make it easier for businesses to set up a Facebook or Instagram Shop and run Shops ads. The third piece of our work is making it easier for advertisers to connect their marketing data. We’re investing in ways to make it easier for advertisers to adopt our Conversions API, understand its impact, and use it across a broader set of objectives. In addition to our existing support for AWS, in September, we announced the support of Google Cloud for the Conversions API Gateway. We’ve also introduced enhanced reporting and rolled out Conversions API for Business Messaging so click-to-message advertisers can now better understand the value of WhatsApp and Messenger and improve their performance. Last, AI. We are leveraging AI across our ads systems and suite of products, which is driving improved performance for advertisers. We’re increasingly adopting the use of larger, more advanced ads models and using AI to power ads products that provide increased automation to advertisers. We’re seeing strong traction with our Advantage+ Shopping solution, particularly around online commerce and CPG advertisers looking to drive online sales. And we’re continuing to invest in several other products within our Meta Advantage+ suite to help advertisers optimize and automate more of their campaigns. Before turning to our revenue outlook, I’d like to provide color on our hiring plans as we look to 2024. One important point to note is that we are currently operating with a significant underrun against our 2023 budgeted headcount. For much of late 2022 and early 2023, we had instituted a broad-based hiring freeze as we undertook our restructuring efforts. In addition, as part of those restructuring efforts, many teams elected to make deeper headcount reductions in order to hire different skill sets that they need. We have since resumed hiring but expect that much of our hiring that was originally planned for and budgeted in 2023 will occur in 2024. As part of our 2024 budget, we plan to selectively allocate incremental headcount toward four key company priorities, AI, infrastructure, Reality Labs, and monetization as well as toward our regulatory and compliance needs. Of those areas, we expect AI to be the largest area of increased investment as we further invest in Generative AI across our core products, internal tooling, and research efforts. We aim to offset some of this growth by continuing our efficiency focus and reducing planned hiring in other areas across the company in 2024. The net effect of our efforts to close out our 2023 hiring underruns and our efficiency-focused 2024 budgeting process is that we expect to end next year with reported, in-seat headcount meaningfully higher than our current headcount, but to grow at a slower rate beyond that. We also expect a step-up in infrastructure-related expense growth next year as we recognize higher depreciation and operating costs from running an expanded infrastructure footprint. In addition, we continue to monitor the active regulatory landscape, including the increasing legal and regulatory headwinds in the EU and the US that could significantly impact our business and our financial results. Of note, the FTC is seeking to substantially modify our existing consent order and impose additional restrictions on our ability to operate. We are contesting this matter, but if we are unsuccessful it would have an adverse impact on our business. Turning now to the revenue outlook. We expect fourth quarter 2023 total revenue to be in the range of $36.5 billion to $40 billion. Our guidance assumes a foreign currency tailwind of approximately 2% to year-over-year total revenue growth in the fourth quarter, based on current exchange rates. Turning now to the expense outlook. We anticipate that our full-year 2023 total expenses will be in the range of $87 billion to $89 billion, lowered from our prior range of $88 billion to $91 billion. This outlook includes approximately $3.5 billion of restructuring costs related to facilities consolidation charges and severance and other personnel costs. We expect Reality Labs operating losses to increase year-over-year in 2023. We are also sharing a preliminary outlook for 2024 expenses, CapEx and our tax rate. We expect full-year 2024 total expenses to be in the range of $94 billion to $99 billion. We continue to expect a few factors to be drivers of total expense growth in 2024. First, we expect higher infrastructure-related costs next year. Given our increased capital investments in recent years, we expect depreciation expenses in 2024 to increase by a larger amount than in 2023. We also expect to incur higher operating costs from running a larger infrastructure footprint. Second, we anticipate growth in payroll expenses as we work down our current hiring underrun and add incremental talent to support priority areas in 2024, which we expect will continue to shift our workforce composition toward higher-cost technical roles. Finally, for Reality Labs, we expect operating losses to increase meaningfully year-over-year due to our ongoing product development efforts in AR/VR and our investments to further scale our ecosystem. Turning now to the capex outlook. We expect 2023 capital expenditures to be in the range of $27 billion to $29 billion, updated from our prior estimate of $27 billion to $30 billion. We anticipate our full-year 2024 capital expenditures will be in the range of $30 billion to $35 billion, with growth driven by investments in servers, including both non-AI and AI hardware, and in data centers as we ramp up construction on sites with the new data center architecture we announced late last year. On to tax. Absent any changes to US tax law, we expect our fourth quarter 2023 and full-year 2024 tax rates to be similar to the third quarter of 2023. Please note that our outlook for 2024 expenses, capital expenditures and tax rate are preliminary estimates. In the future, we expect to provide our forward -- our initial forward year expense, capex and tax rate outlooks on the fourth quarter call. In closing, this was a good quarter for our business as our efficiency efforts are translating into improved financial results and we’re seeing momentum across our company priorities. We’re excited to build on this work in 2024 as we invest in areas that have the potential to meaningfully transform how people engage with our services and each other in the years ahead. With that, Dave, let’s open up the call for questions.
Operator: [Operator Instructions] Your first question comes from the line of Brian Nowak with Morgan Stanley.
Brian Nowak: Great. Thanks for taking our questions. I have two. The first one, Mark, just wanted to ask you about the open source model strategy. You've been a leader in developing a lot of unique open source AI models. You've got some high-profile distribution partners now. How do you think about the strategic opportunity for Meta from the growing open source model adoption? And then the second one, Susan, just on the operating losses at Reality Labs. I understand there’s product development and efforts to scale the ecosystem. Can you help us understand or give us examples of expenditure going on within Reality Labs that could also be ported and used over at Family of Apps perhaps over time?
Mark Zuckerberg: Sure, okay. I can start with the AI models. We have a pretty long history of open sourcing parts of our infrastructure that are not kind of the direct product code. And a lot of the reason why we do this is because it increases adoption and creates a standard around the industry, which often drives forward innovation faster so we benefit, our products benefit, as well as there's more scrutiny on kind of security and safety-related things so we think that there's a benefit there. And sometimes, more companies running models or infrastructure can make it run more efficiently, which helps reduce our costs as well, which is something that we've seen with open compute. So I think there's a good chance that, that happens here over time. And obviously, our CapEx expenses are a big driver of our costs, so any aid in innovating on efficiency is sort of a big thing there. The other piece is just that over time with our AI efforts, we've tried to distinguish ourselves as being a place that does work that will be shared with the industry and that attracts a lot of the best people to come work here. So a lot of people want to go to the place to work where their work is going to touch most people. One way to do that is by building products that billions of people use. But if you're really a focused engineer or researcher in this area, you also want to build the thing that's going to be the standard for the industry. So I know that's pretty exciting and it helps us do leading work. While at the same time, a lot of the secret sauce that goes into our product has specific product logic on top of the model, and we're also able to further train the models with data that we have internally. So I think it's a good balance of improving the quality of what we do and improving the economics around it and improving recruiting while still enabling us to build a leading product.
Susan Li: And Brian, I'll go ahead and take your second question, which is on the operating losses at Reality Labs and whether there's any benefit to Family of Apps from some of that work. So first, I should clarify, the majority of our Reality Labs costs are direct costs in headcount, operating expenses and product costs for the Reality Labs work. The remainder of the Reality Labs total costs are indirect costs such as facilities that get allocated based on our estimate of their benefit to Reality Labs. Now, as you alluded to, Reality Labs is working to build the future of online interactions. And we do expect you'll see some interesting ways that translate into work with the Family of Apps in the near term. For example, with avatars, you've already seen 1 billion avatars created so far. We expect that this will become increasingly important across the Family of Apps. And we're also starting to see how our hardware can help create unique content for Facebook and Instagram today with our Ray-Ban Meta smart glasses making it easier to capture and share to Family of Apps, including live-streaming, and we think that will obviously create more engaging content for the content ecosystem. Longer term, obviously, we think there's a lot of value from operating our Family of Apps experiences on top of a new computing platform that we helped develop, for example, having glasses on that enable you to have our Meta AI assistant with you at all times. And as glasses scale, they'll make it increasingly easy to capture compelling content from a first person point of view while you're staying in the moment or the activity that you're doing and sharing that content should enrich our content ecosystems even further. But again, the operating losses that are occurring within the Reality Labs segment are really driven by the Reality Labs work directly. And we think that over the sort of arc of the years ahead, there will be increasing shared benefits to our Family of Apps experiences.
Operator: Your next question comes from the line of Eric Sheridan with Goldman Sachs.
Eric Sheridan: Thanks for taking the questions. Maybe on the business, I have two. One, when you see maybe a wider divergence than we thought in terms of some of the regional performance of the advertising businesses, anything to call out region by region in teams of either macroeconomic conditions or levels of product initiatives having been rolled out in different parts of the world that might led to a wider divergence in operating performance in the ad business across the globe would be number one? And then two, Susan, you introduced this concept a couple of quarters ago about data center architecture, and you said it's now being deployed in the way you're allocating capital into the business. Is there any update on how we should be thinking about that on a multiyear view in terms of achieving additional capital efficiencies and be able to deploy less CapEx but maybe with a higher throughput or output on those dollars spent? Thank you.
Susan Li: Thanks, Eric. So your first question, I think, was about regional trends or regional themes in our ad revenue, which as you saw this quarter accelerated across all regions. To give you a little bit of color, in North America, we saw accelerate by 7 points due primarily to strong demand from China advertisers. Note that North America didn't experience the same currency tailwinds that drove acceleration in year-over-year growth for the other regions. In the EU or in our EU region, we saw that accelerate 21 points. There was a broad-based acceleration in the region, including demand from China advertisers and some benefit from currency tailwinds after facing currency headwinds in Q2. Asia Pacific accelerated 9 points. We benefited from stronger demand in Southeast Asian countries, and again, the flip to currency tailwinds versus headwinds in Q2. Rest of World accelerated 20 points. We saw both stronger pricing and the same currency dynamic there. Brazil was a strong contributor to the region's acceleration due in part to increased advertisers' demand from China advertisers targeting users in Brazil. Your second question was around the impact of the new data center architecture on our CapEx investments in the years to come. We are still relatively early on this. We had to pause some of our existing data center construction work to switch over to the new data center architecture that played through in some of our 2023 CapEx dynamics. And going forward, as I think we said when we introduced the concept of this architecture, we expect it to be more cost efficient for us. We expect it will give us greater fungibility in the way that we plan for CPU and GPU capacity. So we expect that we'll be realizing the cost benefits and efficiencies and the planning flexibility that the architecture gives us in the years to come.
Operator: And your next question comes from the line of Mark Shmulik with Bernstein.
Mark Shmulik: Yes. Hi, thanks for taking the questions. The first is, this month, you started to roll out some of those first kind of gen AI tools for ad creative. I'd love to hear a little bit about kind of how that's going. Are advertisers using this? And really, is it creating better ads on their behalf? And then secondly, as we kind of look ahead here to the fourth quarter, there's certainly been a lot of unfortunate geopolitical kind of activity around the globe. Would love to just understand some color on how that affects kind of Meta's ad business. Thank you.
Susan Li: Hi, thanks, Mark. I can take both of those. So your first question was around gen AI tools, especially for advertisers and you'll see that we have been increasingly testing these in our AI sandbox. And then as they become more mature, we incorporate them into our ads manager directly. We've incorporated them into some of our Advantage+ solutions. A few that I would highlight that we're rolling out this quarter are text variations, so generating multiple versions of ad text based on an advertiser's original copy that helps highlight the selling points of their products and services, giving them multiple text options to better reach their audience. Another one is image expansion, which helps adjust creative assets to fit different aspect ratios across multiple services like Feed or Reels. That allows advertisers to spend less time themselves trying to repurpose their creative assets in these different formats. Another one is background generation, creating multiple backgrounds to complement the advertisers' product images, allowing advertisers to tailor their creative assets for different audiences. And we're making this available actually through Advantage+ catalog ads. And so we really feel like we've introduced quite a lot of new ads products and features. You asked about the gen AI one specifically. So those are the ones I highlighted. We've actually introduced a number of others that are related to other dimensions of the ad creation experience that we expect will help improve our advertising performance, will help advertisers drive sales, especially over the holidays and especially in the Advantage+ shopping suite. So we're very excited about all of those upcoming launches, and we think that the early advertiser feedback has been very positive. Your second question was on looking ahead in Q4 and the impact of some of the geopolitical activity that we've seen around the world and how that might be affecting our business. So first, I think I should start by saying that our thoughts are with everyone who has been impacted by the horrific violence in the Middle East, and we know that our services can be a vital tool for information and connection and expression at a moment like this. And we're continuing to monitor the situation and are doing everything we can to keep people safe and to keep our services secure. Now in terms of how this translates into impact on the Q4 business, first of all, I should say that coming into Q4, we've been seeing continued strong advertiser demand in key segments, including online commerce and gaming. But having said that, we are also seeing more volatility at the start of the quarter. That's in part why we widened our guidance range to capture that uncertainty. And so for instance, while we don't have material direct revenue exposure to Israel and the Middle East, we have observed softer ad spend in the beginning of the fourth quarter, correlating with the start of the conflict, which is captured in our Q4 revenue outlook. It's hard for us to attribute demand softness directly to any specific geopolitical event. Historically, we have seen broader demand softness follow other regional conflicts in the past such as in the Ukraine war. So this is something that we're continuing to monitor. We've reflected the latest trends and advertiser reaction that we've seen into our Q4 outlook, which again, we think, reflects the greater uncertainty and volatility in the landscape ahead. I want to add here, too, that we are pleased with the fundamentals of the business and with our execution. We've seen promising engagement trends. We're continuing to drive ad performance improvements. We're executing well on our company priorities. So we'll continue to stay focused in those areas, and we'll also remain disciplined with our investment approach as we navigate a volatile environment.
Operator: Your next question comes from the line of Doug Anmuth with JPMorgan.
Doug Anmuth: Thanks for taking the questions. One for Mark and one for Susan. Mark, I was hoping you could talk more about the gen AI-driven vertical chatbots and Meta AI assistant rolled out of Connect a few weeks ago. How do you think about the potential for these products to improve both engagement and monetization over time? And then Susan, I know it's early but I was hoping you could talk a little bit qualitatively about some of the puts and takes to 2024 revenue growth. And then in particular, whether you'd expect revenue to grow faster than expenses off a normalized revenue base backing out restructuring? Thanks.
Mark Zuckerberg: Sure. I could talk about some of the AI launches first. We launched Meta AI, which is sort of an AI assistant that you can ask different questions and get access to real-time information as well as generating images. And we also launched the first version of AI Studio with several initial AI characters that you can interact with. And part of the idea here is that we think that having a basic assistant is really important, but we think that people are going to -- there are going to be lots of different AIs that people interact with. We think ultimately, most creators are going to want one to help grow and engage their community. We think most businesses are going to want one to help support their customers and help drive commerce. So we think that there are going to be a lot of different AIs. In terms of engagement, the first order effect is, I think at scale, I think that this is going to be one of the ways that people use our messaging apps and communicate with, and you're going to talk to people and you'll talk to AIs. What the mix of that is, I think, will kind of shift over time and I don't think anyone can really predict that. But this is a new use case that doesn't take away from people interacting with people. If anything, it should -- we're designing these to make it so that they can help facilitate and encourage interactions between people and make things more fun by making it so you can drop in some of these AIs into group chats and things like that just to make the experiences more engaging. So this should be incremental and create additional engagement. The AIs also have profiles in Instagram and Facebook and can produce content, and over time, going to be able to interact with each other. And I think that's going to be an interesting dynamic and an interesting, almost a new kind of medium and art form. So I think that will be an interesting vector for increasing engagement and entertainment as well. So I'm excited about that. Of course, whenever there's more engagement in the apps, that creates the opportunity for more monetization, so there's that on the monetization side. And then the other big opportunity on monetization, which I talked about upfront is just business messaging. One of the big things that I think is a key unlock for making the business messaging -- for making that business model work around the globe is effectively making it so that businesses in countries where there's a higher cost of labor can have an AI that can respond to messages from people so that way, it's not cost prohibitive for them to engage in that type of interaction with customers. So I think that if we can -- as we are able to roll out the business AIs, I think that, that can really unlock and grow the business -- messaging business in a big way, but we have a lot of work to do to get there. So that's kind of a basic view on how I think this will affect the engagement in business.
Susan Li: I'm happy to take the second question. Thanks, Doug. We obviously have not shared a 2024 revenue outlook yet. You asked about what are some of the significant puts and takes, and I'd maybe point back to what I said earlier about the Q4 outlook just to highlight what a volatile macro environment we believe we're in. I think that will obviously have a big impact on the advertising market next year, and it's something we'll be keeping a very close eye on. But ultimately, we're very subject to volatility in the macro landscape. Certainly, our own ads performance is an area where we have invested a lot, and we've seen a lot of increased value that we've been driving for marketers. We've been increasing the conversions we deliver, higher -- and offering higher return on their ad spend so we think that will be an important factor. We're continuing to enroll a lot of new features, both gen AI and not in our ads tool, and we're continuing to improve the ranking and delivery models that underlie our ads infrastructure. We'll also be obviously lapping stronger periods, especially in -- as you saw with this quarter's results. So all of those factors, I think, will play into the 2024 revenue outlook. You also asked about the kind of the expense philosophy next year, whether expense growth will be tied to revenue growth. Obviously, the revenue outlook is uncertain. We talked a little bit about the -- what's going into the preliminary expense guide for 2024. The big components there are around infrastructure expenses. We do expect, given the increased capital investments that we have made in recent years, that depreciation expenses in 2024 will increase by a larger amount than in 2023. And we expect to incur higher operating costs from running a larger infrastructure footprint. The second big driver is on payroll. We anticipate payroll growth driven by the spillover of hiring that we had intended for 2023 into 2024. And we do expect that Family of Apps will be a larger source of payroll expense growth than Reality Labs in 2024. Additionally, hiring will generally be concentrated in technical roles, which will continue to shift our workforce composition towards a higher cost basis. And of course, the final piece being Reality Labs operating losses, which we expect to increase in 2024 across both the expense growth from higher payroll costs as well as higher non-headcount cost to support the development of our next-gen VR and AR products. How the expense and revenue outlook come together? Obviously, that's -- as we get more information on the revenue outlook for next year, that will influence that. Ultimately, we have talked about the framework that we introduced in the past. We recognize that we have very ambitious investments on the horizon, including over a long-time horizon with our Reality Labs work and newer, equally ambitious investments we've added in the gen AI road map more recently. And we recognize that we have to earn the ability to invest in all of those things by delivering consolidated operating income growth over time. So that's something we're very much focused on.
Operator: Your next question comes from the line of Justin Post with Bank of America Merrill Lynch.
Justin Post: Great. Thank you. I guess I'll ask about the DSA and DMA and also press reports that there could be a subscription offering in Europe. Maybe, Mark, how do you think about subscription usage for Facebook? Maybe an update on how Meta Verified is going and how you're thinking about the evolution of the model in Europe. Maybe we'll start with that. And then for Susan, I know you've talked a lot about Chinese advertisers. How do you think that could affect the growth as you comp that next year? Thanks a lot.
Susan Li: Hi, Justin. Thank you for the question. I think there are multiple parts there and I will do my best to address all of them, but of course, let me know if I miss anything. So the first question was sort of around operating in Europe, in particular, the legal basis for ads. So as we announced in August, we intend to evolve our legal basis for processing personal data for ads to a consent model in the EU, the EEA in Switzerland, given the recent regulatory developments in those regions. We don't have any further details to share on the exact implementation at this time. We're continuing to engage with the DPC and other regulatory authorities on our proposed consent model, but we're committed to making this move as soon as possible, and we will provide an update when we have it. The second question you asked was about Meta Verified. So we're still, I think, quite early here but we've rolled out Meta Verified for creators to most markets globally. We continue to hear positive feedback from creators as we've helped them more easily establish their presence on Facebook and Instagram. We also have recently begun testing Meta Verified for businesses on Facebook and Instagram in select countries, and we have plans to expand that to businesses on WhatsApp in the future. And this will allow businesses to more easily stand out on our apps and build confidence with their customers and let their customers know that they're chatting with the right business. So we're encouraged by the early signs that we're seeing there, but again, very early and not a lot more to share right now. The third part of your question was around Chinese advertisers. So spend from Chinese advertisers further accelerated for us in Q3. We have benefited from strong investments from a few of our larger clients. We've also seen generally broader-based strength from other China advertisers, and we believe factors such as lower shipping costs and easing regulations on the gaming industry have served as tailwinds here. But I think there has been a broader story of improved growth across all advertiser regions in Q3, and even excluding China advertisers, revenue growth has accelerated nicely. And you kind of alluded to whether there's -- the sustainability of the China advertising revenue. And even though we've seen particularly strong growth this year, I would say that there has been a longer-term trend of overall growth with this segment dating back to past years and also periods of volatility in the past, like in the last two years, we've seen periods with higher shipping costs with lockdowns, with regulation weighing on demand. So we recognize there's the potential for volatility in the future as well and especially given that there are so many macro factors at play that are quite hard to predict. Operator Your next question comes from the line of Youssef Squali with Truist.
Youssef Squali: Thank you very much. Two quick questions for me. First, can you share any early read into demand for Quest 3? It's been out for 10 days but I think you've been taking orders from these last three weeks? And is it priced to be at least gross profit breakeven or not necessarily? And then second, Susan, for 2024 as we think about growth, can you speak maybe about political spend contribution that you've had back in 2020 and how that may inform how we should think about its contribution for 2024? Thank you.
Susan Li: Sure. So the first part of your question was early sort of signals with Quest 3. We are not sharing any explicit expectations for Quest 3, either Q4 Reality Labs revenue, unit sales, et cetera. But we are very excited to have Quest 3 in market, in particular, during the holiday shopping period. We think early reviews have been great. And we're very excited to have a product out there that are going to introduce a lot of people to mixed reality experiences for the first time. So it's very early. I think we don't have very many more specifics. But again, we're quite excited to have it in the market and to have it in particular during the holiday marketing season. Your second question was about political spend. And so this is a place where I would say we saw acceleration of positive year-over-year growth in all verticals this quarter really except politics, which is lapping the lead-up to the 2022 US midterms last year. So I will say though that this is also just a very small vertical for us so there's not too much more to add there.
Ken Dorell: Dave, we have time for one last question.
Operator: Certainly. Thank you. That will come from the line of Ross Sandler with Barclays.
Ross Sandler: Great. Hey, Mark, just going back to the AI agent theme. I know it's early but how would you rank the overall strategy here around these AI agents and AI Studio compared to other big initiatives that Meta has made in FoA over the years? Is this bigger than or as big as the Stories transition or the Reels transition? And any thoughts just kind of high level on that? And then the cost of serving up responses, especially stickers and images is a little bit more expensive than your core business of aggregating the News Feed. So how much more expensive, I guess, is the question? And are there things you can do to bring that cost down? Thanks a lot.
Mark Zuckerberg: Yeah, sure. In terms of how big this is going to be, it's hard to predict because I don't think that anyone has built what we're building here. I mean, there's some analogy is like what OpenAI is doing with ChatGPT, but that's pretty different from what we're trying to do. Maybe the Meta AI part of what we're doing overlaps with the type of work that they're doing, but the AI characters piece, there's a consumer part of that, there's a business part, there's a creators part. I'm just not sure that anyone else is doing this. And when we're working on things like Stories and Reels, there were some market precedents before that. Here, there's technology which is extremely exciting. But I think part of what leading in an area and developing a new thing means is you don't quite know how big it's going to be. But what I predict is that I do think that the fundamental technology around Generative AI is going to transform meaningfully how people use each of the different apps that we build. I think for the Feed apps, I think that over time, more of the content that people consume is going to be either generated or edited by AI. Some of it will be creators will now have all these tools to make content more easily and more fun. And I think over time, maybe we'll even get to the point where we can just generate content directly for people based on what they might be interested in. I think that, that could be really compelling. On the messaging side, I think that the way that we're looking at these AIs kind of ties into that directly where you'll be able to message with Meta AI or any of these different AIs for whether it's for fun, you have a question about something, you want to help doing something, you want to play a game or you want to message with a business for commerce or you want to engage with your favorite creator and they wouldn't normally otherwise have time to message you back, but now they have an AI representing them that can. I think that will accrue to kind of to messaging behavior. It's going to change advertising in a big way. It's going to make it so much easier to run ads. Businesses that basically before would have had to create their own creative or images now won't have to do that. They'll be able to test more versions of creative, whether it's images or eventually video or text. That's really exciting, especially when paired with the recommendation AI. On the hardware side, I mean, obviously, the smart glasses that we just rolled out, we sort of thought were a precursor to eventually getting to displays and holograms for augmented reality, and I think we will eventually get there still. It's not that far off. But I think that now the ability to deliver AI through smart glasses may end up being a killer use case for that even before you get to the kind of augmented reality type of use cases. So I think you're basically seeing that there are going to be -- this is a very broad and exciting technology. And frankly, I think that this is partially why working in the technology industry is so awesome, right, is that every once in a while, something comes along like this, that like changes everything and just makes everything a lot better and your ability to just be creative and kind of rethink the things that you're doing to be better for all the people you serve. I mean, I just think that's a lot of what is energizing and fun around building companies like this. But yes, it's hard sitting here now to be able to predict like the metrics are going to be around, like what's the balance of messaging between AIs and people or what the balance and Feeds between AI content and people content or anything like that. But I mean, I'm highly confident that this is going to be a thing and I think it's worth investing in. To the question about efficiency and costs, I think initially, it's most important to focus on getting to product market fit. And we obviously care a lot about efficiency, right? I mean, the CapEx costs for our company are very significant, and it's one of the main things that weighs on the economic model of the company. So on the one hand, as we can improve the efficiency, we're able to do things like train bigger models and serve more people, which currently, right now, we're going to be bottlenecked on based on the amount of infrastructure that we have as this gets to the scales that we aspire to get to. So in the near term, the efficiency wins will primarily just be to deliver better products to more people. But over time, we're going to continue working on that. And I think we've been able to do pretty good work on efficiency on our hardware and compute. And over the long term, once we kind of have more of an understanding about what these products want to be, then we'll be able to drive the economic model based on that. But we'll work on that all throughout, but I think we're still in the pretty early part of that curve.
Ken Dorell: Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again soon.
Operator: This concludes today's conference call. Thank you for joining us. You may now disconnect your lines. |
MSFT | 1 | 2,024 | 2023-10-24 22:14:03 | Operator: Greetings, and welcome to the Microsoft Fiscal Year 2024 First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to your host, Brett Iversen, Vice President of Investor Relations. Mr. Iversen, please go ahead.
Brett Iversen: Good afternoon, and thank you for joining us today. On the call with me are Satya Nadella, Chairman and Chief Executive Officer; Amy Hood, Chief Financial Officer; Alice Jolla, Chief Accounting Officer; and Keith Dolliver, Corporate Secretary and Deputy General Counsel. On the Microsoft Investor Relations website, you can find our earnings press release and financial summary slide deck, which is intended to supplement our prepared remarks during today's call, and provides the reconciliation of differences between GAAP and non-GAAP financial measures. More detailed outlook slides will be available on the Microsoft Investor Relations website when we provide outlook commentary on today's call. Microsoft, completed the acquisition of Activision Blizzard, on October 13, 2023. We will share more on the expected impact of the Activision acquisition during the outlook commentary portion of today's call. On this call we will discuss certain non-GAAP items. The non-GAAP financial measures provided should not be considered as a substitute for or superior to the measures of financial performance prepared in accordance with GAAP. They are included as additional clarifying items to aid investors in further understanding the company's first-quarter performance, in addition to the impact these items and events have on the financial results. All growth comparisons we make on the call today, relate to the corresponding period of last year unless otherwise noted. We'll also provide growth rates in constant currency when available as a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations. Where growth rates are the same in constant currency, we will refer to the growth rate only. We will post our prepared remarks to our website immediately following the call until the complete transcript is available. Today's call is being webcast live and recorded. If you ask a question, it will be included in our live transmission in the transcript and in any future use of the recording. You can replay the call and view the transcript on the Microsoft Investor Relations website. During this call, we'll be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in today's earnings press release, in the comments made during this conference call, and in the Risk Factors section of our Form 10-K, Form 10-Q, and other reports and filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. And with that, I'll turn the call over to Satya.
Satya Nadella: Thank you, Brett. We are off to a strong start to the fiscal year, driven by the continued strength in Microsoft Cloud, which surpassed $31.8 billion in quarterly revenue, up 24%. With Copilots, we are making the age of AI real for people and businesses everywhere. We are rapidly infusing AI across every layer of the tech stack, and for every role and business process to drive productivity gains for our customers. Now I'll highlight examples of our progress starting with infrastructure. Azure again took share as organizations bring their workloads to our cloud. We have the most comprehensive cloud footprint with more than 60 data center regions worldwide, as well as, the best AI infrastructure for both training and inference. And we also have our AI services deployed in more regions, than any other cloud provider. This quarter, we announced the general availability of our next-generation H100 Virtual Machines. Azure AI provides access to best-in-class frontier models from OpenAI and open-source models, including our own, as well as from Meta and Hugging Face, which customers can use to build their own AI apps while meeting specific cost latency, and performance needs. Because of our overall differentiation more than 18,000 organizations now use Azure OpenAI services, including new to Azure customers. And we are expanding our reach with digital-first companies with OpenAI APIs as leading AI start-ups use OpenAI to power their AI solutions, therefore, making them Azure customers as well. We continue to see more cloud migrations with Azure Arc. We're meeting customers where they are, helping them run apps across on-prem edge and multi-cloud environments. We now have 21,000 Arc customers up 140% year-over-year. We are the only other cloud provider to run Oracle's database services, making it simpler for customers to migrate their on-prem Oracle databases to our cloud. Customers like PepsiCo and Vodafone will have access to a seamless fully integrated experience for deploying, managing, and using Oracle database instances on Azure. And we are the cloud of choice for customers' SAP workloads too. Companies like Brother Industries, Hanes, ZEISS, and ZF Group all run SAP on Azure. Now on to data, in the age of Copilots, organizations are looking to consolidate their data estate, that's why with our Microsoft Intelligent Data Platform, we are bringing together operational data stores, analytics, and governance. More than 73% of the Fortune 1000 use three or more of our data solutions today. And with Microsoft Fabric, we are unifying compute, storage, and governance into one end-to-end analytical solution with an all-inclusive business model. More than 16,000 customers are actively using Fabric, including over 50% of the Fortune 500. Now on to developers. With GitHub Copilot, we are increasing developer productivity by up to 55%, while helping them stay in the flow and bringing the joy back to coding. We have over 1 million paid Copilot users and more than 37,000 organizations have subscribed to Copilot for business, up 40% quarter-over-quarter with significant traction outside the United States. This quarter we added new capabilities with GitHub Copilot Chat, which are already being used by both digital natives like Shopify, as well as, leading enterprises like Maersk and PwC to supercharge the productivity of their software developers. All up, the number of developers using GitHub has increased 4x since our acquisition five years ago. We've also brought Copilot to Power Platform, enabling anyone to use natural language to create apps, build virtual agents and analyze data. More than 126,000 organizations, including 3M, Equinor, Lumen Technologies, Nationwide, PG&E, and Toyota have all used Copilot in Power Platform to date. EY for example has enabled Copilot for all 170,000 plus Power Platform users at the company. And this quarter we added new Copilot capabilities to Power Pages making it possible to build a data-driven website using just a few sentences or clicks. Finally, Power Apps remains the market leader and low-code no-code development, now with 20 million monthly active users, up 40% year-over-year. Now on to business applications, all-up Dynamics 365 took share for the 10th consecutive quarter. We're using this AI inflection point to redefine our role in business applications. We are becoming the Copilot-led business process transformation layer on top of existing CRM systems like Salesforce. For example, our Sales Copilot help sellers that more than 15,000 organizations including Rockwell Automation, Sandvik Coromant, Securitas, and Teleperformance, personalize customer interactions based on data from third-party CRMs. We're also bringing Copilot to Dynamics 365 to help with everything from suggested actions and content ideas, to faster access to valuable business data. And this quarter, we introduced Copilot in Dynamics 365 Field Service, to help streamline frontline tasks. Now on to industry and cross-industry clouds. In healthcare, our Dragon Ambient eXperience solution helps clinicians automatically document patient interactions at the point of care. It's been used across more than 10 million interactions to date. And with DAX Copilot, we are applying generative AI models to draft high-quality clinical notes in seconds, increasing physician productivity and reducing burnout. For example, Atrium Health, a leading provider in Southeast United States credits DAX Copilot with helping its physicians each save up to 40 minutes per day in documentation time. We are also introducing healthcare data solutions in Microsoft Fabric, enabling providers like Northwestern Medicine and SingHealth to unify health data in a secure, compliant way. And with our Microsoft Cloud for sovereignty, which will become generally available by the end of the calendar year, we offer industry-leading data sovereignty and encryption controls, meeting the specific needs of public sector customers around the world. Now on to the future of work. Copilot is your everyday AI assistant, helping you be more creative in Word, more analytical in Excel, more expressive in PowerPoint, more productive in Outlook, and more collaborative in Teams. Tens of thousands of employees at customers like Bayer, KPMG, Mayo Clinic, Suncorp, and Visa, including 40% of the Fortune 100, are using Copilot as part of our early access program. Customers tell us that once they use Copilot, they can't imagine work without it and we are excited to make it generally available for enterprise customers next week. This quarter, we also introduced a new hero experience in Copilot, helping employees tap into their entire universe of work, data, and knowledge using chat (ph). And the new Copilot Lab helps employees build new work habits for this era of AI, by helping them turn good prompts into great ones. When it comes to Teams, usage continues to grow with more than 320 million monthly active users, making Teams the place to work across chat, collaboration, meetings, and calling. This quarter, we introduced a new version of Teams that is up to 2 times faster, while using 50% less memory and includes seamless cross-tenant communications and collaboration. We've seen nine consecutive quarters of triple-digit revenue growth for Teams Rooms, and more than 10,000 paid customers now use Teams Premium. Teams has also become a multiplayer canvas for business process. There are more than 2,000 apps in Teams Store, and collaborative apps from Adobe, Atlassian and Workday, each exceeded 1 million monthly active users on Teams. And with Viva, we have created a new market category for employee experience, helping companies like Dell, Lloyds Banking Group, and PayPal build high-performance organizations. With skills in Viva, we're bringing together information from Microsoft 365 and LinkedIn to help employers understand workforce gaps, and suggest personalized learning content to address it, all in the flow of work. All up, we continue to see more organizations choose Microsoft 365, and companies across the private and public sectors including Cerberus, Chanel, and DXC Technology, all rely on our Premium E5 offerings for advanced security compliance, voice, and analytics. Now on to Windows, the PC market unit volumes were at roughly pre-pandemic levels and we continue to innovate across Windows, adding differentiated AI-powered experiences to the operating system. We rolled out the biggest update to Windows 11 ever adding 150 new features including new AI-powered experiences in apps, like, Clipchamp, Paint, and Photos, and we introduced Copilot in Windows, the Everyday AI companion, which incorporates the context to the web, your work data and what you are doing on the PC to provide better assistance. We are seeing accelerated Windows 11 deployments worldwide from companies like BP, Eurowings, Kantar, and RBC. Finally, with Windows 365 Boot and Switch, we're making it easier than ever for employees at companies like Crocs, Hamburg Commercial Bank, the ING Bank to get a personalized Windows 365 Cloud PC with Copilot on any device. Now on to security. The speed, scale, and sophistication of cyberattacks today is unparalleled and security is the number one priority for CIOs worldwide. We see high-demand for Security Copilot, the industry's first and most advanced generative AI product, which is now seamlessly integrated with Microsoft 365 Defender. Dozens of organizations including Bridgewater, Fidelity National Financial, and Government of Alberta have been using Copilot in Preview, and early feedback has been positive. And we look forward to bringing Copilot to hundreds of organizations in the coming months as part of the new early access program, so they can improve the productivity of their own, security operation centers and stop threats at machine speeds. More broadly, we continue to take share across all major categories we serve, and our SIEM, Microsoft Sentinel now has more than 25,000 customers in revenue, surpassed $1 billion annual run-rate, and customers in every industry like Booz Allen Hamilton, Grant Thornton and MetLife use our end-to-end solutions to protect their environments. Now on to LinkedIn. We are now applying this new generation of AI to transform how the 985 million members learn, sell and get hired. Membership growth has now accelerated each quarter for over two years in a row. This quarter, we introduced new AI-driven features across all of our businesses, including our learning coach that gives members personalized content guidelines, and tools to help employers find qualified candidates and sellers and marketers attract buyers in a single step. Since introducing AI-assisted messages for recruiters five months ago, three-fourths of them say, it saved them time. And we have seen a nearly 80% increase in members watching AI-related learning courses this quarter. More broadly, we continue to see record engagement and knowledge sharing on the platform. We now have more than 450 million newsletter subscriptions globally, up 3x year-over-year. Premium subscription sign-ups were up 55% year-over-year and our hiring business took share for the fifth consecutive quarter. Now on to search, advertising, and news. With our Copilot for the Web, we are redefining how people use the Internet to search and create. Bing users have engaged in more than 1.9 billion chats, and Microsoft Edge has now gained share for 10 consecutive quarters. This quarter, we introduced new personalized answers, as well as, support for DALL-E 3, helping people get more relevant answers and to create incredibly realistic images with more than 1.8 billion images have been created to-date. And with our Copilot and Shopping, people can find more tailored recommendations and better deals. We're also expanding to new endpoints, bringing Bing to Meta's AI chat experience in order to provide more up-to-date answers, as well as access to real-time search information. Finally, we are integrating this new generation of AI directly into our ad platforms to more effectively connect marketeers to customer intent in chat experiences, both from us as well as customers like Axel Springer and Snap. Now on to gaming. We were delighted to close our acquisition of Activision Blizzard King earlier this month. Together, we will advance our goal of bringing great games to players everywhere on any endpoint. Already with Game Pass, we're redefining how games are distributed, played, and discovered. We set a record for hours played per subscriber this quarter. We released Starfield this quarter to broader acclaim, more than 11 million people have played the game to date. Nearly half of the hours played have been on PC and on launch day, we set a record for the most Game Pass subscriptions added on a single day ever. Minecraft has now surpassed 300 million copies sold, and with Activision Blizzard King, we now adds significant depth to our content portfolio. We will have $13 billion-plus franchises from Candy Crush, Diablo, and Halo to Warcraft, Elder Scrolls and Gears of War. And we're looking forward to one of our strongest first-party holiday lineups ever, including new titles like Call of Duty: Modern Warfare 3 and Forza Motorsport. In closing, we are rapidly innovating to expand our opportunity across our consumer and commercial businesses, as we help our customers thrive in this new era. In just a few weeks, we'll be holding our flagship Ignite Conference, where we will introduce more than 100 new products and capabilities, including exciting new AI innovations. I encourage you to tune in. With that, I'll turn it over to Amy.
Amy Hood: Thank you, Satya, and good afternoon, everyone. This quarter's revenue was $56.5 billion, up 13% and 12% in constant currency. Earnings per share was $2.99 and increased 27% and 26% in constant currency. Consistent execution by our sales teams and partners drove a strong start to the fiscal year. Results exceeded expectations and we saw share gains again this quarter across many businesses, as customers adopt our innovative solutions to transform their businesses. In our commercial business, the trends from the prior quarter continued. We saw healthy renewals, particularly in Microsoft 365 E5 and growth of new business continued to be moderated for standalone products sold outside the Microsoft 365 suite. In Azure, as expected the optimization trends were similar to Q4. Higher-than-expected AI consumption contributed to revenue growth in Azure. And our consumer business, PC market unit volumes are returning to pre-pandemic levels. Advertising spend, landed roughly in line with our expectations and in gaming strong engagement helped by the Starfield launch benefited Xbox content and services. Commercial bookings increased 14% and 17% in constant currency, in line with expectations, primarily driven by strong execution across our core annuity sales motions, with continued growth in the number of $10 million plus contracts for both Azure and Microsoft 365. Commercial remaining performance obligation, increased 18% to $212 billion, and roughly 45% will be recognized in revenue in the next 12 months, up 15% year-over-year. The remaining portion, which will be recognized beyond the next 12 months increased 20% and this quarter, our annuity mix was 96%. FX did not have a significant impact on our results and was roughly in line with our expectations on total company revenue, segment-level revenue, COGS, and operating expense growth. Microsoft Cloud revenue was $31.8 billion and grew 24% and 23% in constant currency, ahead of expectations. Microsoft Cloud's gross margin percentage increased slightly year-over-year to 73%, a point better than expected, primarily driven by improvements in Azure. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud's gross margin percentage increased roughly 2 points, driven by the improvement just mentioned in Azure as well as Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. Company gross margin dollars increased 16% and 15% in constant currency and gross margin percentage increased year-over-year to 71%. Excluding the impact of the change in accounting estimate, the gross margin percentage increased roughly 3 points, driven by the improvement in Azure and Office 365 as well as sales mix shift to higher margin businesses. Operating expenses increased 1%, lower than expected due to cost-efficiency focus as well as investments that shifted to future quarters. Operating expense growth was driven by marketing, LinkedIn, and cloud engineering, partially offset by devices. At a total company level, headcount at the end of September was 7% lower than a year ago. Operating income increased 25% and 24% in constant currency. Operating margins increased roughly 5 points year-over-year to 48%. Excluding the impact of the change in accounting estimate, operating margins increased roughly 6 six points, driven by improved operating leverage through cost management and the higher gross margin noted earlier. Now to our segment results. Revenue from Productivity and Business Processes was $18.6 billion and grew 13% and 12% in constant currency, ahead of expectations, driven by better-than-expected results in Office 365 Commercial and LinkedIn. Office Commercial revenue grew 15% and 14% in constant currency. Office 365 Commercial revenue increased 18% and 17% in constant currency, slightly better than expected with a bit more in-period revenue recognition, while billings remained relatively in line with expectations. Growth continues to be driven by healthy renewal execution and ARPU growth, as E5 momentum remains strong. Paid Office 365 Commercial seats grew 10% year-over-year, with installed-base expansion across all customer segments. Seat growth was again driven by our small and medium business and frontline worker offerings with continued impact from the growth trends in new standalone business noted earlier. Office Commercial licensing declined 17%, in line with the continued customer shift to cloud offerings. Office Consumer revenue increased 3% and 4% in constant currency with continued momentum in Microsoft 365 subscriptions, which grew 18% to 76.7 million. LinkedIn revenue increased 8%, ahead of expectations, driven by slightly better-than-expected performance across all businesses. Growth was driven by Talent Solutions, though we continue to see negative year-over-year bookings there from the weaker hiring environment in key verticals. Dynamics revenue, grew 22% and 21% in constant currency, driven by Dynamics 365, which grew 28% and 26% in constant currency with continued growth across all workloads. Segment gross margin dollars increased 13% and gross margin percentage increased slightly year-over-year. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly, 1 point, driven by improvements in Office 365. Operating expenses increased to 2% and operating income increased 20% and 19% in constant currency. Next, the Intelligent Cloud segment. Revenue was $24.3 billion, increasing 19% and ahead of expectations, with better-than-expected results across all businesses. Overall, server products and cloud services revenue grew 21%. Azure and other cloud services revenue grew 29% and 28% in constant currency, including roughly 3 points from AI Services. While the trends from prior quarter continued, growth was ahead of expectations, primarily driven by increased GPU capacity and better-than-expected GPU utilization of our AI services, as well as slightly higher-than-expected growth in our per-user business. In our per user business, the enterprise mobility and security installed base, grew 11% to over 259 million seats with continued impact from the growth trends in new standalone business noted earlier. In our on-premises server business, revenue increased 2% ahead of expectations, driven primarily by demand in advance of Windows Server 2012 end of support. Enterprise and partner services revenue increased 1% and was relatively unchanged in constant currency ahead of expectations, driven by a better-than-expected performance in Enterprise Support Services. Segment gross margin dollars increased 20% and 19% in constant currency and gross margin percentage increased slightly. Excluding the impact of the change in accounting estimate, gross margin percentage increased roughly 2 points, driven by the improvement in Azure noted earlier, even as we scale our AI infrastructure to meet growing demand. Operating expenses increased 2% and 1% in constant currency, operating income grew 31% and 30% in constant currency. Now to More Personal Computing, revenue was $13.7 billion, increasing 3% and 2% in constant currency, above expectations, with better-than-expected results across all businesses. Windows OEM revenue increased 4% year-over-year, significantly ahead of expectations, driven by stronger-than-expected consumer channel inventory builds and the stabilizing PC market demand noted earlier, particularly in commercial. Windows Commercial products and cloud services revenue increased 8%, driven by demand for Microsoft 365 E5. Devices revenue decreased 22%, ahead of expectations due to stronger execution in the commercial segment. Search and news advertising revenue, ex-TAC increased 10% and 9% in constant currency, slightly ahead of expectations. We saw increased engagement on Bing and Edge share gains again this quarter, although search revenue growth continues to be impacted by a third-party partnership. And in gaming, revenue increased 9% and 8% in constant currency, ahead of expectations, driven by better-than-expected subscriber growth in Xbox Game Pass as well as first-party content, primarily due to the Starfield launch. Xbox content and services revenue increased 13% and 12% in constant currency and Xbox hardware revenue declined 7% and 8% in constant currency. Segment gross margin dollars increased 13% and 12% in constant currency, and gross margin percentage increased roughly 5 points year-over-year, driven primarily by sales mix-shift to higher-margin businesses. Operating expenses declined 1% and operating income increased 23% and 22% in constant currency. Now back to total company results. Capital expenditures, including finance leases were $11.2 billion to support cloud demand, including investments to scale our AI infrastructure. Cash paid for PP&E was $9.9 billion. Cash flow from operations was $30.6 billion, up 32% year-over-year, driven by strong cloud billings and collections. Free cash flow was $20.7 billion, up 22% year-over-year. This quarter, other income and expense was $389 million, higher-than-anticipated, driven by interest income, partially offset by net losses on investments and foreign currency remeasurement. Our effective tax rate was approximately 18%. And finally, we returned $9.1 billion to shareholders, through share repurchases and dividends. Now moving to our Q2 outlook, which unless specifically noted otherwise is on a U.S. dollar basis. The Activision acquisition closed on October 13. So my commentary includes the net impact of the deal from the date of acquisition. Our outlook includes purchase accounting impact, integration, and transaction-related expenses based on our current understanding of the purchase price allocation and related deal accounting. The net impact includes adjusting for the movement of Activision content from our prior relationship as a third-party partner to first party. Now to FX. Based on current rates, we expect FX to increase total revenue and segment-level revenue growth by approximately 1 point. We expect FX to have no impact to COGS and operating expense growth. In commercial bookings, we expect consistent execution across our core annuity sales motions, including healthy renewals. The growth will be impacted by a low growth expiry base. Therefore, we expect bookings growth to be relatively flat. Microsoft Cloud gross margin percentage to be relatively flat year-over-year, excluding the impact from the accounting estimate change, Q2 Cloud gross margin percentage will be up roughly 1 point, primarily driven by improvement in Azure and Office 365, partially offset by the impact of scaling our AI infrastructure to meet growing demand. We expect capital expenditures to increase sequentially on a dollar basis, driven by investments in our cloud and AI infrastructure. As a reminder, there can be normal quarterly spend variability in the timing of our cloud infrastructure buildout. Next to segment guidance. In Productivity and Business Processes, we expect revenue to grow between 11% and 12% or $18.8 billion to $19.1 billion. Growth in constant currency will be approximately 1 point lower. In Office Commercial, revenue growth will again be driven by Office 365 with seat growth across customer segments and ARPU growth through E5. We expect Office 365 revenue growth to be up roughly 16% in constant currency. We're excited for Microsoft 365 Copilot general availability on November 1st, and expect the related revenue to grow gradually over time. In our on-premise business, we expect revenue to decline in the mid-to-high teens. In Office Consumer, we expect revenue growth in the mid-single-digits, driven by Microsoft 365 subscriptions. For LinkedIn, we expect revenue growth in the mid-single-digits, driven by Talent Solutions and Marketing Solutions. Growth continues to be impacted by the overall market environment for recruiting and advertising, especially in the technology industry, where we have significant exposure. And in Dynamics, we expect revenue growth in the high teens, driven by Dynamics 365. For Intelligent Cloud, we expect revenue to grow between 17% and 18% or $25.1 billion to $25.4 billion. Revenue growth in constant currency will be approximately 1 point lower. Revenue will continue to be driven by Azure, which as a reminder can have quarterly variability, primarily from our per-user business and from in-period revenue recognition, depending on the mix of contracts. In Azure, we expect revenue growth to be 26% to 27% in constant currency, with an increasing contribution from AI. Growth continues to be driven by Azure consumption business and we expect the trends from Q1 to continue into Q2. Our per user business should continue to benefit from Microsoft 365 suite momentum, though we expect continued moderation in seat growth rates, given the size of the installed base. For H2, assuming the optimization and new workload trends continue and with the growing contribution from AI, we expect Azure revenue growth in constant currency to remain roughly stable compared to Q2. And our on-premises server business, we expect revenue growth to be roughly flat with continued hybrid demand, particularly from licenses running in multi-cloud environments. And in enterprise and partner services, revenue should decline by low-to-mid single digits. Now to more Personal Computing, which includes the net impact from the Activision acquisition. We expect revenue of $16.5 billion to $16.9 billion. Windows OEM revenue growth should be mid-to-high single digits with PC market unit volumes expected to look roughly similar to Q1. In devices, revenue should decline in the mid-teens as we continue to focus on our higher-margin premium products. In Windows Commercial products and cloud services, customer demand for Microsoft 365 and our advanced security solutions should drive revenue growth in the low-to-mid teens. Search and news advertising ex-TAC revenue growth should be mid-single digits with roughly 4 points of negative impact from a third-party partnership. Growth should be driven by volume strength, supported by Edge browser share gains and increasing Bing engagement, as we expect the advertising spend environment to be similar to Q1. A reminder that this ex-TAC growth will be roughly 4 points higher than overall search and news advertising revenue. And in gaming, we expect revenue growth in the mid-to-high 40s. This includes roughly 35 points of net impact from the Activision acquisition, which as a reminder includes adjusting for the third-party to first-party content change noted earlier. We expect Xbox content and services revenue growth in the mid-to-high 50s, driven by roughly 50 points of net impact from the Activision acquisition. Now back to company guidance. We expect COGS between $19.4 billion to $19.6 billion, including approximately $500 million of amortization of acquired intangible assets from the Activision acquisition. We expect operating expense of $15.5 billion to $15.6 billion, including approximately $400 million from purchase accounting adjustments, integration and transaction-related cost from the Activision acquisition. Other income and expense should be roughly negative $500 million, as interest income will be more than offset by interest expense, primarily due to a reduction in our investment portfolio balance and the issuance of short-term debt, both for the Activision acquisition. As a reminder, we are required to recognize gains or losses on our equity investments, which can increase quarterly volatility. We expect our Q2 effective tax rate to be between 19% and 20%. Now, some additional thoughts on H2 as well as the full fiscal year. First, FX, assuming current rates remain stable, we expect FX to have no meaningful impact to full year revenue COGS or operating expense growth. Therefore, in H2, we expect FX to decrease revenue COGS and operating expense growth by 1 point. Second, Activision, we expect approximately $900 million for purchase accounting adjustments as well as integration and transaction-related costs in each quarter in H2. For a full FY '24, we remain committed to investing for the cloud and AI opportunity, while also maintaining our disciplined focus on operating leverage. Therefore, as we add the net impact of Activision, inclusive of purchase accounting adjustments as well as integration and transaction-related expenses, we continue to expect full year operating margins to remain flat year-over-year. In closing, with our strong start to FY '24, I am confident that as a team, we will continue to deliver healthy growth in the year ahead, driven by our leadership in commercial cloud and our commitment to lead the AI platform wave. With that. Let's go to Q&A, Brett.
Brett Iversen: Thanks, Amy. We'll now move over to Q&A. Out of respect for others on the call, we request the participants, please ask only one question. Joe, can you please repeat your instructions?
Operator: Yes. [Operator Instructions] And our first question comes from the line of Keith Weiss with Morgan Stanley. Please proceed.
Keith Weiss: Excellent. Thank you for taking the question and very nice quarter. The pace of innovation you guys have been putting out has been pretty amazing. And the new products garnering traction probably faster than we've expected on our side of the equation. But we're also working in an overall spending environment, that remains volatile, and I think investors are getting more concerned on it. So two questions on this, one, based on sort of the new products and the innovation, do you think you guys can sustain the type of commercial growth that we saw in Q1 as we go through the year or is the environment too tricky for that? And then when it relates to investment, Amy, you've been able to keep overall OpEx growth very low, and it was very low this quarter. At some point, should we be thinking about a return to a more aggressive investment behind all this product innovation?
Satya Nadella: Maybe I can start, Keith, and Amy you can add to it. Overall there are multiple things, Keith, they're all happening obviously simultaneously. If you just take Azure and try to characterize, where's the growth for Azure coming from or what sort of drivers for Azure numbers, there are three things all happening in parallel. Like, for example, take cloud migrations. A good reminder of where we are and even the core cloud migration story is the new Oracle announcement. Once we announced that the Oracle databases are going to be available on Azure, we saw a bunch of unlock from new customers who have significant Oracle estates that have not yet moved to the cloud because they needed to rendezvous with the rest of the app estate in one single cloud. And so we're excited about that. So in some sense, even the financial services sector, for example, is a good place where there's a lot of Oracle that still needs to move to the cloud. The second thing, of course, is the workloads start, then workloads get optimized, and then new workloads start, and that cycle continues. We'll lap some of those optimization cycles that were fairly extreme perhaps in the second half of our fiscal. And the third thing is, for us, that's unique and different is new workload starts around AI. Given our leadership position, we are seeing complete new projects start, which are AI projects. And as you know, AI projects are not just about AI meters, they have lots of other cloud meters as well. So that sort of gives you one side of what's happening in terms of enterprise. The other piece is on the SaaS side, obviously, again, this is a new product that's going to go through the enterprise adoption cycle. The results around productivity, which we demonstrated with GitHub Copilot, is what's giving us good confidence and our customers, more importantly, good confidence around what these products represent in terms of value. And so we are in the very early innings there, and so we look forward to seeing the traction for these products going forward.
Amy Hood: Keith, maybe just a few things to add and then I'll talk a little bit about the operating leverage, which is the second part of your question. In general, we saw very consistent execution from Q4 to Q1, and that's what we're talking about into Q2. I think that speaks to our value prop, which is where Satya went. It speaks to making sure that customers are getting a very quick return on value, real productivity improvement, real savings, so that when we're asking at renewal or talking about E5 upgrades or talking about AI services, that those come with real promises of high-value scenarios. And so I think that is an important piece as you think about, stability and commercial demand. And then if you think about the nature of your question, it was partially why I talked about in my full-year guidance that, now, even with the addition of Activision and purchase accounting impacts, and integration impacts, we still feel confident we can deliver consistent operating margins to last year. And it speaks to, I think, some of the improvements, we're making in Azure and even in Microsoft 365 gross margins, even in the core of the commercial cloud. It speaks to the pace at which we are delivering AI revenue with the increasing cost expense and capital investment ahead with the demand we see. And, although you're right, our operating expense comparables in H2 get more challenging than in H1, we're really focused on making sure that every dollar we put and commit is back to the priorities we talked about, which is commercial cloud leadership and leading the AI wave. And so I think that focus is really helping on both execution and leverage.
Keith Weiss: Excellent. Thank you, guys.
Brett Iversen: Thanks, Keith. Joe, next question, please.
Operator: Your next question comes from the line of Mark Moerdler with Bernstein Research. Please proceed.
Mark Moerdler: Thank you very much and congratulations on a really strong quarter. AI has been far stronger than expected, beat your guidance for Azure this quarter. And while you discussed higher utilization and more GPUs have helped, has the fact that Microsoft has a full AI devstack Copilot reference architecture and plugin architecture bidding a meaningful factor, not just from a revenue perspective, but also even potentially from a margin perspective? In addition, can you give us any color on whether Azure GPU is predominantly model training or are we seeing a lot of inferencing yet from clients? Thanks.
Satya Nadella: No. Thank you for the question, Mark. Yeah, it is true that we have -- the approach we have taken is a full stack approach all the way from whether it's ChatGPT or Bing Chat or all our Copilots, all share the same model. So in some sense, one of the things that we do have is very, very high leverage of the one model that we used -- which we trained, and then the one model that we are doing inferencing at scale. And that advantage sort of trickles down all the way to both utilization internally, utilization of third parties, and also over time, you can see the sort of stack optimization all the way to the silicon because the abstraction layer to which the developers are riding is much higher up than low-level kernels if you will. So, therefore, I think there is a fundamental approach we took, which was a technical approach of saying we'll have Copilots and Copilot stack all available. That doesn't mean we don't have people doing training for open source models or proprietary models. We also have a bunch of open source models. We have a bunch of fine-tuning happening, a bunch of RLHF happening. So there's all kinds of ways people use it. But the thing is, we have scale leverage of one large model that was trained and one large model that's being used for inference across all our first-party SaaS apps, as well as our API in our Azure AI service…
Amy Hood: And the reason, Mark, that's important is that it means, even beyond the point Satya made is that, when it comes to our ability to leverage the infrastructure that we're building out, we don't really have a preference in terms of how people are utilizing that infrastructure, whether it's through all the means that Satya mentioned. It gives us a good opportunity to see quick conversion into revenue.
Satya Nadella: Yeah. I mean, one other thing I'd just add to perhaps Mark's question as well as Keith's is, this platform transition, I think is very important for us to be very disciplined on both. I'll call our tech stack as well as our capital spend all to be concentrated. The lesson learned from the cloud side is -- we're not running a conglomerate of different businesses, it's all one tech stack up and down Microsoft's portfolio, and that, I think, is going to be very important because that discipline, given what the spend like -- it will look like for this AI transition any business that's not disciplined about their capital spend accruing across all their businesses could run into trouble.
Mark Moerdler: Extremely helpful. Thank you so much.
Brett Iversen: Thanks, Mark. Joe, next question, please.
Operator: Your next question comes from the line of Brent Thill with Jefferies. Please proceed.
Brent Thill: Thanks, Amy. Good to see the 12% growth. Many investors are asking, can you sustain double-digit growth, especially with a stronger AI boost coming in the next several quarters?
Amy Hood: I think looking at our -- as I said, Q1 was a strong start to the year, Q2 certainly implies that. We've talked about stability for Azure into the second half of the year looking at and in line with what we're seeing for Q2. And so I think we feel good about our ability to execute, but more importantly, our ability to continue to take share.
Brett Iversen: Thanks, Brent. Joe, next question, please.
Operator: The next question comes from the line of Raimo Lenschow with Barclays. Please proceed.
Raimo Lenschow: Hey. Thank you. You sound very optimistic about the opportunity in the office space with Copilot coming out now very soon. Can you speak a little bit about -- what you're seeing in the customer base that tested this already in terms of how excited they were -- the special features there, and what does it mean in terms of adoption curve for that going forward once you go GA on 1st of November? Thank you.
Satya Nadella: No. Thanks. The question, Ramo, the good news is two-fold, one is the fact that, what is 40% of the Fortune 100 are already in the preview and are using the product and I think you all have also done lots of checks and the feedback is very, very positive. And, in fact, the interesting thing is, it's not any one tool, right? Which is the feedback even sort of is very clear that it's the all up. You just keep hitting the Copilot button across every surface, right, whether it's in Word to create documents, in Excel to, do analysis, or PowerPoint or Outlook or Teams just like that. Clearly, the Teams meeting, which is an intelligent recap, it's not just a dumb transcript. It's like having a knowledge base of all your meetings that you can query and add to essentially the knowledge terms of your enterprise. And so we are seeing broad usage across and the interesting thing is, by different functions, whether it's in finance or in sales by roles, we are seeing productivity gains like we saw with developers and GitHub Copilot. So that's the data. We are very excited about our Ignite conference, where we will talk a lot more about all of the use cases and what's -- where's the value and give more prescriptive guidance on how people can deploy. But so far so good, as far as the data is and the feedback is. And of course, this is an enterprise product, I mean, at the end of the day, we are grounded on enterprise cycle times in terms of adoption and ramp, and it's incrementally priced, so, therefore that all will apply still. But at least for something completely new to have this level of usage already and this level of excitement is something we're very, very pleased with.
Raimo Lenschow: Thank you.
Brett Iversen: Thanks, Raimo. Joe, next question, please.
Operator: The next question comes from the line of Karl Keirstead with UBS. Please proceed.
Karl Keirstead: Okay. Great. Thanks, Amy. Congrats on the 28% constant currency Azure growth, that's terrific. I wanted to press you a little bit on the outlook for Azure. You're obviously guiding to a 1 to 2 point decel in December and then stable thereafter. But why would it be stable? Why wouldn't it accelerate in the -- in the second half of your fiscal year, if the AI contribution is increasing as you bring on more GPU capacity? Is this a function of perhaps continued Core ex-AI Azure spend optimization, continuing or maybe even getting slightly worse? Why couldn't we see some upside in that Azure number? I know you're trying to be conservative, but I'd just love to understand it? Thanks so much.
Amy Hood: Thanks, Karl. A couple of things. As I talked about Q2 and then into H2. We've been very consistent that the optimization trends have been consistent for us through a couple of quarters now. Customers are going to continue to do that. It's an important part of running workloads that is not new. There obviously were some quarters where it was more accelerated, but that is a pattern that is and has been a fundamental part of having customers, both make new room for new workload adoption and continue to build new capabilities. And so I think that impact remains through the rest of the year, and my view is unchanged on that. And then of course, I think the key component has always been new workload starts. And at the scale we're talking about, being able to have stability in our Azure business, does mean that we will have a lot of new workload starts. And primarily we're expecting those to come from AI workloads. But AI workloads don't just use our AI services. They use data services and they use other things. And so that combination, I think, looking on a competitive basis, we feel good about our execution, we feel good about taking share and we feel good about consistent trends. And so I feel good about that guide and what it says about where we are on share.
Karl Keirstead: Okay. Terrific. Thanks.
Brett Iversen: Thanks, Karl. Joe, next question, please.
Operator: The next question comes from the line of Brad Sills with Bank of America. Please proceed.
Bradley Sills: Wonderful. Thanks so much. Very impressive to see the Office 365 commercial seat growth hanging in here in that double digit range. It's very impressive just given the scale of that business. We think of Office as having such a dominant market position. Curious, how you think about the -- where that seat is coming from and how many more of those seats are out there to go get?
Amy Hood: Thanks for that question, and maybe I'll take that Satya if you -- if you want to add. In general, our seat growth has -- it does come from all segments, but with particular strength in small and mid-sized businesses, as well as what we call the frontline worker opportunity. And that has been, I would say, looking back a number of quarters where the majority of our seat growth has gone. And while obviously, it slowed a bit to your point, I think the fact that we're still able to add seats at this level speaks to the broadening nature of what Microsoft 365 needs. It's more applicable to more people. And so I think many people have thought, oh my goodness, you've got a lot of customers already. And we look and say, how many people when you expand what Microsoft 365 means, whether it's the security or it means analytics or it means Teams, it means lots of things in an expanding definition. It applies to more types of workers. And frankly, the value is such, especially on the small business front, where it's to the point where I think people feel like it's a great way to spend even the spend money they have is -- this remains a pretty compelling offer.
Bradley Sills: Thank you.
Brett Iversen: Thanks, Brad. Joe, next question, please.
Operator: Your next question comes from the line of Brent Bracelin with Piper Sandler. Please proceed.
Brent Bracelin: Thank you. Good afternoon. One thing that really stood out to me was the intelligent cloud segment operating margins. These came in, I think, at the highest level in six years, despite elevated AI investments. Was there a one-time tailwind here that helped? Or are you at the point where Azure has got economies of scale, where Microsoft could sustain high margins even with an ambitious AI investment cycle?
Amy Hood: You think -- thanks for that question. I think there are a couple things going on and I do -- I would say in particular, this was a very good leverage quarter in that segment. Number one, the Azure revenue growth and the stability we're seeing in it, absolutely is that help the operating leverage. The second component of that is in our core Azure business. The team continues to deliver thoughtful gross margin improvement across both technical decisions, software implementations. Our teams on the infrastructure build side have done really good work to deliver that, and so that's been helpful as well. And then, of course, on operating expenses, there's been a good focus on continuing even within that segment, to make sure we're focusing that work on leading in the AI transition with Azure. And so you're right, even as we're investing in AI infrastructure, which will and should show up as revenue, it'll also show up in COGS and still deliver good margin. But this does have a slightly -- as I talked about earlier, easier comp in Q1 and Q2, given it was some of our highest growth operating expense quarters in our company's history a year ago.
Brent Bracelin: Makes sense. Thank you.
Brett Iversen: Thanks, Brent. Joe, we have time for one last question.
Operator: Our last question will come from the line of Gregg Moskowitz with Mizuho. Please proceed.
Gregg Moskowitz: Okay. Thank you very much for taking the question. And maybe just a follow-up to what Brent was just asking about, but on the gross margin line. Amy, the Microsoft cloud gross margin is up 2 points year-over-year, excluding the useful life change, a little more improvement than we've seen in some time and some investors were worried that it might go in the other direction, given increased AI investments. And so, as you look forward, do you think that you could drive some continued gross margin improvement over the medium term and even as higher CapEx will filter into the model? Thanks.
Amy Hood: Yeah. Let me break that into two components, because they're both important and it's a really good question, Gregg. On our core business, the core Azure business, the core Office 365, M365 business, Dynamics business, they're -- they continue to deliver gross margin year-over-year improvements in the core. And so that, like in other quarters has helped this quarter. In addition, what Satya mentioned earlier in a question, and I just want to take every chance to reiterate it, if you have a consistent infrastructure from the platform all the way up through its layers, then every capital dollar we spend, if we optimize revenue against it, we will have great leverage, because wherever demand shows up in the layers, whether it's at the SaaS layer, whether it's at the infrastructure layer, whether it's for training workloads, we're able to quickly put our infrastructure to work generating revenue, or on our Bing workloads. I mean, I should have mentioned all the consumer workloads use the same frame. And so when you think about our investment in AI, yes, it will -- because we're committed to leading this wave and see demand, you will see that impact in COGS growth. But what we're committed to doing is making sure it's highly leveraged and making sure you see the same growth in revenue. And I think on occasion, you may see something pick up 1 or 2 points and the other one not quite get there, but the point is, it's going to be very well paired because of the choices we've made over the past, frankly, numerous years, to get to a point where that infrastructure is consistent.
Satya Nadella: And I'll just add that it'll be very well paired at the company level. I realize all of you care a lot about each one of our segments and each one of our KPIs, and I do too, but at the end of the day, our stack and the way it works, the way we do our capital allocation, the way we think about even the optimization of the demand to utilization is across the entirety of all of our segments and all of our products.
Gregg Moskowitz: Very helpful. Thanks.
Brett Iversen: Thanks, Gregg. That wraps up the Q&A portion of today's earnings call. Thank you for join us today and we look-forward to speaking with all of you soon.
Amy Hood: Thank you.
Satya Nadella: Thank you.
Operator: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. |
TXN | 3 | 2,023 | 2023-10-24 19:12:07 | Dave Pahl: Welcome to the Texas Instruments Third Quarter 2023 Earnings Conference Call. I'm Dave Pahl, Head of Investor Relations, and I'm joined by our Chief Financial Officer Rafael Lizardi. For any of you who missed the release, you can find it on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through our website. In addition, today's call is being recorded and will be available via replay on our website. This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the notice regarding forward-looking statements contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description. Today, we'll provide the following updates: First, I'll start with a quick overview of the quarter. Next, I'll provide insight into third quarter revenue results, with some details of what we are seeing with respect to our end markets. Lastly, Rafael will cover the financial results, give an update on capital management, as well as share the guidance for our fourth quarter 2023. Starting with a quick overview of the third quarter: Revenue in the quarter came in about as expected at $4.5 billion, flat sequentially and a decrease of 14% year-over-year. Analog revenue declined 16%, Embedded Processing grew 8%, and our Other segment declined 32% from the year-ago quarter. Now I'll provide some insight into our third quarter revenue by market. During the quarter, automotive growth continued and industrial weakness broadened. Similar to last quarter, I'll focus on sequential performance, as it is more informative at this time. First, the industrial market was down mid-single digits, with weakness broadening across nearly all sectors. The automotive market continued to grow and was up mid-single digits. Personal electronics was up about 20% off of a low base. And next, communications equipment was down upper teens. And finally, enterprise systems grew upper-single digits. Given where the market is right now, it is a good time to remind everyone of our plan and areas of strategic investment. First, our confidence in the secular growth of semiconductor content per system, especially in industrial and automotive, remains high, and we are well positioned in these markets. Second, our long-term 300 millimeter manufacturing roadmap provides our customers with geopolitically dependable capacity. To support these buildouts and enable future growth, we continue to expect associated capital expenditures to be about $5 billion per year through 2026. In addition, we made good progress on our inventory replenishment, consistent with our long-term objectives to support growth and provide high levels of customer service. Rafael will now review profitability, capital management and our outlook. Rafael?
Rafael Lizardi: Thanks Dave, and good afternoon everyone. Third quarter revenue was $4.5 billion, down 14% from a year ago. Gross profit in the quarter was $2.8 billion, or 62% of revenue. From a year ago, gross profit decreased primarily due to lower revenue and, to a lesser extent, higher manufacturing costs associated with planned capacity expansion and reduced factory loadings. As a reminder, LFAB-related charges transitioned to cost of revenue in the fourth quarter of 2022. Gross profit margin decreased 690 basis points. Operating expenses in the quarter were $923 million, up 7% from a year ago and about as expected. On a trailing 12-month basis, operating expenses were $3.7 billion, or 20% of revenue. Operating profit was $1.9 billion in the quarter, or 42% of revenue, and was down 29% from the year-ago quarter. Net income in the third quarter was $1.7 billion, or $1.85 per share. Earnings per share included a $0.5 benefit for items that were not in our original guidance. Let me now comment on our capital management results, starting with our cash generation. Cash flow from operations was $1.9 billion in the quarter and $6.5 billion on a trailing 12-month basis. Capital expenditures were $1.5 billion in the quarter and $4.9 billion over the last 12 months. Free cash flow on a trailing 12-month basis was $1.6 billion. In the quarter, we paid $1.1 billion in dividends and repurchased about $50 million of our stock. In September, we announced we would increase our dividend by 5%, marking our 20th consecutive year of dividend increases. This action reflects our continued commitment to return free cash flow to our owners over time. In total, we have returned $5.6 billion in the past 12 months. Our balance sheet remains strong with $8.9 billion of cash and short-term investments at the end of the third quarter. Total debt outstanding was $11.3 billion with a weighted average coupon of 3.5%. Inventory at the end of the quarter was $3.9 billion, and days were 205, down two days sequentially. Inventory was up $179 million in the third quarter, less than half the increase versus the prior quarter, as we near our desired inventory levels. Therefore, we began to lower factory starts in the third quarter, which results in additional charges to the income statement. This impact is comprehended in our outlook. For the fourth quarter we expect TI revenue in the range of $3.93 billion to $4.27 billion and earnings per share to be in the range of $1.35 to $1.57 as we continue to operate in a weak environment. Lastly, we continue to expect our 2023 effective tax rate to be about 13% to 14%. As you are looking at your models for 2024, based on current tax law, we would expect our effective tax rate to remain about what it is in 2023. In closing, we will stay focused in the areas that add value in the long term. We continue to invest in our competitive advantages, which are manufacturing and technology, a broad product portfolio, reach of our channels, and diverse and long-lived positions. We will continue to strengthen these advantages through disciplined capital allocation and by focusing on the best opportunities, which we believe will enable us to continue to deliver free cash flow per share growth over the long term. With that, let me turn it back to Dave.
Dave Pahl: Thanks, Rafael. Operator, you can now open the lines for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we'll provide you an opportunity for an additional follow-up. Operator?
Operator: Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Stacy Rasgon with Bernstein Research. Please proceed with your question.
Stacy Rasgon: Hi guys, thanks for taking my questions. My first one, I did want to ask about gross margins. So I mean depending on what I assume for OpEx next quarter, I'm getting something like 250 basis points of compression maybe more. I know you talked a little bit about how some of that is the impact of utilization. Can you give us some feeling for, I guess, like the magnitude of the different drivers' utilization, lower revenue depreciation, pricing, and how we ought to be thinking about that trajectory as we get into the next year? Is there more to go, I guess, is what I'm asking.
Rafael Lizardi: Yes. Thanks, Stacy. Let me try to help you with that. Of course, for the forecast, we give a range of revenue and a range of NPS, not the pieces. But let me go through some of what I said for third quarter, which applies for fourth quarter and beyond. So for third quarter, like I said in the preferred remarks, in third quarter gross profit decreased primarily due to revenue, so that’s the first driver, then to a lesser extent higher manufacturing costs associated with planned capacity expansion, namely depreciation is the main one there, and reduce the factory loadings and that's the underutilization component. Then as I also said in the prepared remarks, inventory, which is the other side of the coin, as we near desired levels of inventory we will begin lowering factory starts in the third quarter. So there was an impact in third quarter due to that on the income statement. There will be a bigger impact in fourth quarter due to that. Beyond that, we're not forecasting, but of course that will depend on revenue expectations well into next year. Do you have a follow-up?
Stacy Rasgon: I do. Thanks. So you gave us a little color on the end market behavior in Q3. Can you give us some thoughts on, at least even qualitatively, what to expect by end market into Q4? And particularly for auto, it sounds like auto in Q3 was so strong. Do you still see that strength continuing in the Q4 in the year end?
Dave Pahl: Yes, Stacy, I'll take that. When you look at the guidance, it would suggest and we believe that we continue to operate in a weak environment in general. And if there was something significant that was changing from one quarter to the next as our typical practice, we highlight that and we just don't have anything to specifically call out for -- into fourth quarter. So thanks and we'll go to the next caller please.
Operator: Our next question comes from the line of Timothy Arcuri with UBS. Please proceed with your question.
Timothy Arcuri: Thanks a lot. Dave, I also had a question on autos. It sounds like it's holding in there despite this broadening strike. And I guess the question is, are more of your customers on consignment in that business or is the split in autos about the same as that, two-third, one-third versus the rest of the company? And I ask because I'm wondering sort of what you're seeing on the Disti side that you would sell into autos. Do you see bookings at least, weakening that would be more consistent with what we're seeing in terms of this strike and some of the weak macro numbers that we see?
Dave Pahl: Sure. Yes. And as we mentioned in the prepared remarks, it was up, auto was up mid-single digits sequentially and it was up 20% when you look year-on-year. So obviously that growth had continued. In general, I would say that a market like automotive and personal electronics will have larger customers. Those larger customers tend to be biased to more consignment. So we would have that probably more in automotive than if I contrast it to a market perhaps like industrial. But overall, as you know, we've moved to having closer direct relationships with customers, which would include the customers that we have in automotive. And I think we service pretty close to 1,000 or so different automotive OEMs, so there is quite a bit of broadness in who we serve there. You have a follow on, Tim?
Timothy Arcuri: I do, Dave. Yes. So what would it take to -- for you to think about cutting CapEx? And I ask because the plan was put into place when revenue was quite a bit higher than where it is today. Is there kind of a line in the sand for revenue where you would reconsider the plan? I know you've actually increased the plan. Well, revenues continue to weaken, but is there some like tree around, is there some -- if it weakens to this point, you would consider cutting CapEx. Just wondering any comments there. Thanks.
Dave Pahl: Yes, let me comment on that. We're very pleased with the progress on our manufacturing expansion. They will provide geopolitically dependable capacity to support customer growth for the coming decade. And as you know, semiconductor content continues to increase. And to provide us the ability to grow at that 10% growth rate that we talked about at the last capital management call, if the market requires that, we'll continue to make those investments. So we continue to expect $5 billion of CapEx per year in 2023, 2024, 2025, and 2026. So you should count on that. Let me also give everyone, as a reminder, these CapEx numbers are gross, meaning they do not include benefits from the ITC or grants from the CHIPs Act. So we're actively working through the grant application process with the CHIPS program office, which we believe will be meaningful to our manufacturing operations in Texas and Utah and will help support semiconductor growth for decades to come. And funding from the CHIPS Act grants was comprehended in our decision making for these investments.
Timothy Arcuri: Great.
Dave Pahl: Thank you, Tim. We'll go to the next caller, please.
Operator: Our next question comes from the line of Ross Seymore with Deutsche Bank. Please proceed with your question.
Ross Seymore: Hi, guys. Thanks for asking a question. In the third quarter I think it was the first time in a few years that you guys just came in at the midpoint of your guidance. Usually you beat it by 2%, 3%, 4%, something like that. So I guess my question is, anything strange in the linearity in the quarter, either by end market, just aggregate bookings, any color on that you could provide?
Dave Pahl: Nothing strange. Ross, I'd say that the revenue built as we went through the quarter. And I'd say just in general, it's reflective of a weak environment that we're operating in, which is obvious from the guidance that we're giving. Do you have a follow on?
Ross Seymore: I do. On the end market side of things, you said automotive was up about 20% year-over-year. I know oftentimes you go between giving sequentials or year-over-years, but could you give us year-over-years by the end markets, please?
Dave Pahl: Certainly, certainly, yes. So industrial market was down mid-teens. I mentioned automotive was up about 20%. Personal electronics was down about 30%. Comms equipment was down about 50%. And enterprise system was down about 40%. So I think consistent with that weaker environment that we talked about. So thank you, Ross. We'll go to the next caller, please.
Operator: Our next question comes from the line of Toshiya Hari with Goldman Sachs. Please proceed with your question.
Toshiya Hari: Hi, guys. Thanks for taking the question. I was hoping you guys could elaborate a little bit on the pricing environment. I think many of us have been picking up evidence of the pricing environment, particularly in Asia, intensifying over the past couple of months or a couple of quarters. You don't really give pricing as a reason for gross margins to be down sequentially and year-over-year, but what kind of role is pricing playing? Has your strategy changed at all, whether it be on the analog side or MCU side?
Dave Pahl: Yes, so thanks for that question. Always helpful to be able to clarify that. First, I'll just start with pricing doesn't move quickly in our markets, nor is it a primary reason that customers choose our products. So we're typically agreeing to pricing that's out six months or on an annual basis for the following year. And so, we're continuing to move through that. Our pricing strategy, as we mentioned before, hasn't changed. So we're regularly monitoring what's going on with pricing. We always have a goal to remain competitive. And certainly a supply and demand has come into balance, or more closer to balance. We've said for some time that we would expect that pricing to behave like it has over the last couple of decades, meaning, low single digit decline. So as we move out in time, that's what we're beginning to see. So really no changes other than going back to what we've seen over the last couple of decades. You have a follow on?
Dave Pahl: Yes, I do. Thanks, Dave. So I guess over the past 12 months, OpEx is up about 10%. Revenue is down about 10%. So as we think about calendar 2024, I was hoping you could give us a hint as to how to think about OpEx. And Dave, I think you used to give, or you had given multi-year guidance on depreciation. How should we -- to the extent there are any updates, how should we think about 2024 and 2025 depreciation? Thank you.
Rafael Lizardi: Yes. No, thanks for the question. I'll address both OpEx and depreciation. So on OpEx, we've held a steady hand on OpEx for many years and we'll continue to do so. So as an example, to illustrate the point, from 2017 to 2021 we ran at about $3.2 billion of OpEx. And then in 2022, it ticked off to $3.4 billion. And now we're running at about $3.7 billion on a trailing 12-month basis. So you can see the steady hand and just a bit of an increase over the last few years. And that's, as we have has a steady hand with our hires, new college hires, and as we make investments to continue to strengthen the company in the case of R&D, the broad portfolio in the case with sales and TI.com on the reach of our channels. Then on depreciation, so our CapEx expansions are unchanged. We talked about that, addressed it with previous callers. So $5 billion of CapEx per year for the next 2023 and three years beyond that, as we have been talking about. Now when it comes to depreciation, as time has passed, we have more clarity on what to expect on depreciation. So for fourth quarter, let me start fourth quarter of 2023, we expect depreciation to increase on a quarterly basis at about the same rate as what we have been seeing throughout 2023. So essentially, we're going to end the year just shy of $1.2 billion, maybe [11.90, 11.80, 11.70] (ph), somewhat in that range for the year. As an update for 2024, we expect depreciation to be between $1.5 and $1.8 billion, and for 2025 to be between $2 billion and $2.5 billion.
Toshiya Hari: Very helpful. Thank you so much.
Dave Pahl: Thank you, Toshiya. Now we'll go to the next caller, please.
Operator: Our next question comes from the line of Ambrish Srivastava with BMO Capital Markets. Please proceed with your question.
Ambrish Srivastava: Hi. Thank you. I had a question on factory loadings and inventory. So correct me if I'm wrong. I thought that thinking up until now has been we've got to be ready for the upturn and so, we're building inventory for that. And you have highlighted that over several quarters. Look, we're not -- we don't have a target, but you did raise the target in terms of how much inventory you want to carry. So this change, which I want to make sure I'm reading it right, that you're taking underutilization charge because you've reached a desired level of inventory. Is that a reflection that your expectation for the recovery is changing, i.e. you're expecting a slower ramp in revenues than what you perhaps were thinking a couple of quarters ago?
Rafael Lizardi: Let me start and Dave if you want to chime in. But we have targets for where we want inventory levels to be and that goes by product and by state of finish of those products. So for example, of the 80,000 different products that we have, more than -- the vast majority of those are catalog, meaning, they sell to many, many customers. They last for a long, long time. So we can have so many years of inventory at the chip level or finished goods level, in many cases, at both levels, and that's based on our internal process to set those. So those are the -- and in aggregate, that's added up to $4 billion to $4.5 billion, and that's what we've been kind of guiding to and we've been talking about. But what really matters is what happens at the very specific level on a part-by-part number. So as we have near those levels, and you see our inventory level, our inventory levels have increased about $500 million per quarter for two quarters, and then this last quarter, $179 million. So clearly, there is a deceleration of that growth, and that's on purpose because as we near those levels, then we have slowed down the factory starts, that goes primarily with the fab, but also with the assembly test operations. And then we -- that slowdown will continue into fourth quarter. So they reversed the other side of slowing your factory loading is the underutilization charges. So as we near those levels, we are ready to be on the other side of this cycle for the upturn. And of course, it's not just inventory. Capacity is really the bigger driver, but you know what we've been doing on that now for a number of years and we're investing, but inventory really bridges that gap as an upturn happens until you get your factories really cranking at a higher level.
Dave Pahl: Yes, and I'll just add and bring back to our capital management that we've been saying for, I think, over a decade now, our objective with inventory is to maintain high levels of customer service, keep our lead time stable, keep product availability really high. So as we talked about earlier, ti.com, really, essentially all of our catalog products are available for immediate shipment. Lead times are stable. And so, we are prepared for that next upturn when it does come. You have a follow on, Ambrish?
Ambrish Srivastava: Yes, quick one Dave. Just looking at the year-over-year in the fourth quarter, double-digit year-over-year decline, and I looked back many years. There have been other cycles where we've had multiple quarters of negative, but not that many times we have seen a double-digit kind of four, five quarters. I just wanted your perspective on what you folks are seeing this cycle versus and I know no cycle is the same, but just kind of give -- just help investors think about how to think about that double-digit four quarters and could be potentially longer year-over-year decline? Thank you.
Dave Pahl: Sure. Yes. And I think we all know as being students of studying the cycles over the years. They're all the same and they're all different at the same time and they're unique. The one thing that is unique, of course, with the cycle is how the markets have behaved differently. We've seen bifurcation and really lined up very well with when markets recovered. So PE was the first to recover and was very strong early on. The other markets followed very shortly after that and Automotive was last. As you remember, many automotive manufacturers struggle to restart their factories and people weren't going to showrooms when we are in the midst of the pandemic. So really, as we've seen things begin to roll over, Personal Electronics was first. It was then followed by the other markets, and yet we still have automotive that's hanging in there. So I think that's the one thing that's unique. And I think as we've learned and studied the cycles, our product portfolio has changed as well over time. But the best time to be preparing for the upturn is before it shows up. So that's what we've been busy doing and we think we're in a great position to support the next upturn and to continue to gain share. So, thank you, Ambrish. We'll go to the next caller, please.
Operator: Our next question comes from the line of the Vivek Arya with Bank of America Securities. Please proceed with your question.
Vivek Arya: Thanks for taking my question. I wanted to go back to automotive just to make sure that I understood what you said. Do your comments imply that you're seeing a largely seasonal environment in Q4 with no changes in terms of orders to traditional or EV customers? And if that is the case, if I understood it correctly, isn't that surprising given the macro headwinds that sector is facing?
Dave Pahl: Vivek, your question was on third quarter or on fourth quarter?
Vivek Arya: So what is being -- I think when you were asked before, you said that if there was anything abnormal, you would have mentioned it. So I assume that because you didn't mention it, that it is normal.
Dave Pahl: Yes. So yes, what I said is that, if there was something that we needed to explain the outlook or unusual or however you want to describe it, we would do that. So I'm stopping at that point intentionally. And we'll finish up the quarter and report out what happens in the fourth quarter. Do you have a follow-up?
Vivek Arya: Yes. On depreciation, what is driving the revision? Because your CapEx doesn't seem to be changing. And then kind of part B of that is, if I take that year-on-year delta, Rafael, I think it's about $400 million, $500 million or so incremental in 2024. So at the current revenue run rate, that's a 2 point to 3 point headwind to gross margin. I just wanted to make sure that I got those two points right.
Rafael Lizardi: Yes. So the -- for 2024, I said $1.5 billion to $1.8 billion, and that is down from what you probably had before $2 billion. And for 2025, I said $2 billion to $2.5 billion, so that is down from $2.5 which we had said before. And the reason, as you pointed out, CapEx is not changing, so that's not the reason. It's just as time has said, we have more clarity on what to expect. So for example, depreciation on tools that doesn't start until the tool. It's not only received but installed and then qualified and that’s when depreciation starts. So that doesn't happen immediately. So as we have learned more as to how that process works with all the number of tools that we're receiving for the various factories, then we're providing an update on depreciation. Thank you.
Vivek Arya: And the gross margin headwind, is that -- did I have the calculation right? It's a 2 point to 3 point headwind on gross margins.
Rafael Lizardi: Well, so we've given you the tools to calculate gross margin. So let me remind everybody what that is. First is revenue. So you pick the revenue that you believe is going to happen for the next several years. And it's working on a quarterly basis, but of course in any quarter there are a lot of puts and takes, but better to do it over longer horizons. So you start with revenue, then you fold that through at 70% to 75%, which by the way, that is reflective of the great, not only geopolitically dependable capacity that we're putting in place, but it is all that new fab capacity is 300 millimeters. So it has a structural cost advantage, not to mention that we're getting ITC and grants benefits that is installed in the United States. But -- so then you fold that through at 70% to 75%. Then you need to account for the added depreciation. So this year it's probably going to be close to $1.2 billion, and then next year it just gave you $1.5 billion to $1.8 billion. So if you want to pick a point between that, then you get your added depreciation for 2024. And then at a high level, that's it. But of course, in any given quarter, even in any given year, but especially in any given quarter, you have to put some takes. And one of them that we're seeing right now is the underutilization. But that right now is headwind, but that can also be a tailwind when we're on the other side and we're increasing loadings and that -- what does that is that, then it comes back the other way, right? So -- but that's more of a tactical comment that happens in some quarters. Hopefully that answers your question.
Vivek Arya: Yeah. Thank you.
Dave Pahl: Thank you, Vivek. We'll go to the next caller, please.
Operator: Our next question comes from the line of Joe Moore with Morgan Stanley. Please proceed with your question.
Joe Moore: Yes, thank you. I wonder if you could walk us through the calculation on the underutilization charge. I mean, I think it seems like with over [indiscernible] of inventory, you would see the cost impact of that in six months, but you're pulling it forward. Can you just talk about how you determine how much to pull forward?
Rafael Lizardi: Yes. Well, so it's an accounting process and it's essentially when you're below what's considered normal utilization, that percent that you're below that -- and that is generally determined by wafer and the fab is wafer starts and out in the assembly test operation as your -- the number of units that you're producing and you divide that by the capacity that you can get, the maximum capacity. You establish a normal, which is where you normally expect to be. That could be 85%, 90%, 95%, depending on the situation. And whenever you're below that, then you take that percent that you're below and then you take those fixed costs and go straight to the P&L instead of going into inventory. So some of those costs that will come in fixed costs, some of them are depreciation, but it's not only depreciation. You have electricity, for example, is largely fixed. You use [indiscernible] whether that tool is running production or not as long as it's plugged in. So you take that into account. And then at the end of the day, you're not creating money when you do that, you just essentially put it on the balance sheet or the P&L. And in this case, it's going directly into the P&L as a linked quarter charge because that portion of the capacity is not producing. Now one more comment, that gives us tremendous operating leverage on the other side of that, right? Because think about fixed costs on the way down, they heard of it. But on the way up, they're fixed, right? So from a cash standpoint, on the way up, you don't spend any more and then you get just tremendous cash fall-throughs on the revenue, particularly when it's 300-millimeter capacity at very low cost.
Dave Pahl: Do you have a follow-on, Joe?
Joe Moore : Great. Thank you. Separately, on the comm infrastructure business seemed quite soft, both quarter-on-quarter and year-on-year. I know that business isn't a focus for you guys, but can you talk about what's driving that weakness?
Dave Pahl: Yes. And it -- last year was about 7% of our revenue, Joe. So we can find great opportunities in Comms Equipment. We continue to invest, we just don't think it has the secular growth that other markets like industrial, automotive fab. So we continue to make investments there. And as we've talked about that market over the years, it's one that just tends to be choppy. We believe that they're continuing to adjust their inventory levels as we work our way through this quarter. And as I mentioned earlier, it's down 50%. So that's a pretty significant drop. So yes -- so again, long term, we think it's a great market and we're positioned well there, but it will have these types of moves overall. Okay. thanks Joe. We will go to the next caller, please.
Operator: Our next question comes from Tore Svanberg with Stifel. Please proceed with your question.
Tore Svanberg: Yes. Thank you, Dave. Thank you, Rafael. So you talked about operating in a weak environment. Could you also give us some color on bookings trends, maybe even the current run rate versus where you think consumption is? Just trying to understand, and this goes back to Ambrish's question about four consecutive quarters of double-digit declines. So yes, any color on bookings trends would be really helpful.
Dave Pahl: Yes. So as I mentioned, I think as part of another question on revenue order linearity, there was nothing unusual inside of that. Secondly, we obviously, we're describing the environment as being weak. And we don't have a system that tells us, are we shipping above or below demand. The strongest signal that we get is orders from customers. Now as we talked about earlier comms, or a market like Personal Electronics was the first market to go into the downturn. We've had a couple of quarters of growth inside of that market. Now it's up off of a very weak base. But we are seeing that as a trend. If you compare that to the industrial market, we had seen that, let's say, let's call it, about half of the sectors begin to weaken a couple of quarters ago, it was really this quarter that we saw that, that weakness is broadening. So customers, we believe, inside of markets like that inside of markets like Comms equipment that we said they're adjusting their inventories as such. So again, that provides us the opportunity both strategically with building the capacity and more tactically, building, putting in place the inventory to be able to support the next upturn because it will certainly come. Do you have a follow-on?
Tore Svanberg: Yes. Thank you, Dave. Very helpful. Follow-on for Rafael. Rafael, thank you for the depreciation numbers for the next few years. Do you also have an update us on the timing of the offsets to the depreciation, especially in relation to ITC and the CHIPS Act and anything new there?
Rafael Lizardi: So nothing new, frankly. The ITC is the expectation is similar, which is about a 20% to 25% credit on everything that is spent on CapEx in the U.S. for fabs. So what we said back in February is that that's going to be roughly $4 billion of the $20 billion or so that for CapEx, the $5 billion more. So roughly about $4 billion of that we're going to get back on ITC about one year offset. Of that, we have already accrued $1.2 billion on the balance sheet. So you'll see that on our balance sheet on the long-term assets. A portion of that, we will get some time next year, probably by fourth quarter next year is when we expect to get that cash, so that's when the cash will start flowing in. As I mentioned in an earlier call, on an earlier question, we are actively applying for the grant. So that's going to be in addition to the ITC. We're not counting on that. We don't have any numbers on that because you have to apply, you have to wait until the Department of Commerce makes that decision. But we are -- we're planning on receiving the funding from the CHIPS Act grant was comprehended in our decision, and we firmly believe we are very well positioned to receive those funds, and we're a great candidate for that, and we believe there will be meaningful to manufacturing operations in Texas and Utah to support semiconductor growth and the objectives of the CHIPS program office.
Dave Pahl: Great. Thank you, Tore. Let's go to the next caller, please.
Operator: Our next question comes from the line of Harlan Sur with JPMorgan.
Harlan Sur: Thank you. Good afternoon. China headquartered shipments or about 20% of to the first half of this year. Does this geography has experienced the most significant decline. I think it was down like 33%, 35% year-over-year in the first half of this year. Much of your China business is focused on industrial. Is this geography continuing to contribute to the weakness here in Q4? And what other geographies are you seeing that is contributing to this broadening out of sort of the weak industrial trends?
Dave Pahl: Yes. So let me -- I'll speak to what we saw in the third quarter. And just in general, including industrial in China continue to remain weak. So, I think if we're having this call a year ago or so, as China came out of COVID, I think most of us would have expected there to be a more significant rebound, which just hasn't materialized. So yes, I think when you look at on a regional basis compared with the year ago, the only region that was up was Japan. So the other regions were down. And so, again, just described that weakness as being very broad in nature. Do you have a follow-on, Harlan?
Harlan Sur: Yes. Thank you. So your embedded business continues to hold up relatively well, right? Trailing 12 months, it's up 8% year-over-year. You've talked about the positive strategy changes in embedded. Last quarter, you also cited some constraints. I assume that those constraints have fully normalized. So do you anticipate embedded continuing to hold up? Or do you anticipate this segment starting to weaken from here with some of the capacity constraints potentially easing?
Dave Pahl: Yes. As we talked about before, we had focused on changing the product strategy that we had inside of embedded. I'd say we're very pleased with the results that we have so far. Our first objective was to stabilize that business. And we continue to invest in it because we believe it has long-term growth potential and contribution to free cash flow. So we're very pleased with where we're going. I think more tactically, as we talked about last quarter, we saw that business does rely more heavily on foundry suppliers. We began to see those -- that capacity begin to free up for us. And I think that it was different because we had capacity in place to service analog, our own capacity there overall. So, yes. So again, we think that business long term is going to be a great driver for us in the future. So thank you. And I think we've got time for one more caller.
Operator: Our next question comes from the line of William Stein with Truist Securities. Please proceed with your question.
William Stein: Great. Thanks for squeezing me in. Dave, can you remind us what's in the other segment besides calculators and perhaps why that end market was down so much more than the others? I know it's very seasonal from calculators, but there was a big drop year-over-year.
Dave Pahl: Yes. So besides calculators, we have our DLP or Digital Processor Products that are in there. So those products are continuing to make their way through inventory correction overall. And calculators had a weaker back-to-school this season. Do you have a follow-on?
William Stein: Yes, perhaps something that hasn't come up in a while, but lead times. We were dealing with this golden screw issue for a while where there were quite a number of parts or quite a big part of the, let's say, all the available SKUs that had very extended lead times with revenue down as much as it is. I'm guessing that, that's mostly resolved and lead times are like sort of stock to four weeks for most things at this point. But if you could level set me on that, the degree to which there are still extended lead times, that would be really helpful. Thank you.
Dave Pahl: Sure. Yes. So and I may have mentioned this earlier, but almost all of our catalog products are available on ti.com for immediate shipment. And so, as we approach our desired level of inventory, we've got a product that is positioned both in finished goods as well as in wafer form to be able to restock that. Of course, lead times, therefore, are what I described normal levels and continue to be consistent. And there's probably no time that we don't -- with so many different products and so many different customers. We'll have hotspots, but they are very few and far between and our ability to close those is very -- we've got flexible manufacturing as most of our production is fungible. So with that, I'll ask Rafael to wrap up the call for us.
Rafael Lizardi: All right. Let me wrap up by reiterating what we have said previously. At our core were engineers and technologies, the foundation of our company but ultimately, our objective and the best metric to measure progress and generate value for owners is a long-term growth of free cash flow per share. While we strive to achieve our objective, we will continue to pursue our three ambitions. We will act like owners who will own the company for decades. We will adapt and succeed in a world that's ever changing and we will be a company that we are personally proud to be part of and would want as our neighbor. When we are successful, our employees, customers, communities and owners all benefit. Thank you, and have a good evening.
Operator: This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation. |
GOOGL | 3 | 2,023 | 2023-10-24 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Third Quarter 2023 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's Third Quarter 2023 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Form 10-K, including our Risk Factors section and our Form 10-Q. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now, I'll turn the call over to Sundar.
Sundar Pichai: Thank you, Jim, and hello, everyone. I'm pleased with our business results this quarter, which demonstrates strong growth in Search and YouTube and momentum in Cloud. Google turned 25 in September, which offered an opportunity to reflect on our progress over the last quarter century and to look ahead to the opportunities enabled by AI we are so excited and confident about.
Our product momentum continued this quarter, as you saw with Cloud Next made on YouTube and made by Google. It's all part of our focus on making AI more helpful for everyone, and we are making good progress across the 4 areas that we shared last quarter.
First, improving knowledge and learning. This includes our work with the Search Generative Experience, which is our experiment to bring generative AI capabilities into Search. We have learned a lot from people trying it, and we have added new capabilities like incorporating videos and images into responses and generating imagery. We have also made it easier to understand and debug generated code. Direct user feedback has been positive with strong growth in adoption. In August, we opened up availability to India and Japan with more countries and languages to come. As we add features and expand into new markets, we are engaging with the broader ecosystem, and we'll continue to prioritize approaches that add value for our users, send valuable traffic to publishers and support a healthy open Internet.
With generative AI applied to Search, we can serve a wider range of information needs and answer new types of questions, including those that benefit from multiple perspectives. We are surfacing more links with SGE and linking to a wider range of sources on the results page, creating new opportunities for content to be discovered. Of course, ads will continue to play an important role in this new Search experience. People are finding ads helpful here as they provide useful options to take action and connect with businesses. We'll experiment with new formats native to SGE that use generative AI to create relevant, high-quality ads customized to every step of the Search journey.
The second area we are focused on is boosting creativity and productivity. Bard is particularly helpful here. It's a direct interface to a conversational LLM and we think of it as an early experiment and complementary experience to Google Search. Bard can now integrate with Google apps and services showing relevant information from Workspace, Maps, YouTube and Google Flights and Hotels.
We've also improved the Google IT feature. It provides other sources to help people evaluate Bard's responses and explore information across the web. Earlier this month, we announced Assistant with Bard, a personal assistant powered by generative AI. It combines Bard's generative and reasoning capabilities with Assistant's personalized help. You can interact with it through text, voice or images. And in the coming months, you'll be able to opt in on Android and iOS mobile devices. Our collaborative tools in Workspace and YouTube are also part of how we boost creativity and productivity, and they are seeing great initial traction.
Third, we are enabling developers, businesses and other organizations to build their own transformative products and services. For example, thousands of customers and partners are already using Google Cloud to capture the potential of AI, and we'll share more there in a minute.
And fourth, we are building and deploying AI responsibly so that everyone can benefit. One area we are focused on is making sure people can more easily identify when they are encountering AI-generated content online, using new technology powered by Google DeepMind SynthID, images generated by Vertex AI can be watermarked in a way that is invisible to the human eye without reducing the image quality. Underlying all this work is the foundational research done by our teams at Google DeepMind and Google Research. We are excited to roll out more of what they've been working on soon.
As we expand access to our new AI services, we continue to make meaningful investments in support of our AI efforts. We remain committed to durably reengineering our cost base in order to help create capacity for these investments in support of long-term sustainable financial value. Across Alphabet, teams are looking at ways to operate as effectively as possible focused on their biggest priorities.
Turning next to YouTube, which saw solid momentum in both its ads and subscription businesses in Q3. NFL Sunday Ticket is now live in receiving excellent reviews. Fans love our multi-view feature, which can live stream up to 4 games on a single screen. We have heard positive feedback from our partners at the NFL about the new features and live stream reliability. This is a clear example of our ability to execute big partnerships with excellence and at scale.
I'm really pleased with the growth and engagement on YouTube Shorts. We continue to work on closing the monetization gap here. Shorts now average over 70 billion daily views and are watched by over 2 billion signed-in users every month. At Made On YouTube in September, we announced new tools that make it easier to create engaging content. Dream Screen is an experimental feature that allows creators to add AI-generated video or image backgrounds to Shorts. And YouTube Create is a new mobile app with a suite of production tools for editing Shorts, longer videos or both.
Next, Google Cloud. We see continued growth with Q3 revenue of $8.4 billion, up 22%. Today, more than 60% of the world's 1,000 largest companies or Google Cloud customers. At Cloud Next, we showcased amazing innovations across our entire portfolio of infrastructure, data and AI, workspace collaboration and cybersecurity solutions. We offer advanced AI optimized infrastructure to train and serve models at scale. And today, more than half of all funded generative AI start-ups are Google Cloud customers. This includes AI21 Labs, Contextual, Elemental Cognition, Writer and more. We continue to provide the widest choice of accelerator options. Our A3 VMs powered by NVIDIA's H100 GPU are generally available, and we are winning customers with Cloud TPU v5e, our most cost efficient and versatile accelerator to date.
On top of our infrastructure, our Vertex AI platform helps customers build, deploy and scale AI-powered applications. We offer more than 100 models, including popular third-party and open source models, as well as tools to quickly build Search in conversation use cases. From Q2 to Q3, the number of active generative AI projects on Vertex AI grew by 7x, including Highmark Health, which is creating more personalized member materials.
Duet AI was created using Google's leading large foundation models and is specially trained to help users to be more productive on Google Cloud. We continue expanding its capabilities and integrating it across a wide range of cloud products and services. With Duet AI, we are helping leading brands like PayPal and Deutsche Bank boost developer productivity, and we are enabling retailers like Aritzia and Gymshark to gain new insights for better and faster business results. In fact, companies are increasingly using AI for the purpose of finalizing data, and customers are choosing Google Cloud because we are the only large cloud provider with a unified platform to analyze structured and unstructured data.
In Workspace, thousands of companies and more than 1 million trusted testers have used Duet AI. They are writing and refining content in Gmail and Docs, creating original images from text within slides, organizing data and sheets and more. These innovations enable us to provide new services and grow our base of 10 million paying customers including enterprises like Grupo Boticário, Unilever and Warner Music.
We also integrated Duet AI across our cybersecurity portfolio to differentiate in the marketplace, providing generative AI-powered assistance in Mandiant Threat Intelligence, Chronicle Security Operations and Security Command Center. This reduces the time security teams spend writing, running and refining searches by 7x. We are the only leading security provider that combines frontline intelligence and expertise, a modern security operations platform and a trusted cloud foundation, all infused with generative AI, helping product customers and partners like BT, Jack Henry and Associates and CoverMyMeds.
Turning to Hardware. We unveiled our new products this month. We introduced our new Pixel 8, Pixel 8 Pro and Pixel Watch 2 to very positive consumer feedback and reviews. Pixel is the fastest-growing smartphone brand in our top markets and the only one that grew in units sold year-over-year. Our portfolio of Pixel products are brought to life, thanks to our combination of foundational technologies AI, Android and Google Tensor. Google Tensor G3 is the third generation of our tailor-built chip. It's designed to power transformative experiences by bringing the latest in Google AI research directly to our newest phones.
A new AI-powered editing feature in Google photos on Pixel 8 and Pixel 8 Pro remote distractions, generate the best shot from multiple images and reduce distracting sounds in videos. Pixel and our third-party ecosystem are powered by Android. We just released Android 14 with more accessibility features.
I also want to mention Chromebook Plus, a new category which provides the best of Chrome on great hardware with built-in Google apps and powerful AI capabilities. We also shared that Chromebooks will now get regular automatic updates for 10 years, more than any other operating system.
In Other Bets, Waymo is onboarding more riders to its commercial ride-hailing service as it gradually adds over 100,000 people from its San Francisco waitlist. Austin will follow as its next ride-hail city. Wing and Walmart announced a new partnership to provide drone delivery service in the Dallas-Fort Worth area.
Before handing over to Philipp, I want to thank our employees around the world who are working to create innovative products and provide great services to people and businesses who use our products. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone. I'll start with our performance for the quarter and then give color into the 3 key priority areas for ads, Google AI, Retail and YouTube, that we've identified on past calls as opportunities for long-term growth and advertising.
Google Services revenues of $68 billion were up 11% year-on-year. In Google advertising, Search and other revenues grew 11% year-on-year led by solid growth in the retail vertical. In YouTube ads, revenues were up 12% year-on-year driven by growth in both brand and direct response. In Network, revenues declined 3% year-on-year. Google other revenues were up 21% year-on-year led by strong growth in YouTube subscription revenues.
Let's start with Google AI. Recent dramatic advances in everything from foundational research models to LLMs to generative AI are improving our ability to deliver better performance and profitability for advertisers and more helpful, delightful experiences for users.
We covered many innovations last quarter after GML like our conversational experience in Google Ads, significant updates to Performance Max and new campaign types like demand gen. And as Sundar said, we're continuing to experiment with new ad formats on SGE. It's extremely important to us that in this new experience, advertisers still have the opportunity to reach potential customers along their search journeys. I'll highlight more ways we're innovating with the best of Google AI as we double-click into our core business.
In retail, we had a great quarter. In a market where every dollar counts, our proven AI-powered solutions like Search and PMax are helping retailers drive reliable, strong ROI and meet customers wherever they are across the funnel. In Q3, we also started prepping retailers for what will be a long holiday season. Let me share some things.
Number one, with the maximum number of days between Thanksgiving and Christmas and expectations for many micro peaks beyond Cyber 5, we're arming businesses with insights and planning tools, including opti score and Performance Planner to uncover new opportunities, plan budgets and targets to stay competitive and be smarter with their inventory and pricing strategy.
Number two, consumer expectations are shifting, especially around price and convenience. We've seen 4x deals queries during the holidays versus other periods. 75% of users say they'll shop with those offering free shipping. Retailers are capitalizing on these trends with our differentiated merchant offerings like merchant promotions and fulfillment options. And we're making improvements to significantly boost the number of deals shown to shoppers in Search this holiday season. Look out for more in the coming days about new ways we'll help shoppers browse deals across the web this year.
Number three, no surprise, omnichannel is the way to succeed. With our suite of omni product solutions, including local inventory ads, omni bidding and PMax for store goals, retailers, big and small, are capturing demand and incremental store budgets while engaging with high-value customers.
Innovation continues across our shopping and merchant experiences powered by Google AI. Our virtual try-on tool for apparel launched in June and has been a hit with consumers and brands. Users engage with virtual try-on images at a higher rate versus regular brand-provided images.
Product Studio is another launch from GML getting positive feedback in pilot mode. It is the best of gen AI to help businesses create unique and tailored imagery for free that they can then scale across their channels. We're seeing early merchant testers using it to seasonalize their content for the holidays.
Let's shift to YouTube. It's worth repeating our intense focus on creator success, coupled with our multi-format strategy, are at the center of how we think about YouTube's long-term growth. Shorts Connected TV and our subscription offerings are key drivers here, and we're investing across each to solidify YouTube's position as the best place to create, the best place to watch and the best place to deliver results.
Sundar mentioned watch time and engagement momentum on Shorts as well as our monetization progress. He also covered subscription growth and NFL Sunday Ticket. As for Connected TV, we continue to be the #1 overall streaming destination according to Nielsen. 150 million-plus people are watching YouTube on CTV screens every month in the U.S.
Whether it's music videos, NFL Sunday Ticket, free movies shorts, a continuous stream of Mr. Beast or some other creator-led content, viewers want choice and variety, and we're giving it to them all in one place. And to help creators and advertisers connect with these billions of viewers across moments, screens and formats, we're bringing Google AI to awesome new creation tools and ad solutions.
AI will do wonders for creation and storytelling. From Dream Screen and YouTube Create, which Sundar talked about, to features that audit up content in multiple languages, flip interim existing assets, remix and clip videos and more, we're just getting started.
We're also helping brands break through its speed and scale across the funnel to drive results. Spotlight Moments launched last week. It uses AI to identify trending content around major cultural moments for brand sponsorship opportunities. There's video reach campaigns, which are expanding to in-feed and Shorts, and will be generally available in November. AI is helping advertisers find as many people as possible and their ideal audience for the lowest possible price. Early tests are delivering 54% more reach at 42% lower cost. And then with video view campaigns, AI is serving skippable ads across in-stream, in-feed and Shorts and helping advertisers earn the maximum number of views at the lowest possible cost. So far, they're driving 40% more views on average versus in-stream alone.
Then for YouTube and other feed-based services, there's our new demand-gen campaign, which launched in April, rolled out worldwide last week and was designed for the needs of today's social marketers to engage people as they stream, scroll and connect. It combines video and image ads in one campaign with access to 3 billion users across YouTube and Google and the ability to optimize and measure across the funnel using Google AI. Demand gen is already driving successful brands like Samsung and Toyota.
Before I wrap, one quick highlight on our close collaboration and commitment to our most important ecosystems and partners. In July, we launched Google News Showcase in the U.S., our curated online news experience and licensing program with more than 150 news publications, 90% of which are local or regional. Globally, over 2,500 news publications have signed on to News Showcase and the product is live in 23 countries today. Our commitment to open access to news and information remains strong.
With that, I'll end with a thank you to our customers and partners around the world for their continued trust and collaboration and our Googlers everywhere for their incredible hard work and dedication.
Ruth, over to you.
Ruth Porat: Thank you, Philipp. We are very pleased with our financial results for the third quarter, driven by meaningful growth in Search in YouTube and Momentum in Cloud. My comments will be on year-over-year comparisons for the third quarter, unless I state otherwise. I will start with results at the Alphabet level followed by segment results and conclude with our outlook.
For the third quarter, our consolidated revenues were $76.7 billion, up 11% in both reported and constant currency. Search remained the largest contributor to revenue growth. In terms of expenses, total cost of revenues was $33.2 billion, up 7%, primarily reflecting other cost of revenues of $20.6 billion, which was up 6%. Growth here was primarily driven by content acquisition costs mainly for YouTube subscription offerings.
As noted in our earnings release, the overall increase in data center and other operations costs was partially offset by a reduction in depreciation expense due to the change in estimated useful lives we made starting in the first quarter of the year.
Operating expenses were $22.1 billion, up 6%, reflecting the following: first, an increase in R&D expenses driven primarily by compensation; second, an increase in G&A expenses, reflecting the impact of charges related to legal matters; and finally, sales and marketing expenses, which were relatively flat to last year.
Operating income was $21.3 billion, up 25%, and our operating margin was 28%. Other income and expense was a loss of $146 million. Net income was $19.7 billion. This reflects an effective tax rate of 7% in the third quarter from an IRS change related to the use of foreign tax credits, which had an outsized impact on the third quarter rate because the change resulted in a catch-up for prior periods.
We delivered free cash flow of $22.6 billion in the third quarter and $78 million for the trailing 12 months. We ended the quarter with $120 billion in cash and marketable securities. As a reminder, our cash balance and free cash flow in the second and third quarters benefited from the deferral of certain tax payments to the fourth quarter of 2023. As noted in our earnings release, on October 16, we made an estimated tax payment of $10.5 billion related to this deferral, which will be reflected in our cash balance and free cash flow in the fourth quarter.
Turning to segment results. Within Google Services, revenues were $68 billion, up 11%. Google Search and other advertising revenues of $44 billion in the quarter were up 11% led again by growth in retail. YouTube advertising revenues of $8 billion were up 12% driven by both brand advertising and direct response. Network advertising revenues of $7.7 billion were down 3%. Other revenues were $8.3 billion, up 21%, primarily reflecting growth in YouTube nonadvertising revenues driven by subscriber growth in YouTube TV followed by YouTube Music Premium. TAC was $12.6 billion, up 7%. Google Services operating income was $23.9 billion, up 27%, and the operating margin was 35%.
Turning to the Google Cloud segment. Revenues were $8.4 billion for the quarter, up 22%. GCP revenue growth remained strong across geographies, industries and products, although the Q3 year-on-year growth rate reflects the impact of customer optimization efforts. Google Workspace also delivered strong revenue growth, primarily driven by increases in average revenue per seat. Google Cloud had operating income of $266 million, and the operating margin was 3%. As to our Other Bets, for the third quarter, revenues were $297 million and the operating loss was $1.2 billion.
Turning to our outlook for the business with respect to Google Services.
First, within advertising. After a period of historic volatility, we were pleased with the year-on-year revenue growth of Search and YouTube advertising in the third quarter.
Second, within other revenues. In our YouTube subscription products the substantial growth in revenues primarily reflects subscriber growth. Looking ahead, a full quarter of NFL Sunday Ticket revenues as well as associated content acquisition costs will be reflected in Q4 results compared to only a few weeks in the third quarter.
Play had solid growth in the third quarter driven primarily by an increase in the number of buyers.
With respect to Hardware, there is a headwind to revenues in the fourth quarter, reflecting efforts to optimize the portfolio with tighter targeting of our go-to-market investments as well as the ongoing impact from the difference in launch timing for the Pixel 6A and 7A that we mentioned last quarter.
Turning to Google Cloud. We are pleased with the ongoing customer engagement with GCP and Workspace and the potential benefit of our AI solutions, including infrastructure and services such as Vertex AI and Duet. We continue to invest aggressively given the significant potential we see while remaining focused on profitable growth.
In terms of expenses and profitability, we're pleased with our operating performance. As we have repeatedly stressed, we remain focused on durably reengineering our cost base to create investment capacity to support our growth priorities, most important of which is with AI. We have a number of work streams in place.
First, we are maintaining a slower pace of head count growth, reflecting product prioritization and reallocation of talent to support our most important growth opportunities.
Second, we remain focused on optimizing our real estate footprint, including how and where we work to reduce our expense growth. As you can see from our earnings release, we incurred $207 million in accelerated rent and depreciation in the third quarter related to these actions.
Third, we have engineering work streams underway to improve productivity across Alphabet. Given the magnitude of investment in our technical infrastructure, we have a superb team focused on efficiency of our operations there. We are also making progress in streamlining operations across Alphabet through the use of AI.
Finally, there are ongoing work streams that are improving the efficiency of our spend with suppliers and vendors through our central procurement organization. And to be clear, across the portfolio of Other Bet companies, we have also been working to identify opportunities to create sharper focus and to operate more efficiently and effectively.
With respect to sequential quarter-on-quarter trends, two further points. First, cost of sales in the fourth quarter will reflect both higher Hardware costs given Pixel family launches as well as increased CAC for YouTube as previously noted. Second, as usual, we expect sales and marketing expenses to be more heavily weighted to the end of the year, in part to support product launches and the holiday season. Finally, our reported CapEx in Q3 was $8 billion driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers, reflecting a meaningful increase in our investments in AI compute.
The growth in reported cash CapEx in Q3 is somewhat muted due to the timing of supplier payments which can cause variability from quarter-to-quarter. We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.
In closing, we remain very excited about the opportunities ahead and committed to deliver sustainable financial value.
Thank you. Sundar, Philipp and I will now take your questions.
Operator: [Operator Instructions] And our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two. The first one, maybe just a little bit of a jump ball. There's somewhat of an investor debate about sort of the incremental return on capital to Search when it comes to AI. I know it's early, but are there any examples that you're seeing with SGE or Bard on higher utility, higher conversion rates, more engagement, just something to sort of show signal around the return that could come from these investments?
And the second one, Ruth, I know you've spoken a lot about durably reengineering the cost base. I think in the past, you've talked about how expenses could grow slower than revenue in 2024. Is that sort of still the high level way to think about it? Or is that potentially changing a bit as investments are continuing?
Sundar Pichai: Ruth, do you want to take the second part? I'll take the first.
Ruth Porat: Sure. Thanks for that, Brian. So overall, that's sort of a truism, as you know well, looking to grow revenues at a faster rate than expenses as we're focused on delivering sustainable financial value. And so that really takes us to the work streams, which I tried to tick through. Again, those remain the driver. They're the real priority. Those are the efforts that are going to enable us to expense growth. And it's moderated as possible while supporting the investment growth that is so exciting in front of us, in particular, around AI.
Sundar Pichai: And to your first part, obviously, we see AI as a foundational platform shift and are excited about the opportunities across our business. It starts with Search. And I've been pretty pleased with how the user feedback has been on SGE. We are rolling it out to more users. Through it all, we are making sure the product works well, and we are generating value for our ecosystem, and that adds transitions well. And I think I view this as, with AI, the opportunity to evolve Search and Assistant over the next decade ahead. And I think as we've always seen, when you continue to invest and build great experiences, you can get value on the other side. And I do think over time, there will be newer paths, just like we have done on YouTube. I think with the AI work, there are subscription models as a possible path as well. And obviously, all of the AI investments we are doing applies across Cloud, too, and I'm pretty optimistic about what's ahead there as well.
Operator: Your next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: One for Sundar and one for Ruth. Sundar, you talked a lot about AI. I was hoping you could talk more about Gemini and how it will differentiate from other models some of the multimodal capabilities and what new experiences or agents do you think it could unlock and how we should think about timing? And then also just on Cloud, hoping you can talk about some of the factors there on the decel in cloud and just what you're seeing in terms of optimizations? And is there any sign of new workload deployments taking place?
Sundar Pichai: Thanks. Good questions. On Gemini, obviously, it's effort from our combined Google DeepMind team. I'm very excited at the progress there as we're working through getting the model ready. To me, more importantly, we are just really laying the foundation of what I think of as the next-generation series of models we'll be launching throughout 2024. The pace of innovation is extraordinarily impressive to see. We are creating it from the ground up to be multimodal, highly efficient tool and API integrations and, more importantly, laying the platform to enable future innovations as well.
And we are developing Gemini in a way that it is going to be available at various sizes and capabilities, and we'll be using it immediately across all our products internally as well as bringing it out to both developers and cloud customers through Vertex. So I view it as a journey, and each generation is going to be better than the other. And we are definitely investing, and the early results are very promising.
On Cloud, maybe what I would say is, overall, we had definitely started seeing customers looking to optimize spend. We leaned into it to help customers given some of the challenges they were facing. And so that was a factor. But we are definitely seeing a lot of interest in AI. There are many, many projects underway now. Just on Vertex alone, the number of projects grew over 7x. And so we see signs of stabilization, and I'm optimistic about what's ahead.
Operator: Your next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Two, if I could. Sundar, you guys led over a year ago, starting with Performance Max. And I wanted to know if we could get your updated thoughts on how AI might impact the broader advertising industry and how you're aligning Alphabet and Google's goals with AI and where it might take the advertising industry in the years ahead. That would be the first question.
And then about a year ago, Philipp and Ruth started talking about some of the brand advertising headwinds that YouTube was facing. As we start to lap those headwinds, how should we be thinking about a broad recovery in brand advertising versus elements of still headwinds that are being faced in the broader ad space, specifically with YouTube?
Philipp Schindler: So maybe I'd take the first one. We're very pleased with how Performance Max is performing. It gives advertisers really maximum performance across all inventory from, one, really AI-powered campaign, and it's probably the ultimate example of AI in action across our ads product. It's delivering excellent ROI. Those using it achieve like, on average, over 18% more conversions at a similar cost per action. So since rolling it out 2 years ago, we've continued to expand the features, give advertisers additional ways to steer how it works and do a lot of things like account-level negative keywords, other details here.
We launched new life cycle goals, customer life cycle goals, we call them; a revamped asset creation flow that really helps business adapt and scale their most successful creatives. I think that's one to watch. We will also continue to build other new PMax features based on all the advertiser feedback we're seeing. So we're very, very encouraged by the progress here.
Overall, maybe -- there was a second part to your question a bit, on what we're hearing from the customers out there. Look, driving ROI and efficiency is still top of mind for many, right? It's a rapidly shifting and still quite unpredictable consumer landscape out there. Our AI tools are very well received, AI, gen AI are top of mind for everybody, really. There's a ton of excitement, lots of questions about it. Many understand the value. Nearly 80% of our advertisers already use at least one AI-powered search ads product. And yes, we're hearing a lot of good feedback on, number one, our ads AI Essentials, which are really helping to unlock the power of AI and set up for durable ROI growth on the advertiser side, this is -- those are products like the foundation for data and measurement, things like Google Tech, consent mode and so on; and obviously, Search and PMax, we talked about it; and then all the gen AI products, all those different ones. So there's a whole lot of interest in those products, yes.
Ruth Porat: And then on to your second question regarding YouTube, as we said, overall year-on-year growth in revenues was driven by both brand advertising and direct response. But very much to your question, yes, there was a stabilization in spending by advertisers. We're really pleased about that. We're particularly pleased about the ongoing performance in the Living Room and on Shorts. And as I said, that's both watch time growth and monetization. I'd say the other thing benefiting YouTube is the retail strength we talked about with Search, retail strength in APAC in both Search and YouTube. And that really began in the second quarter, continued in the third quarter, but that was another contributor. So quite a number of things going on. I feel good about the results the team was able to deliver here.
Operator: Your next question comes from Lloyd Walmsley with UBS.
Lloyd Walmsley: Two, if I can. First, as we just think about the rollout of SGE across the user base, like how far along is that? And how do you balance the product rollout and consumer uptake versus monetization in that transition?
And then the second one, also sort of generative AI related, how quickly are you guys finding new ways of optimizing whether that's shrinking model sizes, chip efficiencies or anything else? And do you think overall capital intensity of the business scales up or do you just find ways to do this more efficiently as usage scales? Anything you could share there would be great.
Sundar Pichai: On the first part about SGE, we are still in very, very early days in terms of how much we have rolled it out, but we have definitely gotten it out to enough people both geographically across user segments and enough to know that the product is working well, it improves the experience and -- but there are areas to improve, which we are fine-tuning. Our true north here is getting at the right user experience we want to, and I'm pretty comfortable seeing the trajectory. And we've always worked through these transitions, be it from desktop to mobile or from now mobile to AI and then to experience. And so it's nothing new. And I feel very comfortable that as we go through it, the strength of our teams, both on the organic side as well as at site, to drive the right experience for users, including ads, will pay dividends. And I think we'll continue to make improvements and make progress there.
On your second question, at a high level, I would say, all through the -- we just celebrated 25 years. And of all the things I was proud about, when I looked at the strength of the work we have done across our infrastructure as a company, our technical infrastructure as a company, and various given stages, at a given moment in time when we adopted new generations of technology, we have looked at the cost of it. But then the curves, the efficiency curves, we have driven on top of it has always been phenomenal to see. And I see the current moment as no different. Already through this year, we are driving significant efficiencies both in our models, in training costs and serving costs and our ability to adapt what's needed to the right use case. And so I think we'll do everything that is needed to make sure we have the leading AI models and infrastructure in the world, bar none, and we'll continue driving efficiencies from there.
Operator: Your next question comes from Michael Nathanson with MoffettNathanson.
Michael Nathanson: I'm going to ask you guys a multipart question on YouTube TV. So firstly, what were the broader objectives for getting Sunday Ticket? How does it perform versus those objectives? What lessons have you learned from having the NFL Sunday Ticket? How does that affect your appetite for more sports going forward?
Philipp Schindler: So as Sundar said earlier, we're several weeks into our first season, and we're very pleased with how it's going. I think, in the broader context, you have to look at it as an overall YouTube subscription strategy. The great feedback we've gotten so far in the YouTube experience is very, very significant. People love the navigation. They love multi-view, they love the chats and the polls. And frankly, people are very happy with the lack of latency here. The #1 piece of concrete feedback the team has gotten is actually that people want the ability to pick their own games from multi-view, which is multi-view is the awesome feature we started rolling out on YouTube TV, that gives sense to the ability to basically watch multiple streams at once. And yes, overall, the teams are working hard to build a fantastic experience, and we are really trying to stay focused on getting our first season right and providing the best possible experience really for fans here.
Operator: Your next question comes from Justin Post with Bank of America.
Justin Post: A couple of questions on Q4. Can you provide any color if there's been any pause in advertising around the Middle East conflict in October, anything we should be aware of for Q4?
And then second, when we do think about the Sunday Ticket impact, I know you can't give us revenues or expenses, but overall, would that be a headwind to margins in Q4 or something we should be thinking about?
Ruth Porat: So look, on the first question, obviously, this is tragic. There are no words to talk about what's going on. And all of our focus has been on supporting our people there and how our products can be as helpful as possible in this very painful time broadly, and so nothing really to add.
And then in terms of the second question, Sunday Ticket, the only thing I tried to call out there is that clearly, this is the first full quarter of Sunday Ticket that is contributing overall to the subscription revenues that we see. That's in part of other revenues. Also, obviously, it is contributing to higher CAC in the fourth quarter. So we try to make that really clear. And as we look longer term, we expect to generate an attractive return over the life of the deal. We're continuing to invest in support of this and excited about the additional opportunities that come out of it, working with partners to deliver clips and other opportunities.
As we've said, we've heard positive feedback from our partners at the NFL about the new features and live stream reliability. And this is really a clear example of our ability to execute big partnerships with excellence at scale and really leverage a lot of the extraordinary magic at YouTube and across Google, and that's what we're excited about.
Operator: Your next question comes from Ken Gawrelski with Wells Fargo.
Kenneth Gawrelski: Two questions, if I may. First, how do you think about the future structure of AI-driven Search capabilities? Will activity remain centralized in a search bar or will it be decentralized and present in many different applications, including on third-party applications? You alluded to Bard being integrated into multiple Google experiences earlier in the call.
And then the second question is, any update on the Chrome cookie deprecation plan to begin in 1Q '24? What have you seen so far based on your early testing of Privacy Sandbox? And what advertiser feedback have you received?
Sundar Pichai: On your first question, look, I broadly think of it as people are looking for information. They always look for it in many, many different ways. We've given the product search example. People can directly go to Amazon, as an example, or come to Google. So if you zoom back and take an information view of the world, there's always been many different ways to get it. And part of our work we do in making Search be world-class and give users what they're looking for is so that we can get as much of that intent as possible. So I don't see that changing. With mobile, there were more ways people could get information, but we worked out to make Search work better in the mobile world. And similarly, a view with AI, there'll be many ways people get information, but it also offers us an opportunity in Search and in Assistant to take it to the next level and answer use cases, which we couldn't have done before, and expand the diverse set of needs where we are sourced. So that's how I see the opportunity ahead.
Philipp Schindler: And to the second part of your question, yes, Chrome still plans to begin phasing out third-party cookies in the second half of '24. In the last several months, Chrome has really made significant progress on the Privacy Sandbox with APIs for developer testing, and they're now generally available in Chrome. Our ads team is testing these APIs. And as we shared back in April, the preliminary results of our interest-based ads testing showed that a combination of what we call privacy preserving signals and AI optimization actually provides positive results for businesses preparing for a cookie-less future.
We also recently announced that in Q1 of '24, we plan to deprecate third-party cookies for 1% of Chrome users, and this will support developers, obviously, in conducting their real-world experiments to assess the readiness and effectiveness of their products without third-party cookies. And we're overall encouraged by the ecosystem engagement on Privacy Sandbox. We'll continue to work with the industry and regulators in how these technologies can support the transition to, frankly, a more private web.
Operator: And our last question comes from Mark Mahaney with Evercore.
Mark Stephen Mahaney: Two questions, please. Ruth, you talked about these elevated levels of investments in Q4 and in '24. I'm sorry, were you referring to just CapEx or CapEx and total expenses? And then on the comments around stabilization in Cloud, is this something that you just started to see in the September quarter? Or had you seen that starting earlier in the year? And if you just started seeing it in the September quarter, would you have any thoughts on why you would have seen it, like Google Cloud would have seen it maybe later than some of the other hyperscalers?
Ruth Porat: So I think what you're referring to is my CapEx comment. I was trying to make the point that we are committed to meaningfully investing in CapEx given all the opportunities we see. We do continue to expect elevated levels of investment in our technical infrastructure. It will be increasing in the fourth quarter. And I talked about some of the difference in timing, muted timing, in the third quarter due to the timing of supplier payments and then tried to make it clear that we will continue to grow CapEx in 2024. Or more specifically, to your question, 2024 aggregate CapEx will be above the full year 2023. So that was the main one.
And then as it relates to Cloud, as Sundar said, what we're really excited about is the revenue growth does reflect healthy customer adoption across the portfolio, and that's infrastructure, data analytics and security. And so I can't comment on others, but we feel good about where we're sitting here looking forward, and we'll let you do the forecasting. GCP growth in the third quarter was above the growth rate for Cloud overall, and we feel really good about the work that they're doing there. And then, of course, in addition to that is all of the contribution from Google Workspace.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again in our fourth quarter 2023 call. Thank you, and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
GOOG | 3 | 2,023 | 2023-10-24 00:00:00 | Operator: Welcome, everyone. Thank you for standing by for the Alphabet Third Quarter 2023 Earnings Conference Call. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Jim Friedland, Director of Investor Relations. Please go ahead.
James Friedland: Thank you. Good afternoon, everyone, and welcome to Alphabet's Third Quarter 2023 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler and Ruth Porat.
Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations and financial performance may be considered forward-looking. Such statements are based on current expectations and assumptions that are subject to a number of risks and uncertainties. Actual results could differ materially. Please refer to our Form 10-K, including our Risk Factors section and our Form 10-Q. We undertake no obligation to update any forward-looking statement.
During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise.
And now, I'll turn the call over to Sundar.
Sundar Pichai: Thank you, Jim, and hello, everyone. I'm pleased with our business results this quarter, which demonstrates strong growth in Search and YouTube and momentum in Cloud. Google turned 25 in September, which offered an opportunity to reflect on our progress over the last quarter century and to look ahead to the opportunities enabled by AI we are so excited and confident about.
Our product momentum continued this quarter, as you saw with Cloud Next made on YouTube and made by Google. It's all part of our focus on making AI more helpful for everyone, and we are making good progress across the 4 areas that we shared last quarter.
First, improving knowledge and learning. This includes our work with the Search Generative Experience, which is our experiment to bring generative AI capabilities into Search. We have learned a lot from people trying it, and we have added new capabilities like incorporating videos and images into responses and generating imagery. We have also made it easier to understand and debug generated code. Direct user feedback has been positive with strong growth in adoption. In August, we opened up availability to India and Japan with more countries and languages to come. As we add features and expand into new markets, we are engaging with the broader ecosystem, and we'll continue to prioritize approaches that add value for our users, send valuable traffic to publishers and support a healthy open Internet.
With generative AI applied to Search, we can serve a wider range of information needs and answer new types of questions, including those that benefit from multiple perspectives. We are surfacing more links with SGE and linking to a wider range of sources on the results page, creating new opportunities for content to be discovered. Of course, ads will continue to play an important role in this new Search experience. People are finding ads helpful here as they provide useful options to take action and connect with businesses. We'll experiment with new formats native to SGE that use generative AI to create relevant, high-quality ads customized to every step of the Search journey.
The second area we are focused on is boosting creativity and productivity. Bard is particularly helpful here. It's a direct interface to a conversational LLM and we think of it as an early experiment and complementary experience to Google Search. Bard can now integrate with Google apps and services showing relevant information from Workspace, Maps, YouTube and Google Flights and Hotels.
We've also improved the Google IT feature. It provides other sources to help people evaluate Bard's responses and explore information across the web. Earlier this month, we announced Assistant with Bard, a personal assistant powered by generative AI. It combines Bard's generative and reasoning capabilities with Assistant's personalized help. You can interact with it through text, voice or images. And in the coming months, you'll be able to opt in on Android and iOS mobile devices. Our collaborative tools in Workspace and YouTube are also part of how we boost creativity and productivity, and they are seeing great initial traction.
Third, we are enabling developers, businesses and other organizations to build their own transformative products and services. For example, thousands of customers and partners are already using Google Cloud to capture the potential of AI, and we'll share more there in a minute.
And fourth, we are building and deploying AI responsibly so that everyone can benefit. One area we are focused on is making sure people can more easily identify when they are encountering AI-generated content online, using new technology powered by Google DeepMind SynthID, images generated by Vertex AI can be watermarked in a way that is invisible to the human eye without reducing the image quality. Underlying all this work is the foundational research done by our teams at Google DeepMind and Google Research. We are excited to roll out more of what they've been working on soon.
As we expand access to our new AI services, we continue to make meaningful investments in support of our AI efforts. We remain committed to durably reengineering our cost base in order to help create capacity for these investments in support of long-term sustainable financial value. Across Alphabet, teams are looking at ways to operate as effectively as possible focused on their biggest priorities.
Turning next to YouTube, which saw solid momentum in both its ads and subscription businesses in Q3. NFL Sunday Ticket is now live in receiving excellent reviews. Fans love our multi-view feature, which can live stream up to 4 games on a single screen. We have heard positive feedback from our partners at the NFL about the new features and live stream reliability. This is a clear example of our ability to execute big partnerships with excellence and at scale.
I'm really pleased with the growth and engagement on YouTube Shorts. We continue to work on closing the monetization gap here. Shorts now average over 70 billion daily views and are watched by over 2 billion signed-in users every month. At Made On YouTube in September, we announced new tools that make it easier to create engaging content. Dream Screen is an experimental feature that allows creators to add AI-generated video or image backgrounds to Shorts. And YouTube Create is a new mobile app with a suite of production tools for editing Shorts, longer videos or both.
Next, Google Cloud. We see continued growth with Q3 revenue of $8.4 billion, up 22%. Today, more than 60% of the world's 1,000 largest companies or Google Cloud customers. At Cloud Next, we showcased amazing innovations across our entire portfolio of infrastructure, data and AI, workspace collaboration and cybersecurity solutions. We offer advanced AI optimized infrastructure to train and serve models at scale. And today, more than half of all funded generative AI start-ups are Google Cloud customers. This includes AI21 Labs, Contextual, Elemental Cognition, Writer and more. We continue to provide the widest choice of accelerator options. Our A3 VMs powered by NVIDIA's H100 GPU are generally available, and we are winning customers with Cloud TPU v5e, our most cost efficient and versatile accelerator to date.
On top of our infrastructure, our Vertex AI platform helps customers build, deploy and scale AI-powered applications. We offer more than 100 models, including popular third-party and open source models, as well as tools to quickly build Search in conversation use cases. From Q2 to Q3, the number of active generative AI projects on Vertex AI grew by 7x, including Highmark Health, which is creating more personalized member materials.
Duet AI was created using Google's leading large foundation models and is specially trained to help users to be more productive on Google Cloud. We continue expanding its capabilities and integrating it across a wide range of cloud products and services. With Duet AI, we are helping leading brands like PayPal and Deutsche Bank boost developer productivity, and we are enabling retailers like Aritzia and Gymshark to gain new insights for better and faster business results. In fact, companies are increasingly using AI for the purpose of finalizing data, and customers are choosing Google Cloud because we are the only large cloud provider with a unified platform to analyze structured and unstructured data.
In Workspace, thousands of companies and more than 1 million trusted testers have used Duet AI. They are writing and refining content in Gmail and Docs, creating original images from text within slides, organizing data and sheets and more. These innovations enable us to provide new services and grow our base of 10 million paying customers including enterprises like Grupo Boticário, Unilever and Warner Music.
We also integrated Duet AI across our cybersecurity portfolio to differentiate in the marketplace, providing generative AI-powered assistance in Mandiant Threat Intelligence, Chronicle Security Operations and Security Command Center. This reduces the time security teams spend writing, running and refining searches by 7x. We are the only leading security provider that combines frontline intelligence and expertise, a modern security operations platform and a trusted cloud foundation, all infused with generative AI, helping product customers and partners like BT, Jack Henry and Associates and CoverMyMeds.
Turning to Hardware. We unveiled our new products this month. We introduced our new Pixel 8, Pixel 8 Pro and Pixel Watch 2 to very positive consumer feedback and reviews. Pixel is the fastest-growing smartphone brand in our top markets and the only one that grew in units sold year-over-year. Our portfolio of Pixel products are brought to life, thanks to our combination of foundational technologies AI, Android and Google Tensor. Google Tensor G3 is the third generation of our tailor-built chip. It's designed to power transformative experiences by bringing the latest in Google AI research directly to our newest phones.
A new AI-powered editing feature in Google photos on Pixel 8 and Pixel 8 Pro remote distractions, generate the best shot from multiple images and reduce distracting sounds in videos. Pixel and our third-party ecosystem are powered by Android. We just released Android 14 with more accessibility features.
I also want to mention Chromebook Plus, a new category which provides the best of Chrome on great hardware with built-in Google apps and powerful AI capabilities. We also shared that Chromebooks will now get regular automatic updates for 10 years, more than any other operating system.
In Other Bets, Waymo is onboarding more riders to its commercial ride-hailing service as it gradually adds over 100,000 people from its San Francisco waitlist. Austin will follow as its next ride-hail city. Wing and Walmart announced a new partnership to provide drone delivery service in the Dallas-Fort Worth area.
Before handing over to Philipp, I want to thank our employees around the world who are working to create innovative products and provide great services to people and businesses who use our products. Philipp?
Philipp Schindler: Thanks, Sundar, and hi, everyone. I'll start with our performance for the quarter and then give color into the 3 key priority areas for ads, Google AI, Retail and YouTube, that we've identified on past calls as opportunities for long-term growth and advertising.
Google Services revenues of $68 billion were up 11% year-on-year. In Google advertising, Search and other revenues grew 11% year-on-year led by solid growth in the retail vertical. In YouTube ads, revenues were up 12% year-on-year driven by growth in both brand and direct response. In Network, revenues declined 3% year-on-year. Google other revenues were up 21% year-on-year led by strong growth in YouTube subscription revenues.
Let's start with Google AI. Recent dramatic advances in everything from foundational research models to LLMs to generative AI are improving our ability to deliver better performance and profitability for advertisers and more helpful, delightful experiences for users.
We covered many innovations last quarter after GML like our conversational experience in Google Ads, significant updates to Performance Max and new campaign types like demand gen. And as Sundar said, we're continuing to experiment with new ad formats on SGE. It's extremely important to us that in this new experience, advertisers still have the opportunity to reach potential customers along their search journeys. I'll highlight more ways we're innovating with the best of Google AI as we double-click into our core business.
In retail, we had a great quarter. In a market where every dollar counts, our proven AI-powered solutions like Search and PMax are helping retailers drive reliable, strong ROI and meet customers wherever they are across the funnel. In Q3, we also started prepping retailers for what will be a long holiday season. Let me share some things.
Number one, with the maximum number of days between Thanksgiving and Christmas and expectations for many micro peaks beyond Cyber 5, we're arming businesses with insights and planning tools, including opti score and Performance Planner to uncover new opportunities, plan budgets and targets to stay competitive and be smarter with their inventory and pricing strategy.
Number two, consumer expectations are shifting, especially around price and convenience. We've seen 4x deals queries during the holidays versus other periods. 75% of users say they'll shop with those offering free shipping. Retailers are capitalizing on these trends with our differentiated merchant offerings like merchant promotions and fulfillment options. And we're making improvements to significantly boost the number of deals shown to shoppers in Search this holiday season. Look out for more in the coming days about new ways we'll help shoppers browse deals across the web this year.
Number three, no surprise, omnichannel is the way to succeed. With our suite of omni product solutions, including local inventory ads, omni bidding and PMax for store goals, retailers, big and small, are capturing demand and incremental store budgets while engaging with high-value customers.
Innovation continues across our shopping and merchant experiences powered by Google AI. Our virtual try-on tool for apparel launched in June and has been a hit with consumers and brands. Users engage with virtual try-on images at a higher rate versus regular brand-provided images.
Product Studio is another launch from GML getting positive feedback in pilot mode. It is the best of gen AI to help businesses create unique and tailored imagery for free that they can then scale across their channels. We're seeing early merchant testers using it to seasonalize their content for the holidays.
Let's shift to YouTube. It's worth repeating our intense focus on creator success, coupled with our multi-format strategy, are at the center of how we think about YouTube's long-term growth. Shorts Connected TV and our subscription offerings are key drivers here, and we're investing across each to solidify YouTube's position as the best place to create, the best place to watch and the best place to deliver results.
Sundar mentioned watch time and engagement momentum on Shorts as well as our monetization progress. He also covered subscription growth and NFL Sunday Ticket. As for Connected TV, we continue to be the #1 overall streaming destination according to Nielsen. 150 million-plus people are watching YouTube on CTV screens every month in the U.S.
Whether it's music videos, NFL Sunday Ticket, free movies shorts, a continuous stream of Mr. Beast or some other creator-led content, viewers want choice and variety, and we're giving it to them all in one place. And to help creators and advertisers connect with these billions of viewers across moments, screens and formats, we're bringing Google AI to awesome new creation tools and ad solutions.
AI will do wonders for creation and storytelling. From Dream Screen and YouTube Create, which Sundar talked about, to features that audit up content in multiple languages, flip interim existing assets, remix and clip videos and more, we're just getting started.
We're also helping brands break through its speed and scale across the funnel to drive results. Spotlight Moments launched last week. It uses AI to identify trending content around major cultural moments for brand sponsorship opportunities. There's video reach campaigns, which are expanding to in-feed and Shorts, and will be generally available in November. AI is helping advertisers find as many people as possible and their ideal audience for the lowest possible price. Early tests are delivering 54% more reach at 42% lower cost. And then with video view campaigns, AI is serving skippable ads across in-stream, in-feed and Shorts and helping advertisers earn the maximum number of views at the lowest possible cost. So far, they're driving 40% more views on average versus in-stream alone.
Then for YouTube and other feed-based services, there's our new demand-gen campaign, which launched in April, rolled out worldwide last week and was designed for the needs of today's social marketers to engage people as they stream, scroll and connect. It combines video and image ads in one campaign with access to 3 billion users across YouTube and Google and the ability to optimize and measure across the funnel using Google AI. Demand gen is already driving successful brands like Samsung and Toyota.
Before I wrap, one quick highlight on our close collaboration and commitment to our most important ecosystems and partners. In July, we launched Google News Showcase in the U.S., our curated online news experience and licensing program with more than 150 news publications, 90% of which are local or regional. Globally, over 2,500 news publications have signed on to News Showcase and the product is live in 23 countries today. Our commitment to open access to news and information remains strong.
With that, I'll end with a thank you to our customers and partners around the world for their continued trust and collaboration and our Googlers everywhere for their incredible hard work and dedication.
Ruth, over to you.
Ruth Porat: Thank you, Philipp. We are very pleased with our financial results for the third quarter, driven by meaningful growth in Search in YouTube and Momentum in Cloud. My comments will be on year-over-year comparisons for the third quarter, unless I state otherwise. I will start with results at the Alphabet level followed by segment results and conclude with our outlook.
For the third quarter, our consolidated revenues were $76.7 billion, up 11% in both reported and constant currency. Search remained the largest contributor to revenue growth. In terms of expenses, total cost of revenues was $33.2 billion, up 7%, primarily reflecting other cost of revenues of $20.6 billion, which was up 6%. Growth here was primarily driven by content acquisition costs mainly for YouTube subscription offerings.
As noted in our earnings release, the overall increase in data center and other operations costs was partially offset by a reduction in depreciation expense due to the change in estimated useful lives we made starting in the first quarter of the year.
Operating expenses were $22.1 billion, up 6%, reflecting the following: first, an increase in R&D expenses driven primarily by compensation; second, an increase in G&A expenses, reflecting the impact of charges related to legal matters; and finally, sales and marketing expenses, which were relatively flat to last year.
Operating income was $21.3 billion, up 25%, and our operating margin was 28%. Other income and expense was a loss of $146 million. Net income was $19.7 billion. This reflects an effective tax rate of 7% in the third quarter from an IRS change related to the use of foreign tax credits, which had an outsized impact on the third quarter rate because the change resulted in a catch-up for prior periods.
We delivered free cash flow of $22.6 billion in the third quarter and $78 million for the trailing 12 months. We ended the quarter with $120 billion in cash and marketable securities. As a reminder, our cash balance and free cash flow in the second and third quarters benefited from the deferral of certain tax payments to the fourth quarter of 2023. As noted in our earnings release, on October 16, we made an estimated tax payment of $10.5 billion related to this deferral, which will be reflected in our cash balance and free cash flow in the fourth quarter.
Turning to segment results. Within Google Services, revenues were $68 billion, up 11%. Google Search and other advertising revenues of $44 billion in the quarter were up 11% led again by growth in retail. YouTube advertising revenues of $8 billion were up 12% driven by both brand advertising and direct response. Network advertising revenues of $7.7 billion were down 3%. Other revenues were $8.3 billion, up 21%, primarily reflecting growth in YouTube nonadvertising revenues driven by subscriber growth in YouTube TV followed by YouTube Music Premium. TAC was $12.6 billion, up 7%. Google Services operating income was $23.9 billion, up 27%, and the operating margin was 35%.
Turning to the Google Cloud segment. Revenues were $8.4 billion for the quarter, up 22%. GCP revenue growth remained strong across geographies, industries and products, although the Q3 year-on-year growth rate reflects the impact of customer optimization efforts. Google Workspace also delivered strong revenue growth, primarily driven by increases in average revenue per seat. Google Cloud had operating income of $266 million, and the operating margin was 3%. As to our Other Bets, for the third quarter, revenues were $297 million and the operating loss was $1.2 billion.
Turning to our outlook for the business with respect to Google Services.
First, within advertising. After a period of historic volatility, we were pleased with the year-on-year revenue growth of Search and YouTube advertising in the third quarter.
Second, within other revenues. In our YouTube subscription products the substantial growth in revenues primarily reflects subscriber growth. Looking ahead, a full quarter of NFL Sunday Ticket revenues as well as associated content acquisition costs will be reflected in Q4 results compared to only a few weeks in the third quarter.
Play had solid growth in the third quarter driven primarily by an increase in the number of buyers.
With respect to Hardware, there is a headwind to revenues in the fourth quarter, reflecting efforts to optimize the portfolio with tighter targeting of our go-to-market investments as well as the ongoing impact from the difference in launch timing for the Pixel 6A and 7A that we mentioned last quarter.
Turning to Google Cloud. We are pleased with the ongoing customer engagement with GCP and Workspace and the potential benefit of our AI solutions, including infrastructure and services such as Vertex AI and Duet. We continue to invest aggressively given the significant potential we see while remaining focused on profitable growth.
In terms of expenses and profitability, we're pleased with our operating performance. As we have repeatedly stressed, we remain focused on durably reengineering our cost base to create investment capacity to support our growth priorities, most important of which is with AI. We have a number of work streams in place.
First, we are maintaining a slower pace of head count growth, reflecting product prioritization and reallocation of talent to support our most important growth opportunities.
Second, we remain focused on optimizing our real estate footprint, including how and where we work to reduce our expense growth. As you can see from our earnings release, we incurred $207 million in accelerated rent and depreciation in the third quarter related to these actions.
Third, we have engineering work streams underway to improve productivity across Alphabet. Given the magnitude of investment in our technical infrastructure, we have a superb team focused on efficiency of our operations there. We are also making progress in streamlining operations across Alphabet through the use of AI.
Finally, there are ongoing work streams that are improving the efficiency of our spend with suppliers and vendors through our central procurement organization. And to be clear, across the portfolio of Other Bet companies, we have also been working to identify opportunities to create sharper focus and to operate more efficiently and effectively.
With respect to sequential quarter-on-quarter trends, two further points. First, cost of sales in the fourth quarter will reflect both higher Hardware costs given Pixel family launches as well as increased CAC for YouTube as previously noted. Second, as usual, we expect sales and marketing expenses to be more heavily weighted to the end of the year, in part to support product launches and the holiday season. Finally, our reported CapEx in Q3 was $8 billion driven overwhelmingly by investment in our technical infrastructure with the largest component for servers followed by data centers, reflecting a meaningful increase in our investments in AI compute.
The growth in reported cash CapEx in Q3 is somewhat muted due to the timing of supplier payments which can cause variability from quarter-to-quarter. We continue to invest meaningfully in the technical infrastructure needed to support the opportunities we see in AI across Alphabet and expect elevated levels of investment, increasing in the fourth quarter of 2023 and continuing to grow in 2024.
In closing, we remain very excited about the opportunities ahead and committed to deliver sustainable financial value.
Thank you. Sundar, Philipp and I will now take your questions.
Operator: [Operator Instructions] And our first question comes from Brian Nowak with Morgan Stanley.
Brian Nowak: I have two. The first one, maybe just a little bit of a jump ball. There's somewhat of an investor debate about sort of the incremental return on capital to Search when it comes to AI. I know it's early, but are there any examples that you're seeing with SGE or Bard on higher utility, higher conversion rates, more engagement, just something to sort of show signal around the return that could come from these investments?
And the second one, Ruth, I know you've spoken a lot about durably reengineering the cost base. I think in the past, you've talked about how expenses could grow slower than revenue in 2024. Is that sort of still the high level way to think about it? Or is that potentially changing a bit as investments are continuing?
Sundar Pichai: Ruth, do you want to take the second part? I'll take the first.
Ruth Porat: Sure. Thanks for that, Brian. So overall, that's sort of a truism, as you know well, looking to grow revenues at a faster rate than expenses as we're focused on delivering sustainable financial value. And so that really takes us to the work streams, which I tried to tick through. Again, those remain the driver. They're the real priority. Those are the efforts that are going to enable us to expense growth. And it's moderated as possible while supporting the investment growth that is so exciting in front of us, in particular, around AI.
Sundar Pichai: And to your first part, obviously, we see AI as a foundational platform shift and are excited about the opportunities across our business. It starts with Search. And I've been pretty pleased with how the user feedback has been on SGE. We are rolling it out to more users. Through it all, we are making sure the product works well, and we are generating value for our ecosystem, and that adds transitions well. And I think I view this as, with AI, the opportunity to evolve Search and Assistant over the next decade ahead. And I think as we've always seen, when you continue to invest and build great experiences, you can get value on the other side. And I do think over time, there will be newer paths, just like we have done on YouTube. I think with the AI work, there are subscription models as a possible path as well. And obviously, all of the AI investments we are doing applies across Cloud, too, and I'm pretty optimistic about what's ahead there as well.
Operator: Your next question comes from Doug Anmuth with JPMorgan.
Douglas Anmuth: One for Sundar and one for Ruth. Sundar, you talked a lot about AI. I was hoping you could talk more about Gemini and how it will differentiate from other models some of the multimodal capabilities and what new experiences or agents do you think it could unlock and how we should think about timing? And then also just on Cloud, hoping you can talk about some of the factors there on the decel in cloud and just what you're seeing in terms of optimizations? And is there any sign of new workload deployments taking place?
Sundar Pichai: Thanks. Good questions. On Gemini, obviously, it's effort from our combined Google DeepMind team. I'm very excited at the progress there as we're working through getting the model ready. To me, more importantly, we are just really laying the foundation of what I think of as the next-generation series of models we'll be launching throughout 2024. The pace of innovation is extraordinarily impressive to see. We are creating it from the ground up to be multimodal, highly efficient tool and API integrations and, more importantly, laying the platform to enable future innovations as well.
And we are developing Gemini in a way that it is going to be available at various sizes and capabilities, and we'll be using it immediately across all our products internally as well as bringing it out to both developers and cloud customers through Vertex. So I view it as a journey, and each generation is going to be better than the other. And we are definitely investing, and the early results are very promising.
On Cloud, maybe what I would say is, overall, we had definitely started seeing customers looking to optimize spend. We leaned into it to help customers given some of the challenges they were facing. And so that was a factor. But we are definitely seeing a lot of interest in AI. There are many, many projects underway now. Just on Vertex alone, the number of projects grew over 7x. And so we see signs of stabilization, and I'm optimistic about what's ahead.
Operator: Your next question comes from Eric Sheridan with Goldman Sachs.
Eric Sheridan: Two, if I could. Sundar, you guys led over a year ago, starting with Performance Max. And I wanted to know if we could get your updated thoughts on how AI might impact the broader advertising industry and how you're aligning Alphabet and Google's goals with AI and where it might take the advertising industry in the years ahead. That would be the first question.
And then about a year ago, Philipp and Ruth started talking about some of the brand advertising headwinds that YouTube was facing. As we start to lap those headwinds, how should we be thinking about a broad recovery in brand advertising versus elements of still headwinds that are being faced in the broader ad space, specifically with YouTube?
Philipp Schindler: So maybe I'd take the first one. We're very pleased with how Performance Max is performing. It gives advertisers really maximum performance across all inventory from, one, really AI-powered campaign, and it's probably the ultimate example of AI in action across our ads product. It's delivering excellent ROI. Those using it achieve like, on average, over 18% more conversions at a similar cost per action. So since rolling it out 2 years ago, we've continued to expand the features, give advertisers additional ways to steer how it works and do a lot of things like account-level negative keywords, other details here.
We launched new life cycle goals, customer life cycle goals, we call them; a revamped asset creation flow that really helps business adapt and scale their most successful creatives. I think that's one to watch. We will also continue to build other new PMax features based on all the advertiser feedback we're seeing. So we're very, very encouraged by the progress here.
Overall, maybe -- there was a second part to your question a bit, on what we're hearing from the customers out there. Look, driving ROI and efficiency is still top of mind for many, right? It's a rapidly shifting and still quite unpredictable consumer landscape out there. Our AI tools are very well received, AI, gen AI are top of mind for everybody, really. There's a ton of excitement, lots of questions about it. Many understand the value. Nearly 80% of our advertisers already use at least one AI-powered search ads product. And yes, we're hearing a lot of good feedback on, number one, our ads AI Essentials, which are really helping to unlock the power of AI and set up for durable ROI growth on the advertiser side, this is -- those are products like the foundation for data and measurement, things like Google Tech, consent mode and so on; and obviously, Search and PMax, we talked about it; and then all the gen AI products, all those different ones. So there's a whole lot of interest in those products, yes.
Ruth Porat: And then on to your second question regarding YouTube, as we said, overall year-on-year growth in revenues was driven by both brand advertising and direct response. But very much to your question, yes, there was a stabilization in spending by advertisers. We're really pleased about that. We're particularly pleased about the ongoing performance in the Living Room and on Shorts. And as I said, that's both watch time growth and monetization. I'd say the other thing benefiting YouTube is the retail strength we talked about with Search, retail strength in APAC in both Search and YouTube. And that really began in the second quarter, continued in the third quarter, but that was another contributor. So quite a number of things going on. I feel good about the results the team was able to deliver here.
Operator: Your next question comes from Lloyd Walmsley with UBS.
Lloyd Walmsley: Two, if I can. First, as we just think about the rollout of SGE across the user base, like how far along is that? And how do you balance the product rollout and consumer uptake versus monetization in that transition?
And then the second one, also sort of generative AI related, how quickly are you guys finding new ways of optimizing whether that's shrinking model sizes, chip efficiencies or anything else? And do you think overall capital intensity of the business scales up or do you just find ways to do this more efficiently as usage scales? Anything you could share there would be great.
Sundar Pichai: On the first part about SGE, we are still in very, very early days in terms of how much we have rolled it out, but we have definitely gotten it out to enough people both geographically across user segments and enough to know that the product is working well, it improves the experience and -- but there are areas to improve, which we are fine-tuning. Our true north here is getting at the right user experience we want to, and I'm pretty comfortable seeing the trajectory. And we've always worked through these transitions, be it from desktop to mobile or from now mobile to AI and then to experience. And so it's nothing new. And I feel very comfortable that as we go through it, the strength of our teams, both on the organic side as well as at site, to drive the right experience for users, including ads, will pay dividends. And I think we'll continue to make improvements and make progress there.
On your second question, at a high level, I would say, all through the -- we just celebrated 25 years. And of all the things I was proud about, when I looked at the strength of the work we have done across our infrastructure as a company, our technical infrastructure as a company, and various given stages, at a given moment in time when we adopted new generations of technology, we have looked at the cost of it. But then the curves, the efficiency curves, we have driven on top of it has always been phenomenal to see. And I see the current moment as no different. Already through this year, we are driving significant efficiencies both in our models, in training costs and serving costs and our ability to adapt what's needed to the right use case. And so I think we'll do everything that is needed to make sure we have the leading AI models and infrastructure in the world, bar none, and we'll continue driving efficiencies from there.
Operator: Your next question comes from Michael Nathanson with MoffettNathanson.
Michael Nathanson: I'm going to ask you guys a multipart question on YouTube TV. So firstly, what were the broader objectives for getting Sunday Ticket? How does it perform versus those objectives? What lessons have you learned from having the NFL Sunday Ticket? How does that affect your appetite for more sports going forward?
Philipp Schindler: So as Sundar said earlier, we're several weeks into our first season, and we're very pleased with how it's going. I think, in the broader context, you have to look at it as an overall YouTube subscription strategy. The great feedback we've gotten so far in the YouTube experience is very, very significant. People love the navigation. They love multi-view, they love the chats and the polls. And frankly, people are very happy with the lack of latency here. The #1 piece of concrete feedback the team has gotten is actually that people want the ability to pick their own games from multi-view, which is multi-view is the awesome feature we started rolling out on YouTube TV, that gives sense to the ability to basically watch multiple streams at once. And yes, overall, the teams are working hard to build a fantastic experience, and we are really trying to stay focused on getting our first season right and providing the best possible experience really for fans here.
Operator: Your next question comes from Justin Post with Bank of America.
Justin Post: A couple of questions on Q4. Can you provide any color if there's been any pause in advertising around the Middle East conflict in October, anything we should be aware of for Q4?
And then second, when we do think about the Sunday Ticket impact, I know you can't give us revenues or expenses, but overall, would that be a headwind to margins in Q4 or something we should be thinking about?
Ruth Porat: So look, on the first question, obviously, this is tragic. There are no words to talk about what's going on. And all of our focus has been on supporting our people there and how our products can be as helpful as possible in this very painful time broadly, and so nothing really to add.
And then in terms of the second question, Sunday Ticket, the only thing I tried to call out there is that clearly, this is the first full quarter of Sunday Ticket that is contributing overall to the subscription revenues that we see. That's in part of other revenues. Also, obviously, it is contributing to higher CAC in the fourth quarter. So we try to make that really clear. And as we look longer term, we expect to generate an attractive return over the life of the deal. We're continuing to invest in support of this and excited about the additional opportunities that come out of it, working with partners to deliver clips and other opportunities.
As we've said, we've heard positive feedback from our partners at the NFL about the new features and live stream reliability. And this is really a clear example of our ability to execute big partnerships with excellence at scale and really leverage a lot of the extraordinary magic at YouTube and across Google, and that's what we're excited about.
Operator: Your next question comes from Ken Gawrelski with Wells Fargo.
Kenneth Gawrelski: Two questions, if I may. First, how do you think about the future structure of AI-driven Search capabilities? Will activity remain centralized in a search bar or will it be decentralized and present in many different applications, including on third-party applications? You alluded to Bard being integrated into multiple Google experiences earlier in the call.
And then the second question is, any update on the Chrome cookie deprecation plan to begin in 1Q '24? What have you seen so far based on your early testing of Privacy Sandbox? And what advertiser feedback have you received?
Sundar Pichai: On your first question, look, I broadly think of it as people are looking for information. They always look for it in many, many different ways. We've given the product search example. People can directly go to Amazon, as an example, or come to Google. So if you zoom back and take an information view of the world, there's always been many different ways to get it. And part of our work we do in making Search be world-class and give users what they're looking for is so that we can get as much of that intent as possible. So I don't see that changing. With mobile, there were more ways people could get information, but we worked out to make Search work better in the mobile world. And similarly, a view with AI, there'll be many ways people get information, but it also offers us an opportunity in Search and in Assistant to take it to the next level and answer use cases, which we couldn't have done before, and expand the diverse set of needs where we are sourced. So that's how I see the opportunity ahead.
Philipp Schindler: And to the second part of your question, yes, Chrome still plans to begin phasing out third-party cookies in the second half of '24. In the last several months, Chrome has really made significant progress on the Privacy Sandbox with APIs for developer testing, and they're now generally available in Chrome. Our ads team is testing these APIs. And as we shared back in April, the preliminary results of our interest-based ads testing showed that a combination of what we call privacy preserving signals and AI optimization actually provides positive results for businesses preparing for a cookie-less future.
We also recently announced that in Q1 of '24, we plan to deprecate third-party cookies for 1% of Chrome users, and this will support developers, obviously, in conducting their real-world experiments to assess the readiness and effectiveness of their products without third-party cookies. And we're overall encouraged by the ecosystem engagement on Privacy Sandbox. We'll continue to work with the industry and regulators in how these technologies can support the transition to, frankly, a more private web.
Operator: And our last question comes from Mark Mahaney with Evercore.
Mark Stephen Mahaney: Two questions, please. Ruth, you talked about these elevated levels of investments in Q4 and in '24. I'm sorry, were you referring to just CapEx or CapEx and total expenses? And then on the comments around stabilization in Cloud, is this something that you just started to see in the September quarter? Or had you seen that starting earlier in the year? And if you just started seeing it in the September quarter, would you have any thoughts on why you would have seen it, like Google Cloud would have seen it maybe later than some of the other hyperscalers?
Ruth Porat: So I think what you're referring to is my CapEx comment. I was trying to make the point that we are committed to meaningfully investing in CapEx given all the opportunities we see. We do continue to expect elevated levels of investment in our technical infrastructure. It will be increasing in the fourth quarter. And I talked about some of the difference in timing, muted timing, in the third quarter due to the timing of supplier payments and then tried to make it clear that we will continue to grow CapEx in 2024. Or more specifically, to your question, 2024 aggregate CapEx will be above the full year 2023. So that was the main one.
And then as it relates to Cloud, as Sundar said, what we're really excited about is the revenue growth does reflect healthy customer adoption across the portfolio, and that's infrastructure, data analytics and security. And so I can't comment on others, but we feel good about where we're sitting here looking forward, and we'll let you do the forecasting. GCP growth in the third quarter was above the growth rate for Cloud overall, and we feel really good about the work that they're doing there. And then, of course, in addition to that is all of the contribution from Google Workspace.
Operator: And that concludes our question-and-answer session for today. I'd like to turn the conference back over to Jim Friedland for any further remarks.
James Friedland: Thanks, everyone, for joining us today. We look forward to speaking with you again in our fourth quarter 2023 call. Thank you, and have a good evening.
Operator: Thank you, everyone. This concludes today's conference call. Thank you for participating. You may now disconnect. |
TSLA | 3 | 2,023 | 2023-10-18 22:06:06 | Elon Musk: [Call Starts Abruptly]…of new factories and we believe there’s still meaningful room for improvement there. Regarding Autopilot and AI, our vehicles are now driven over 0.5 billion miles with FSD beta, full self-driving beta, and that number is growing rapidly. We recently completed a 10,000 GPU cluster of H100s. We think probably bring it into operation faster than anyone’s ever brought that much compute per unit time into production, since training is the fundamental limiting factor on progress with full self-driving and vehicle autonomy. We’re also seeing significant promise with FSD version 12. This is the end-to-end AI where it’s photon count in, controls out. Really you can think of it as there’s just a large bitstream coming in and a tiny bitstream going out, compressing reality into a very small set of outputs, which is actually kind of how humans work. The vast majority of human data input is optics from our eyes. And so, we are like the car, photons in, controls out with neural nets, just neural nets in the middle. So, interesting to think about that. We’ll continue to invest significantly in AI development, as this is really the mass game changer. And I mean success in this regard in the long-term I think has the potential to make Tesla the most valuable company in the world by far. If you have fully autonomous cars at scale and fully autonomous humanoid robots that are truly useful, it’s not clear what the limit is. Regarding energy storage, we deployed 4 gigawatt hours of energy of storage products in Q3. And as this business grows, the energy division is becoming our highest margin business. Energy and service now contribute over $0.5 billion to quarterly profit. The Cybertruck, I know a lot of people are excited about the Cybertruck. I am too. I’ve driven the car. It’s an amazing product. I do want to emphasize that there will be enormous challenges in reaching volume production with the Cybertruck, and then in making a Cybertruck cash flow positive. This is simply normal for when you’ve got a product with a lot of new technology or any new vehicle, brand new vehicle program, but especially one that is as different and advanced as the Cybertruck, you will have problems proportionate to how many new things you’re trying to solve at scale. So, I just want to emphasize that while I think this is potentially our best product ever and I think it is our best product ever, it is going to be -- require immense work to reach volume production and be cash flow positive at a price that people can afford. Often people do not understand what is truly hard. That’s why I say prototypes are easy, production is hard. People think it’s the idea, or you make a prototype, you design a car. And as soon as they’re designing a car, it’s just anyone can do it, it does require taste, it does require effort to design a prototype. But it’s difficult to going from a prototype to volume production, it’s like 10,000% harder to get to volume production than to make a prototype in the first place, and then it is even harder than that to reach positive cash flow. That is why there have not been new car startups that have been successful for a 100 years apart from Tesla. So, I just want to temper expectations for Cybertruck. It’s a great product, but financially it will take, I don’t know, a year to 18 months before it is a significant positive cash flow contributor. I wish there was some way for that to be different, but that’s my best guess. The demand is off the charts. We have over 1 million people who’ve reserved the car. So it’s not a demand issue, but we have to make it and we need to make it at a price that people can afford, insanely difficult things. In conclusion, we continue to focus on ramping production while maintaining positive cash flow and we continue to target -- expect to have around 1.8 million vehicle deliveries, as stated earlier this year. The Tesla AI team is I think one of the world’s best, and I think it is actually by far the world’s best when it comes to real world AI. I’ll say that again, Tesla has the best real world AI team on earth, period, and it’s getting better. And lastly, I wanted to thank all of our employees who are making a lot of extra effort during uncertain times. Thank you very much for your hard work and the impact that you’re making.
Martin Viecha: Thank you very much, Elon. And our CFO, Vaibhav, has some opening remarks as well.
Vaibhav Taneja: Thanks, Martin. Vehicle deliveries in Q3 outpaced production, and we had yet another record quarter of profitability in our energy business. Congratulations to the Tesla team for the continued focus on operational excellence as we navigate through a period of economic uncertainty, higher interest rates, and shifting consumer sentiment. As Elon mentioned, our Q3 operational and financial performance was impacted by planned downtimes for our factory upgrades. This was necessary to allow for further factory improvements and production rate increases. Despite such factory shutdowns, our cost per vehicle decreased to approximately $37,500. We saw sequential decreases in material cost and freight. Reducing the cost of our vehicles is our top priority. On the operating expenses front, R&D expenses continued to rise due to Cybertruck prototype builds and pilot production testing combined with spend on AI technologies like full self-driving, Optimus and Dojo. We have and will continue to make investments in these areas, and hence our capital expenditure and R&D will continue to grow in the near term. However, our focus is to continue making investments through positive cash flow from operations. This year itself, we have generated operating cash flows of approximately [$8.9 billion] (ph) and free cash flows of approximately $2.3 billion. Our other businesses are becoming more prominent on a standalone basis with energy business leading the charge, primarily from the growth in Megapack deployments. Our services and other businesses on a year-on-year basis also continue to show positive momentum as we benefit from our growing fleet. As regards our pricing strategy, in addition to what we have shared before, I want to elaborate that most car buying happens with one or other form of financing, and hence we also view pricing in terms of monthly costs for the customer. And therefore, as interest costs in the U.S. have risen substantially, it has required us to adjust the price of our vehicles to keep the monthly cost in parity. We’ve tried to offset such adjustments via focus on reducing costs. However, there is an inherent lag in cost reductions, which in turn impacts margins. To that extent, we recently announced a partner vehicle leasing program in the U.S. whereby you can get a standard Model Y for as low as $399 a month. In conclusion, as we navigate through a challenging economic environment, we’re focused on reducing costs, maximizing delivery volumes, and continuing making investments in the future, in particular, AI and other next generation platform. We believe this strategy positions us well for the long term. Once again, I would like to thank the Tesla team for their efforts in the last quarter.
A - Martin Viecha: Thank you very much. And now let’s go to investor questions. The first investor question comes from Craig. How many Cybertruck deliveries do you anticipate for 2024?
Elon Musk: It’s difficult to make an accurate guess at this point. Going back to what I said earlier that the ramp is going to be extremely difficult. And like I said, there’s no way around that. If you try to make -- if we just try to do some copycat vehicle design, of which there are literally 200 models that are slight variations on a theme in the combustion engine world, distinctions without a difference, then it’s really not that hard. But if you want to do something radical and innovative and something really special, like the Cybertruck, it is extremely difficult because there’s nothing to copy. You have to invent not just the car, but the way to make the car. So, the more uncharted the territory, the less predictable the outcome. Now, I can say that -- if you say, well, where will things end up? I think we’ll end up with roughly a 0.25 million Cybertrucks a year, I don’t think we’re going to reach that output rate next year. I think we’ll probably reach it sometime in 2025. That’s my best guess.
Martin Viecha: Thank you. The second question is, can you provide a progress update on the 4680 cell, particularly progress towards performance improvements and cost savings outlined on Battery Day? Thank you.
Unidentified Company Representative: Sure thing, Martin. 4680 cell production in Texas increased 40% quarter-over-quarter. Congrats to the Texas team for producing their 20 million cell off of line one. Texas is now our primary 4680 facility. We’re heavily focused on quality. Scrap is down 40% quarter-over-quarter. With the increased volume and yield improvements, cell costs consistently improved month-over-month within the quarter, although we have a lot more work to do to achieve our steady state goals. And that is our priority. The Cybertruck cell with 10% higher energy than our Model Y cell started production on line two in Texas. This quarter we convert to building a 100% Cybertruck cells to simplify and focus the factory as we ramp all four lines in Phase 1 over the next three quarters. Phase 2 of the Texas 4680 facility is currently under construction. The additional four lines incorporate further capital efficiencies over Phase 1, and our target is for them to start producing in late 2024. Lastly, in Kato, we’re retooling to enable large scale pallet runs of our next generation cell designs. Kato’s long-term goal is to be the launch pad for new cells, one generation ahead of our mass production facilities, enabling faster iteration and smoother ramp ups of new designs.
A – Martin Viecha: Thank you. The next question from institutional investors. Could you please provide an update on capacity expansion plans for company’s factories in Berlin and Austin, and the opening schedule of Gigafactory Mexico?
A – Unidentified Company Representative: Berlin and Austin factories, the current priority is actually maximize the output from our existing lines, by laser focus on efficiency improvement. As always, maintaining a high quality and the reducing per unit cost will be as critical as growing the production volume. For Mexico, we’re working on infrastructure and factory design in parallel with the engineering and development of the new production that we’ll be manufacturing there. That’s what I can share for now.
Elon Musk: In Mexico we’re laying the groundwork to begin construction and doing all the long lead items. But I think we want to just get a sense for what the global economy is like before we go full tilt on the Mexico factory. I’m worried about the high interest rate environment that we’re in. I just can’t emphasize this enough that the vast majority of people buying a car is about the monthly payment. And as interest rates rise, the proportion of that monthly payment that is interest increases naturally. So, if interest rates remain high or if they go even higher, it’s that much harder for people to buy the car, they simply cannot afford it. And we are tracking, I believe at this point for Model Y to be the best selling car on earth, but not just in revenue, but in unit volume. If you compare that to the other vehicles that are number two and number three and whatnot, they cost much less than our car. So, we’re just hitting law of large numbers situations here. I know people want to us advertising, we are advertising. I think there’s something to be gained on the advertising front. I don’t think it’s nothing. But informing people of a car that is great, but they cannot afford doesn’t really help. So that is really the thing that must be solved is to make the car affordable or the average person cannot buy it for any amount of money or they can’t afford it. So, this is big deal.
Martin Viecha: The next question is, when do you expect Model 3 Highland to be available in the U.S.? I just wanted to address that unfortunately we don’t answer product related questions and timings on earnings calls. So let’s go to the next one. Current sell side consensus assumes that Tesla will deliver 2.3 million vehicles in 2024, representing 28% growth versus 2023 guidance. Is this growth rate achievable without any mass market launches in 2024? And when does Tesla expect to return to its 50% long-term CAGR?
Vaibhav Taneja: When we look at 2024, there are a lot of moving pieces. I just talked about what is happening in the macroeconomic environment. So, we’re focused on growing our volumes in a very cost efficient manner and are carefully reviewing all our options, and we’ll be able to provide a much more meaningful update at our next earnings call.
Elon Musk: Yes. I mean, at the risk of stating the obvious, it is not possible to have a compound growth rate of 50% forever, or you will exceed the mass of the known universe. I think we will grow very rapidly, much faster than any other car company on earth by far.
Martin Viecha: Thank you. Next question is do you have an approximate timeline in mind for the robotaxi driven or non-driven? What excites you most about how this project is progressing?
Elon Musk: Well, robotaxi is like necessarily non-driven. I guess, I’m very excited about our progress with autonomy, the end-to-end, nothing but nets self-driving software is amazing. It drives me all around Austin with no interventions. So, it’s clearly the right move. So, it’s really pretty amazing. And obviously, that same software and approach will enable Optimus to do useful things and enable Optimus to learn how to do things simply by looking. So extremely exciting in the long term. As I mentioned before, given that economic output is a number of people times productivity, if you no longer have a constraint on people, effectively, you’ve got a humanoid robot that can do as much as you’d like, your economy is wisely infinite or infinite for all intents and purposes. So, I don’t think anyone is going to do it better than Tesla, not by a long shot. Boston Dynamics is impressive, but their robot lacks a brain or like the Wizard of Oz, whatever. Yes, lacks a brain. And then you also need to be able to design the humanoid robot in such a way that it can be mass manufactured. And then at some point, the robots will manufacture the robots. Now obviously, we need to make sure that it’s a good place for humans in that future. We do not create some variance of the terminator outcome. So, we’re going to put a lot of effort into localized control of the humanoid robot. So basically, anyone will be able to shut it off locally, and you can’t change that, even if you put -- like a software update, you can’t change that. It has to be hard-coded.
Martin Viecha: Thank you. The next question is, why was the price dropped on FSD if it is getting better and robotaxi is expected so soon?
Elon Musk: Well, we just wanted to make it more affordable as more people try it. Yes, I think, over time, the price of FSD will increase proportionate to its value. So we regard the current price as a kind of a temporary low.
Martin Viecha: The next question is again on FSD. Mercedes is accepting legal liability for when its Level 3 autonomous driving system drive pilot is active. Is Tesla planning to accept legal liability for FSD? And if so, when?
Elon Musk: Well, there’s a lot of people that assume we have legal liability judging by the lawsuits. We’re certainly not being let that off the hook on that front, whether we’d like to or wouldn’t like to do.
Unidentified Company Representative: I mean I think it’s important to remember for everyone that Mercedes’ system is limited to roads in Nevada and some certain cities in California, doesn’t work in the snow or the fog. It must have a lead car in plains, only 40 miles per hour. Our system is meant to be holistic and drive in any conditions, so we obviously have a much more capable approach. But with those kind of limitations, it’s really not very useful.
Elon Musk: No, I think some people understand the profundity of the Tesla AI system. It’s very, very few. It’s basically Baby AGI. It has to understand reality in order to drive, Baby AGI.
Martin Viecha: Thank you. The next question on Optimus. Will Optimus be working on Gigafactory lines next year? If so, how many would you guess will be deployed?
Elon Musk: I think at this point, we are not ready to discuss details of the Optimus program, but we will make -- provide periodic updates online. So, as you can see, we’re -- Optimus a year ago could barely walk and now it can do yoga. So, a few years from now, it can probably do ballet.
Martin Viecha: Sounds good. And the last question from investors is Neural net path planning represents a significant advance in capability and safety for FSD. What steps is Tesla taking to make this technology available outside the U.S.?
Elon Musk: Yes. Our approach has been to try to get it -- like the more places we’re trying to make it work, the harder the problem is. So, the reason we don’t do it in all countries simultaneously is that it would take much longer to make it work anywhere at all. So, that’s why it’s currently just North America. And also for most parts of the world, you have to get approval before deploying things, whereas in the U.S., you can deploy things at risk or at least you take liability for what you’re deploying. So, it’s -- most countries require some sort of extensive approval program. So, we only want to go through that extensive approval program when we think it’s kind of ready for prime time in that country. I apologize it’s not in those countries, but we keep plenty of ways to make it better. And it really needs to drive such that it exceeds the -- even unsupervised, significantly exceeds the probability of entry of a human or significantly better, a lower probability of entry than a human by far. I think we’re tracking to that point very quickly. Obviously, in the past, I’ve been overly optimistic about this. The reason I’ve been overly optimistic is that the progress tends to sort of look like a log curve, which is that you have kind of rapid initial improvements that if you were to extrapolate that rapid fairly linear rate of improvement, you get to self-driving quite quickly, but then the rate of improvement curves over logarithmically as such to asymptote. That’s not happened several times. I would characterize our progress in real world AI as a series of stacked log curve. I think that’s also true in other parts of AI, like LLMs and whatnot, a series of stacked log curves. Each log curve is higher than the last one. So if you keep stacking them, keep stacking logs, eventually get to FSD.
Martin Viecha: Thank you. Let’s now go to analyst questions. The first question comes from Will Stein from Truist.
Will Stein: We learned earlier on the call, it sounds like you don’t think the truck will ramp to significant volume until its third year of production. Should we have a similar anticipation for the ramp of the next-gen platform, or is there any reason that we should be maybe more optimistic or pessimistic about the ramp profile there?
Elon Musk: Yes. I mean, to be clear, it’s not really the third year of production. It’s kind of like the 18th month of production is roughly my guess. So, it’s just that they happen -- it will happen -- is that the -- it starts this year, spans next year and gets to 2025. So technically, there are three calendar years in there, but there’s actually only 18 months, not three years. I would be very disappointed if it took us -- and that would be shocking if it took us three years. But 18 months from initial deliveries to have -- to reach volume and reach prosperity with an immense -- I can’t tell you how much the blood, sweat and tears level required to achieve that is just staggering. I have been through it many times. Then, here we go again.
Will Stein: Similar path for the next-gen platform?
Unidentified Company Representative: I mean, there’s like unique complexity to Cybertruck.
Elon Musk: Yes. I mean Cybertruck is -- yes. I mean, we dug our own grave with Cybertruck. Nobody -- generally, everybody digs a grave better than themselves. And so it is -- Cybertruck’s one of those special products that comes along only once in a long while. And special products that come along once in a long while are just incredibly difficult to bring to market, to reach volume, to be prosperous. It’s fundamental to the nature of the newness. So now the sort of high-volume, low-cost smaller vehicle is actually much more conventional.
Unidentified Company Representative: Yes. In terms of like the technologies we’re putting into it, we didn’t have to invent full hard stainless steel or have mega 9,000-ton castings or the largest hot stamping in the world or new [Technical Difficulty] are quite in the same way as the Cybertruck. I think it will be quite a fast ramp. As I was just saying, we’re doing everything possible to simplify that vehicle in order to achieve a units per minute level that is unheard of in the auto industry.
Unidentified Company Representative: I mean, the single location makes it easier to automate. It also makes it lower cost. Yes, that’s intrinsically lower cost.
Elon Musk: Yes. Let’s be clear, it will be cool, but it’s utilitarian. It’s not meant to be -- fill you with magic. It can get you from A to B. It will be still beautiful. But it’s utility.
Unidentified Company Representative: That’s not 14 inches of [indiscernible] suspension.
Elon Musk: Yes. So I mean, the Cybertruck has a lot of bells and whistles.
Martin Viecha: All right. Thank you very much. Let’s go to Pierre Ferragu from New Street Research.
Pierre Ferragu: I have first like a follow-up question on FSD and pricing and adoption. So, I agree with you that as FSD improves, we should see its value increasing. But I guess, like the ultimate values of FSD, which is to be able to handle like a robotaxi is not going to necessarily interest everybody, and you have a bit of a degraded version that would be like a chauffeur service where the car drives by itself, but you still have to be in the car and around. And then there is like the hands-on -- eyes-on version of the service. And I guess, there should be like much lower cost, lower feature kind of variance of the service that could have a very large penetration on your installed base and more expensive one that would remain at a lower penetration level. So, I’m just wondering if you’re taking that -- and last but not least, like the simplest version of FSD available and are going to work from a technical perspective, probably before like the ultimate robotaxi version can work if ever. And so I’m wondering how you take that into account and how you’re thinking like the financial contribution of FSD over time and whether you could evolve your pricing along that kind of tiers to increase adoption.
Elon Musk: Yes. A fully autonomous vehicle, I think, Pierre, your -- sort of the economics of autonomous vehicle are truly astounding in a positive way. When you look at passenger vehicles today, they only get about 10 to 12 hours of usage per week. That’s -- if you drive 1.5-hour a day on average, that’s roughly 10 hours a week out of 168 hours. And then there’s also you’re going to have parking and insurance. You got to take care of the car. It’s like there’s a lot of overhead. So I mean, yes, it’s like the economics of the system are just insanely positive given that the car -- like all of the cars we’re making and have made for a while, we believe, are capable of full autonomy. So then if you’re able to say increase the utility of that car by a factor of 5, which only means that you’re -- it’s being used for maybe 50 hours a week out of 168, so you still notice -- you’re still assuming -- that still assumes less than 1/3 of the hours of the week is doing something useful. You’ve increased the value of that by 5, but it still costs the same, like you have something -- then we’re a hardware company with software margins.
Martin Viecha: Pierre, do you have a follow-up?
Pierre Ferragu: Yes, I have actually a follow-up on different topic for you that I have if that’s okay. It’s about like your gross margin in the quarter. Could you give us a sense of like in how the gross margin evolved sequentially, how much was the impact of idle cost? How much was like the sequential benefit, I imagine, of production ramping at Berlin and Austin? And then I saw like this massive jump in energy storage, very strong positive surprise. So, if you can give us the background on that and tell us how we should think about that gross margin going forward.
Vaibhav Taneja: Thanks for the question. So, in terms of -- you have few different aspects of your question. So if I just look at from Q3 perspective, obviously, factory idle time had an impact. It did impact by -- and I won’t give you the exact percentage, but it had a decent impact for the quarter. And when you look at the other pieces, which we are trying to do, we did see certain of our other factories ramping up pretty well, right? And they actually contributed pretty well to the margin for this quarter. In fact, one of the factories came pretty close to in terms of per unit cost to where we are for our other established factory, which is Fremont. So that was a positive in the quarter. When it comes to energy margins, Megapack deployment was the key driver there. And that product has done well. I mean, on the cost curve also, we’ve been able to do a lot there. But I do want to caution that Megapack deployments are a bit lumpy. So yes, we had a great quarter this period. But depending upon where we are trying to deploy that product in different markets, you would see periods where there would be downward pressure on deployment because of us trying to get the product to that base way…
Unidentified Company Representative: Yes, product in transit. Yes.
Vaibhav Taneja: Yes.
Martin Viecha: Okay. Thank you very much. Let’s go to Rod Lache from Wolfe Research.
Rod Lache: Really nice to see the rate of vehicle cost improvement despite the downtime that you took. You’ve taken now about $2,000 out of the average vehicle costs over the past year. Can you give us maybe a sense of the rate of improvement that you see from the changes that you alluded to, the factory changes you alluded to? Is there a way maybe to convey the speed of improvement on your existing product from here? And then related to that, can you share the timing of your next-gen -- the lower-priced product that you talked about earlier this year?
Vaibhav Taneja: Yes. So just in terms of product margins, there are lots of puts and takes when you look at this. There are certain things which we control, and there are certain things which we don’t control. We get -- we expect that we’ll get some benefits from our cost reduction efforts, which are all underway. So on the other hand, we just finished our factory upgrades late in Q3. Some of these factories are still in the early ramp phase in Q4. We’re still not up to where we want those factories to be. So, they will impact in the near term. Plus, like Elon mentioned, we’re going to be ramping Cybertruck, which is going to be another headwind, which we will be dealing with. On top of all that, there’s overall uncertainty in the macroeconomic environment, which even makes it harder to predict precisely as to where we land. But yes, this is something which -- it’s an evolving thing which we’re observing every day and reacting to it on a daily basis.
Unidentified Company Representative: I would just say that on the cost reduction efforts, like we are not -- we are unflagging in our pursuit of additional cost downs for 2024. We do have a good pipeline of them and work on both the engineering side and the factory operations side. And our intention is to like maintain or exceed the trend that you saw, trying as hard as we possibly can.
Rod Lache: The timing of the next-gen product, can you share that?
Elon Musk: Not at this time.
Rod Lache: Okay. And just as a follow-up, obviously, price is also a driver of demand, but that’s obviously not happening in a vacuum. And you mentioned that -- I think you mentioned that at some point during this call that you’re also maybe hitting the law of large numbers on some of your products. Can you just share how you’re thinking about price elasticity just at this point in this macro environment? And any thoughts along those lines?
Elon Musk: I think that there’s very significant price elasticity. I mean, to be totally frank, if our car costs the same as a RAV4, nobody would buy a RAV4 or at least they’re very unlikely to. It’s worth noting that a lot of these incentives, like the tax credit and whatnot, they’re actually very difficult for the average person to access because they -- most people do not have $10,000 or even $7,500, burning a hole in their bank account. A lot of -- a large number of people are living paycheck to paycheck, and with a lot of debt. They’ve got credit card debt, mortgage debt. So, that’s reality for most people. It’s sometimes difficult for people who are high income and I’d say high to be like someone who’s earning over $200,000 a year to understand what life is like for someone who is earning $50,000 or $60,000 or $70,000 a year, which is most people. So like for a lot of people, like this tax credit just -- they can’t front $7,500 for 18 months or even 6 months to get -- for the tax credit, and they actually don’t, in some case, even have that $7,500 in taxes. So, it’s really just the best regard to people is how much money do they have to pay immediately and how much per month. That’s it. I think you stop right there. And our car is still much more expensive than a RAV4 when you look at it that way.
Vaibhav Taneja: Now one other thing which I’ll add, when you look at car buying in general, we’re trying to get to the next set of EV adapters.
Elon Musk: Not an EV adapter. Just who wants a great car.
Vaibhav Taneja: Exactly.
Elon Musk: It’s not -- so now you get things like -- honestly, I would say it’s like -- somewhat correlates with why doesn’t everyone work from home crowd. I’m like -- I mean this is like some real Marie Antoinette vibes from people who say why is there no work from home. Like what about all the people that have to come to the factory and fill the cars or that all people that have to go to the restaurant and make your food and deliver your food. It’s like what are you talking about, you -- I mean, how detached from reality does the work from home crowd have to be? While they take advantage of all those who do -- who cannot work from home. So, I mean, you have to say like why did I sleep in the factory so many times, because it mattered. So I just can’t emphasize again how important cost is. It’s not an optional thing for most people, it is a necessary thing. We have to make our cars more affordable that people can buy it. And I keep harping on this interest thing, but I mean it just raises the cost of the car. I mean, we’re looking an internal analysis, which we think is more or less on track that when you look at the cost -- or the price reductions we’ve made in, say, the Model Y and you compare that to how much people’s monthly payment has risen due to interest rates, the price of the Model Y is almost unchanged.
Vaibhav Taneja: If you factor in the...
Elon Musk: Yes, which is what I’m trying to say. The thing that matters is the monthly -- it’s how much money do they have to put down and do they literally have that in their bank account or their check balance and then what is the monthly payment. And it doesn’t matter how -- if that monthly payment is principal interest or whatever, it’s just a number, and that number has to not cause their bank account to go negative. That’s it. So going from near zero interest rates to kind of the current very high interest rates, the actual monthly payment is basically the same. It’s just a bunch more of it is going to interest. And there are some incremental challenges beyond that, which is the difficulty of getting credit at all has increased. And so, the number of people who simply cannot get credit, period, even if they’ve got a job and everything is solid, the banks are a little gun-shy on handing out credit given that a bunch of them kicked the bucket earlier this year.
Unidentified Company Representative: There’s also just fewer options, even if they planned out credit, there’s fewer banks to go there.
Elon Musk: Digital banks still exist. Well, if your bank does not exist, you have to establish a relationship with a new bank. And so a lot of regional banks are died, and I mean even Credit Suisse, I mean, geez, that was a shocker. A 160-year-old-ish Swiss institution, it doesn’t exist anymore. That’s mind blowing. And I think there’s still quite a few shoes to drop on the bad credit situation. I mean, commercial real estate obviously is in terrible shape. Credit card debt has been rising significantly. The credit card interest rates are usurious. It’s over 20% interest rates, meaning like -- which over time is just it becomes obviously extremely punishing because if somebody’s paying 20% interest on their credit cards, means they cannot pay them off. If you can’t pay them off and you’re still accruing interest of 20%, you’re at best headed to a bad place.
Martin Viecha: Thank you. Let’s go to next question from George from Canaccord.
George Gianarikas: Just to focus on the cost per vehicle coming down in future quarters as you discussed in your written remarks. I’m curious as to what the levers of that could be. Is it more scale, more factory utilization? Is it material cost reductions? Are there things like gigacasting? I mean, can you just kind of give us some data points to give us confidence if that’s going to come down over time. And if I can sneak one in, please, there are press reports -- and I know how perilous it is to believe some of these. But, they say that you’ve included radar as an option in some Model Ys in China. And I’m just here to ask if that’s true. And if so, why?
Elon Musk: We’ve not included radar. We have radar as -- a Tesla designed radar is an experiment in Model S and X. That’s it. We’ll see whether that experiment is worth it, but there are no plans to integrate radar into 3 and Y. Just as humans drive well, and in fact, an excellent human driver can drive with amazing safety simply with their eyes, the car will far exceed the average human safety just with vision, far, far, far because, I mean, the car is looking at all directions all at once. We don’t have eyes at the back of our head. And the computer never gets tired and never gets distracted, get drunk, hopefully. And so, radar is -- what really matters is how much does it affect the probability of an accident. And in order for the radar to be effective, you have to be able to do radar-only braking -- you have to do actions that are radar-only. Otherwise, you get this disambiguation problem between vision and radar. That’s why we actually turned off the radar in cars historically that we had shipped, all 3 and Y used to have radar, but we turned it off because the radar actually generated more noise than signal. Now the Tesla designed radar is a high-resolution radar that has some potential to be useful, but the jury is still very much out on whether that is in fact the case.
Unidentified Company Representative: On the cost question, I guess, from the vehicle side, like as Drew mentioned earlier, we are always trying to engineer our products to be cheaper to make and more efficient to make. That comes obviously on the engineering side as we come up with new innovations but as well on the supply chain side. With our partners, we work with them to automate some of their lines and move their bottlenecks and their high cost as well. On the logistics side, getting parts to the factory, it’s not like a one thing that -- you have to check cost everywhere and we do it ruthlessly at all times.
Unidentified Company Representative: Operations efficiency. All of the above.
Vaibhav Taneja: Yes. I would say there’s a whole laundry list of things, which we are chasing. We internally call it the cost attack, where we’re literally going line by line and saying how can we make it better. And it’s a grind.
Elon Musk: It’s a grind. It’s like Game of Thrones but pennies. I mean first approximation, if you’ve got a $40,000 car, and roughly 10,000 items in that car, that means each thing, on average, costs $4. So in order to get the cost down, say, by 10%, you have to get $0.40 out of each part on average. It is a game of pennies.
Unidentified Company Representative: We play it.
Elon Musk: Willingly, yes. We’ve done it many, many times. And even something as simple as like a sticker, like there’s too many stickers internally in the car that nobody ever sees. There’s something as simple as a QR code. You may think, well, putting a QR code on a part. Why don’t just put them on there, it’s like, well, are we actually going to use that QR code?
Unidentified Company Representative: That’s a penny.
Elon Musk: Yes, exactly. And then inevitably, sometimes the QR code doesn’t go on properly or you can’t read it properly, and it stops the line.
Unidentified Company Representative: More than a penny.
Elon Musk: Yes, absolutely. So chipping away, with -- I mean it is trying to -- it does feel like digging a tunnel with a spoon at times.
Unidentified Company Representative: Very much escaping prison.
Vaibhav Taneja: On top of it, like we said, we did some factory upgrades, so we expect volume to go up. That would also bring some savings from higher production. But then on the flip side, we’re going to be ramping a new product like Cybertruck, which we talked about. So, yes, so those are the real puts and takes what we are working for.
Elon Musk: Yes. But there’s not like some accidently some brick of gold that we go left in the car, unfortunately. And it’s -- we’re trying to be very rigorous about improving the quality and capability of the car because it’s like any fool can reduce the cost of a car by making it worse and just deleting functionality and capability and that’s how I call this sort of any fool -- like if you want to like lose weight and you’d say, well, I need to lose over 15 pounds right away, well, you could chop your arm off, but then you’re sitting with one arm. You’re still fat. So sort of like yes, you actually have to eat less food and work out. That’s the actual way. It’s not super fun because food is delicious. And personally, I’m not -- I don’t love working out. I wish I did, but I don’t. Unless moving the mouse consists of working out, in which case, I love moving the mouse.
Martin Viecha: All right. Let’s go to Colin Langan from Wells Fargo.
Colin Langan: You said in the commentary that you’re not going full tilt on the plant in Mexico until there are signs that the economy is strong. Can you continue at a 50% CAGR without that plant? And where would that come from? And any color on what you mean sort of not going full tilt? Could that plant get delayed indefinitely, or what are you are kind of talking about?
Elon Musk: No, we’re definitely making the factory in Mexico. We feel very good about that. We put a lot of effort into looking at different locations, and we feel very good about that location, and we are going to build a factory there, and it’s going to be great. The question is really just one of timing. And there’s going to be a broken record on the interest front. It’s just the interest rates have to come down. Like, if interest rates keep rising, you just fundamentally reduce affordability. It is just the same as increasing the price of the car. So I just don’t have visibility into it. If you can tell me what the interest rates are, I can tell you when we should build the factory. We’re going to build it. And I mean think we’ll start the initial phases of construction next year. But I am still somewhat scarred by 2009 when General Motors and Chrysler went bankrupt. While that’s now 14 years ago, it’s -- that is seared into my mind with a branding iron because Tesla was just hanging on by a thread during that entire time and with -- I mean, we closed a financing round in 2008 at 6 p.m. December 24th, Christmas Eve. And if we had not closed that financing round, we would have bounced payroll two days after Christmas. So we actually closed that around the last hour, the last day that it was possible, stressful to say the least, and then barely made it through 2009. So, I’m like -- I want to just -- I don’t want to be going at top speed into uncertainty. A lot of wars going on in the world obviously as well, so -- and we have room here.
Unidentified Company Representative: Like in Giga Texas. You said we still have room in this building. It’s not full with Cybertruck and the line. There’s plenty of growth opportunities still to have inside the building where our team already is.
Elon Musk: We also have 2,000 acres here.
Unidentified Company Representative: There’s also…
Elon Musk: We’re actually only occupying a tiny corner of the land that we have. We could technically do all the scaling, research just here. So, personnel is our biggest challenge and the greater Austin area only has -- generously the greater Austin area only has 2 million people. So people are moving here and they’re willing to move here, but there is somewhat of a housing crisis. They got to live somewhere. So I don’t know. I mean, I’m just curious. Like I just -- I’m not saying things will be bad. I’m just saying they might be. And I think like Tesla is an incredibly capable ship, but we need to make sure like as -- if the macroeconomic conditions are stormy, even if the best ship is still going to have tough times, the weaker ships will sink. We’re not going to sink. But even a great ship in a storm has challenges. Now that storm will apply to everyone, not just to us and not just to auto industry. It will apply to everyone, I think. So apart from necessary sort of staples, like food and stuff. So I just -- I don’t know. If interest rates start coming down, we will accelerate.
Martin Viecha: All right.
Elon Musk: If anybody’s got any guesses on this, I’d love to be less wrong. And I apologize if I’m perhaps more paranoid than I should be because that might also be the case because I am -- I have PTSD from 2009, big time. And in 2017 through 2019 were not a picnic either. That was very tough going. So the auto industry is also somewhat cyclic because people hesitate to buy a new car if there’s uncertainty in the economy. So it’s car companies do very well in good economic times, and they don’t do as well in tough economic times. So, it’s just -- whereas if somebody is selling bread, then I think that people still eat bread. Yes, we need bread. We need food all time. But new car, you don’t have to have...
Vaibhav Taneja: Especially if there are wars going on and then that impacts your sentiment.
Elon Musk: Yes. I mean people are reading about wars all over the world. Buying a new car tends to not be front of mind.
Martin Viecha: All right. Unfortunately, that’s all the time we have today. Thank you very much for all of your good questions, and we’ll see you again in three months. Thank you very much. |
NFLX | 3 | 2,023 | 2023-10-18 21:44:05 | Operator: Good afternoon, and welcome to the Netflix Q3 2023 Earnings Interview. I'm Spencer Wang, VP of Finance, IR and Corporate Development. Joining me today are Co-CEOs, Ted Sarandos; and Greg Peters; and CFO, Spence Neumann. Our interviewer this quarter is Jessica Reif Ehrlich from Bank of America. As a reminder, we will be making forward-looking statements and actual results may vary. Jessica, let me turn it over to you now for your first question.
Q - Jessica Reif Ehrlich: Thank you. So let's start with you, Ted. Now that one strike is over, the Writers Guild, what are the implications for your business?
Theodore Sarandos: Thanks, Jessica. Let me first say, we want nothing more than to resolve this and get everyone back to work. That's true for Netflix. That's true for every member of the [NPTP]. It's why our member CEOs have prioritized these negotiations above everything else we are doing. We spent hours and hours with SAG-AFTRA over the last few weeks, and we were actually very optimistic that we are making progress. But then at the very end of our last session together, the Guild presented this new demand that kind of on top of everything for a per subscriber levy unrelated to viewing or success, and this really broke our momentum, unfortunately. But you should know, we are incredibly and totally committed to ending this strike. The industry, our communities and the economy are all hurting. So we need to get a deal done that respects all sides as soon as we possibly can. In terms of the impact, these are the times that I'm glad we have such a rich and deep and broad programming selection. Programming costs themselves rise nearly every year, primarily driven by competition. Competition for talent, competition for shows and films. And you can see we've managed successfully through that year on year on year. And the same is true for – during COVID when we were able to manage the slate through a prolonged and pretty unpredictable production interruptions. But I really think we are not really that focused right there on it and how this impacts much, except for our biggest opportunity, which is to continue improving the quality of the slate. We focused on that day-in, day-out, year-in, year-out. And I'm incredibly pleased with Bela and the team and the progress that they are making. So if you'll indulge me for just a second, I just would draw your attention to the Q4 slate as an example of that, headlined by the return of The Crown for its final season. This is one of the most ambitious television shows in the history of television. We have a new season of Big Mouth, history – a new season of [Elite], the launch of Berlin, which is a spin-off from our La Casa de Papel, our Money Heist franchise, and new limited series like All the Light We Cannot See from Shawn Levy. That's Incredible and Bodies from the UK. And that's just on the TV side. And on the film side, one of our strongest quarters ever. We have this enormous Sci-Fi Spectacular from Zack Snyder, Rebel Moon, a new film from David Fincher, The Killer and these films that just lit up the fall film festivals recently, like May, December from Todd Haynes and Bradley Cooper's Maestro, The Dock Feature, American Symphony. That's all coming in Q4. And for family viewing too, we've got a new animated feature from Adam Sandler, [indiscernible] Leo, that's hysterical, Chicken Run 2, which is a sequel to the most successful stop-motion animation film ever, and a new series from the CoComelon World called CoComelon Lane, Family Switch from Director McG, sorry, it's Jennifer Garner and Ed Helms. So it's an incredible slate, something new and exciting for all taste, all moods, all ages, and we're just super proud of the team that they've been able to manage through this and still deliver so much joy for our members.
Jessica Reif Ehrlich: One more on strike-related like just the aftermath, you discussed at a recent conference, giving talent more transparency. Could you talk about what that looks like? What are the new metrics talent will be paid on? And is it even standardized across the industry?
Theodore Sarandos: Yes. Look, what I talked about there was heading towards a world that we're streaming data will be much more readily available. Remember, streaming itself is not that exotic anymore. We've been doing it for 15 years. So we – at the beginning, we thought there was a hard kind of apples and oranges comparison to ratings and streaming. And I think we've gotten to a place where it's mostly about engagement and that does capture the value of watching and that things will become much more transparent the way TV has always had ratings and music has always had billboard and the theatrical has always had box office. So it will be much more common for the data to be fully transparent. What I didn't mention though is that part of that – of our reason for not publishing early was part of our promise with creators. At the time we started creating original program, our creators felt like they were pretty trapped in this kind of overnight ratings world and weekend box office world defining their success and failures. And as we all know, show might have enormous success down the road and it wasn't captured in that opening box office. So part of this was the relationship with talent, not just the business aspects of it. And I do think that over time, people are much more interested in this. We're on the continuum today of how much data do we publish. I think we've been leading the charge, starting everyone down the path of a top 10, publishing our top 10 list and our annual wrap-up list and everything that give a lot of transparency to the viewing. And I just expect it will be more and more transparent.
Jessica Reif Ehrlich: Great. Let's move on to page sharing. Have you identified most of the borrowers and can you provide any help in, in how much more is left to go and the challenge in completing the crackdown?
Gregory Peters: Sure. I'll take that one. And I'll start by saying we're just incredibly pleased with how it's been going. And you can see the progress from our membership growth in Q2. Now in Q3, you can see it embedded in the revenue outlook for Q4. I think paid sharing represents the kind of difficult challenge where we needed to balance both important relevant consumer considerations with the importance of ensuring that our business got reasonably paid when we deliver entertainment. And it's an example where we leveraged core executional capabilities that we've been building for over a decade, sort of how you develop good product experiences, how do you solve hard problems through them? How do you have an iterative model where you listen to consumers to tell us what's working and what's not? So we've been excited about that. But because it's such a challenging problem, we're shifting essentially consumers' expectations and what they expect from us. We've always thought that making this change should be done in a steady, considered way. And so our plan has been to stage out this rollout. We've been delivering our product experience to different borrower cohorts according to that plan. And as a result, I think as you're alluding to, there are a number of borrower cohorts, which has, as of today, have not received part of that experience. And just to explain that a bit. I mean, part of the motivation to stage it out is based on technical considerations. So this is our ability to build features and improve model accuracy over time in a way that allows us to ensure that we're accurately developing and applying our interventions and as effective and as positive a way for consumers as possible. Part of that has been just to stage things out based on borrower behavior. So we want to show up with the right product experience at the right moment. That's more likely to convert a borrower over rather than have them spin-off. So we want to think about that from maximizing long-term revenue. So we're going to continue the rollout for the next couple of quarters. I think folks are trying to figure out how much juice is left there. And I would say we anticipate that we will have incremental acquisition, incremental adds for the next several quarters. We've seen that in the last couple of quarters. I think also worth noting that, that was on top of also very healthy organic, meaning not driven by paid sharing growth. So we anticipate seeing that for the next several quarters to come. And then just stepping back, there's a set of borrowers that we're not going to convert. We haven't converted yet. We're not going to convert over the next couple of quarters. But that really represents how we think about paid sharing going forward, which is it's now become part of just our standard way of operating. And we have many hundreds of millions of qualified households out there. There are Smart TV households that we want to win over the next several years. And those borrowers we're not going to convert in the next couple of quarters represent that same group. So we got to go after them the same way we're going after people who have never signed up for Netflix, which is having an incredible content offering and incredible value and get them so excited that they just have to sign up.
Jessica Reif Ehrlich: Right. Moving on to the recent advertising restructuring. Can you talk about why you made the management change and what you would like to accomplish?
Gregory Peters: Yes. First, I'd say Jeremy has done a great job getting us essentially from zero to where we are today. She laid the foundation for the ads business. She's hired and built a burgeoning team of leaders who in turn now are hiring the teams and people who are going to take the business forward. But it's an important time and I think a great time for Amy to come in and extend that great work to build on that foundation and drive our ads business to the next level. And why am I so specifically excited about Amy in the role. First of all, she's a high Netflix tenure employee. She's been with the company for over seven years. She's demonstrated really positive impact and great results in several different roles, but most recently as part of the studio and leading a big global team that is scaling very, very, very quickly, which sounds familiar when you think about where we want to take our ads business. Second, she's got broad entertainment experience, ranging from content licensing, distribution. She's got business development, finance strategy at Netflix and in prior roles. So I think when you think about that assemblage of skills, and you think about the existing ads leadership team that we have that has got a rich, rich history in ads in general and connected TV, especially if you think about somebody like Peter Naylor, who started selling connected TV at Hulu. That's a strong team to take our ads business to the next level. And maybe I'll just – I want to maybe just restate what we think the promise and the opportunity and sort of where we're at on ads business is. And so first of all, just starting off with – this is a $180 billion opportunity when you think about linear TV, you think about connected TV, not including YouTube, not including China and Russia. And we think we're in a great position to win some of those dollars. We've got great content. The brands want to be next to. We're a safe place for brands to exist. We got great engagement from our members. That's a really strong foundation to work with. But we got a lot of work, and we know we have a lot of work to fulfill that potential. Among that work, we've said it many times, I'll say it probably many times going forward. But scale is the number one priority. We're making good progress there. This quarter, we grew our ad plan membership 70% sequentially, quarter-to-quarter. That's on top of the last quarter where we grew at 100% quarter-to-quarter. We now have 30% of our new sign-ups choosing our ads planned in our ads countries. And we've done it by making the ads offering more competitive. We've gotten to over 95% content period with our non-ads plans. We've improved features like a number of streams, the video resolution. We're going to keep doing that. We're adding downloads now. So we'll keep that good trajectory going and keep focusing on it. Second big priority for us is delivering features and products that advertisers want. We've heard again and again, I've heard it this week, a week from advertisers. Top of that list is measurement. We've launched our measurement partnership with Nielsen in the United States this month in October. So we're excited about that. We've got a long list of other partners across other countries that we've got to deliver that same capability in. So we're excited about getting that out. We're also excited about new products. So we've rolled out our top 10 media buy. We're going to roll out our Binge ad product later this year. We're launching more ways to buy programmatically through Microsoft that gives more buyers, more ways to access our inventory. So we've got a lot of work to do here on all of those fronts, but we've always said this is a multi-year build to multi-year progress. We've got a lot that we've got going on, and we're excited about the future to come.
Jessica Reif Ehrlich: So now that you've phased out basic for new subs and you're getting extra members or paid more per sub from password share and crackdown and you've introduced advertising in 12 countries. Could you talk about the outlook for ARM in 2024 and beyond?
Spencer Neumann: You guys want me to take that one?
Gregory Peters: Go ahead, Spencer.
Spencer Neumann: All right, you wind it up for me. Thanks, Jessica. So I would say just generally, when we think about 2024 and beyond, think about it as our revenue growth profile in general. And we talked about this recently. We expect a more balanced mix of membership and ARM growth in 2024 and beyond 2024. So just looking at 2024 specifically, as Ted talked about, we expect to have a great slate to drive the business forward. And we expect to continue to do things like add extra members, grow our advertising revenue, as Greg discussed. And in addition to have some pricing adjustments, you saw that in our letter, all those things will drive ARM. So 2023 was a pretty unusual year where essentially all of our growth came from member growth. And going forward, more broadly, not just 2024 and beyond, we'll grow our business by continuing to kind of improve our service, increasing engagement, increasingly satisfying current and future members. And now that, as Greg discussed, I know we've got an account sharing solution, we have a more clear path to more deeply penetrate that big addressable market of a half a billion connected TV households and growing. And with our continued plan evolution, pricing sophistication and all that hard work on our ads business, we'll keep getting better at monetizing that big and growing reach and engagement. So we believe – we've got a long runway for growth in both kind of more membership and higher ARM over time in a more balanced way than what you saw this year, which was again a pretty unusual year.
Jessica Reif Ehrlich: And then you touched on, Greg touched on scale and advertising. How do you get to scale? Is it all through pricing, like pricing changes? And what would you consider scale?
Gregory Peters: Yes. I think it's important to note that scale isn't – it's not a binary condition, right? So it's not like you suddenly add one more member and you become a must buy situation. So we become increasingly competitive with increasing reach. It's also, I think, worth noting that it's different in different countries. And it's largely based on what's the competitive channels and what's that competitive dynamic. So having said that, though, we carry several relevancy targets on a per country basis, think about this as essentially a percentage of market penetration that helps us focus and drive the rate of growth that we desire. And we've got more work to do to get those. So I mean like we're not satisfied with the scale that we're at in any country that we're in. We want to be bigger, and we know we can be bigger. I think there's a variety of techniques that we can employ to do that pricing and thinking about how do we factor in what's optimal pricing for ads, no ads. That's part of what we're doing and thinking about plan evolution. Part of it is what I mentioned before, which is feature set, right? These are the things that consumers want to sign up for. Part of it, too, is actually just educating consumers. I think what we are seeing is in some of our countries, consumers think about an ads experience mostly anchored in linear and what their expectation around ad load, frequency rates are. And to some degree, actually, some of our streaming competitors haven't done maybe as great a job in building an ad experience, which informs that expectation as well. The part of it is just educating consumers about what the actual Netflix ads experience is so that they can think about what's the right choice for them. Do they want to lower price with ads and what we think is a great ads experience for consumers really, or do they want to pay more and skip ads. So it's all those things coming together that ultimately drive us to the several multiples of scale that we're at today that we'll be satisfied with.
Jessica Reif Ehrlich: One last one maybe on advertising before we move on to margins. But you mentioned a lot of the innovative offerings that you plan on and some of it sponsors. It's very unique. It's different. When do we get to a point or when will you have a point where it's targeted, addressable, so it's really relevant for consumers. And so they would want to see the ads.
Gregory Peters: Yes. So we're working with Microsoft right now on targeting, so you'll see that roll out in the near future. And that, I think, is the first step of how we think about increasing targeting relevance through both a combination of product sets. So what are the types of ad products that brands can buy that yield increasing relevance as well as improving our sort of sophistication on what we might call targeting from a digital perspective, which is basically matching consumers who are most interested in that particular brand's message.
Jessica Reif Ehrlich: Right. So Spence, I guess this one's for you on margins. But could you elaborate on areas like ad tech content spend? Well, you did talk about content spend in your letter, but any other meaningful investment areas, something that that maybe we're not thinking about?
Spencer Neumann: Sure. So let me step back a bit with some quick context. So first, Jessica, we set margin targets. They're our best judgment of how kind of best to grow the long-term value of Netflix, and we're trying to balance investment for future growth with near-term profits. So for instance, after investing heavily to launch Global in 2016, global Netflix, we wanted to take a disciplined approach to building profitability as we grew revenue because we felt, one, it was a good way to build that profit muscle across the company. And two, we understood that investors were – they've been pretty patient with us, so we wanted to demonstrate the scalability and the health of the business model. And so that took us from – it was like 4% OI margin to operating income margin business in 2016 to our current roughly 20% margin. So we think a pretty good indicator that ad scale streaming can be a quite good business. Now stepping back, there's no change in our financial objectives and also no change in our long-term margin expectations, including the fact that we see a – and we don't think we're anywhere near a margin ceiling. We've got a long runway of margin growth. So again, no change in our objectives, no change in our long-term margin expectations. But our current profitability and scale, we think it's prudent to balance that historical pace of margin improvement with growth investments. So you asked about growth investments. We think we've got a lot of places where we can continue to invest, plenty of room to invest further in our existing content categories, we're a small share of viewing in every country in which we operate. Plus building out those ads capabilities that Greg talked about our live offering and new content categories like games. So there's plenty to do. But all that said, we'll continue to drive healthy margin expansion. We expect roughly 22% to 23% operating margin in 2024, assuming no material swings in FX. So that's up from our current expectation of 20% this year, which is at the high end of the range that we targeted in the beginning of the year. So again, Jessica, just like we did in the past, going forward, we'll take a disciplined approach to balancing margin improvement with investing into our growth. We actually put a chart at the end of the letter that shows how we managed that balance historically, growing content investment, profit margins and cash flow. And you should expect that we'll carry that same discipline going forward as we invest and grow into that big opportunity ahead.
Jessica Reif Ehrlich: How does licensing content from third parties play into your overall content strategy? It seems like you've had incredible success with third-party content in – I mean you always have, but in the last year, things like Suits or Band of Brothers, and you mentioned it in the letter. But if you could just talk about the third-party licenses?
Theodore Sarandos: Yes. Yes. Licensing third-party content has always been part of our strategy, and we've – something we've been really great at being able to do is match that audience. I think Suits is a great example of the impact of the Netflix effect that we can have because of our distribution footprint and our recommendation system, we were able to take Suits, which had played on cable and had played out in other streaming services and pop it right into the center of the culture in a huge way, not just in the U.S. but all over the world. According to the Nielsen charts then, Suits was the number one watch streaming series for 13 straight weeks. That's like – that is a record for Nielsen. So this continues to be important for us to add a lot of breadth of storytelling to our consumers of a wide range of tests. And we can't make everything, but we can help you find just about anything. That's really the strength. And I do think that looking – you mentioned Band of Brothers, but in that HBO deal, we had Insecure, we had Ballers, that came out and they were very successful in Netflix, and they popped into the top 10 on their originating network for the first time. So that was just on their streaming service, which is really powerful. And I think we have more to come with Six Feet Under and True Blood coming and not just on the TV side, but we're also proud to be able to bring movies like Super Mario Bros and Spider-Man: Across the Spider-Verse from our other suppliers. And in one way or another, we're in business with nearly every supplier, including our direct competitors. And I think that we bring a ton of value to them. And I think when you think about what happens when that show runs in and becomes a huge success on Netflix, it has lasting value. I mean look at the value we created that still continues today for shows like Friends, and The office and Fuller House and Gilmore Girls and all these other shows that really found an audience on Netflix even after they have more or less played out through traditional models.
Jessica Reif Ehrlich: Spence, one more on margins for you, but you said in September that long-term margins will be I think the way you said it was similar to other networks, which historically have been in the 40% to 50% range. Could you help us think through the ramp in margins over time?
Spencer Neumann: Jessica, I'll probably disappoint you as I have in the past on this. We're not going to put a long-term number out there. As I said, we don't see any ceiling – any near-term ceiling to our long-term margin potential. We've talked in the past about how we're going to feel our way through to those kind of long-term steady-state margins, but we think we have a lot of things working in our favor. We have a very scalable business model. You see that you see that play out over the last handful of years and continue to do so as we produce content all over the world for big local impact, but also with the ability for those stories to through great subs, dubs, discovery to reach more and more people and to be enjoyed around the world. So it's a very scalable content model. It's a global network at scale that has, in many ways, has not been seen with legacy entertainment networks. So we think we've got a long way to go. As I just talked about, we want to balance those increasing profits in the near term with investing into that long-term opportunity. So still a lot of runway that's a set of benchmarks you can look at it. There's others as well. But suffice to say, we think we've got a long and healthy runway in terms of growing margins.
Spencer Wang: Only thing I would add to that, Jessica, also I totally agree with what Spence said, which is, again, a lot of opportunity to grow margins, but profit dollars also matter, too, right? So as we expand into big new addressable markets like advertising that Greg alluded to or gaming also, right? So those open up big new sort of areas for us to expand into. And then we intend to grow margins, too, but we also want a lot of profit dollars as well. So we're not narrowly optimizing just for a percentage margin.
Jessica Reif Ehrlich: Right. Of course. You announced some price changes today in premium and basic in several countries and more to come. Can you provide a current view of price increase or timeframe for the standards here?
Gregory Peters: Yes. So as you know, our focus on planned evolution over the last 18 months has largely been about paid sharing. And now that we've rolled that out, we broadly see the benefits, as I outlined in the letter, that's become a normal part of our business, which then allows us to return to our core approach to pricing. And that approach, that philosophy has not changed. We look to wisely invest the money that members pay us, deliver back to them more amazing stories, more entertainment value. And then when we think we're doing that, we'll occasionally ask them to pay a bit more to keep that virtuous circle spinning. So hence, the changes that you noted that we've announced in the letter. I think it's also worth noting that we seek to have a wide and even wider over time range of price points with the corresponding set of features, of course, that allows entertainment fans from around the world that have different needs to be able to access the great storytelling that our creative partners are doing at a price point that works for them at a feature set that works for them. Part of that widespread is the low entry price point. And that's why we're keeping that low entry price point static as it is. So we think that this $699 in the U.S., £499 in the UK, EUR 599 in France. It's just an incredible entertainment value. And if you think about the breadth and the variety of storytelling that we're offering, whether that's compared to our streaming competitors compared to traditional pay TV, certainly, even the price of a movie ticket, we think that's just an amazing offer. And our goal and plan; is to continue to be a great entertainment value. And beyond that, we're not going to comment on other price changes or other changes on tiers. We'll sort of find our way based on that philosophy and see when the right time to ask customers to pay a little bit more would be.
Jessica Reif Ehrlich: One more question on the pricing, though. Would you – given the price increase for just premium and basic not standard, do you expect any – or advertising tier? Do you expect any movement between the tiers as a result of these price increases?
Gregory Peters: I think pricing always results in a bit of movement between the tiers. More of that movement is how people are signing up. So we see that as more what it influences. But also, it will influence plan changes as well. But generally, plan changes tend to be – our plans tend to be relatively sticky. So I would imagine that there is a – that momentum will continue.
Jessica Reif Ehrlich: So your letter today says that you stated that you will spend $17 billion in 2024 on content spend, up from $13 billion in 2023. Obviously, that was somewhat strike impacted. That is how should we – how can you help us think through how content spend will grow beyond 2024? What is normalized growth?
Theodore Sarandos: Well, you see that we've done is we want to grow the content spend. Just about half a step ahead of the – ahead of revenue to create the value proposition for our members. So the more we put into it, and a lot of it is tied to the ability to create hits out of that pool. And I would say one thing, if I could, if you don't – this past quarter, we had this really remarkable story about something that we could do, but Spence talked a little bit about the kind of scale of the content spend, but this show one piece. One piece is something that is a very unique property to create 26 years ago by Eiichiro Oda, it is over 1,000 episodes of the animated series based on the Japanese Manga. It's nearly sacred IP. And we were able to – with our Japanese creative teams and our American teams getting together, working with our partners at Tomorrow Studios and the showrunner, Steven Maeda to adapt this into a show that the world fell in love with. And what I say to that is we've got – this show is number one in 84 countries around the world, which is something that Stranger Things didn't do, that Wednesday didn't do. And it's so rare for an English show to be that popular in Japan and Korea, Brazil and in the U.S. at the same time. And the other fun part of it is Iñaki Godoy, who stars in the show, it was one of the most difficult casting challenges in the history of our original programming was who's going to play Monkey Luffy and he was right under our nose, right in our talent family. We discovered him a couple of years ago, and had him in this great show at our Mexican series called Who Killed Sara and then we were able to cast him in this and now he's a global superstar. So this is that kind of thing you could do well, thing that's hard to copy and gives us kind of competitive running room from our competitors being able to do that more and more. I don't mean – when I say that, I don't mean making things more global, I think making things that really resonate for the core audience. And usually, local audiences want very local content. And in this case, the local audience is the fan of one piece, which was very discriminating, and we had to please them first, just like our original shows in Spain, I have to really please the Spanish customer first. So we can do this. We spend the money well. We have impact with the spend, and we grow it as we grow revenue.
Spencer Neumann: Maybe – sorry, Jessica. I was just going to build it a little bit on Ted's point on the kind of trajectory of content spend. So – and we talked about this a little bit in the past. So first, in the letter, we talk about the 2024, we hope to get cash content spend back up to at or near that $17 billion level. The biggest swing factor is going to be when the SAG-AFTRA strike resolves. And so that will get us to a cash to P&L ratio kind of closer to 1:1.1x. And so we're not putting a specific number out there for free cash flow in 2024. What that gets us to, when you think about the combination of our revenue growth outlook, our margin guidance and target cash content spend, we'll deliver substantial free cash flow in 2024. And then going beyond that, we do expect to tick up our content investment over time as we also prove at sustained healthy revenue growth. So assuming – we talked about, I think, in the last call, assuming no big expansions, we'd expect our cash to P&L ratio of content spend cash to content amort in the P&L to be roughly 1.1x. So that's kind of one way folks are thinking about how to model our growth in content spend. If we – as we grow our revenue, as we improve our profitability, we should see both increasing content spend but also free cash flow growing nicely over time.
Jessica Reif Ehrlich: And then just one last, just a follow-up for Ted though. There's so much going on in content right now. Can you maybe talk about investment priorities? Like how do you think about whether it's local language film, TV, you've made a lot of deals with some third-party film companies, television companies. Could you give us some color on how you think about content spend?
Theodore Sarandos: Yes. We always have a lot of plate spinning because our members have got such different tastes and different desires. And we're trying to please them all – and like I say, trying to find that person who really fell in love with us for prestige TV and then discovered Love is blind. That's a pretty common household to be honest with you. So we've got to be able to be good at so many different things. And our partnerships, I'm assuming you're talking about Skydance in this case, really helps us find and keep up that scale as we grow. So we're really thrilled with our success in animated features. It's a very long cycle of development and production. Sometimes it could take a decade to deliver a really great animated feature film. And as you know, we move pretty fast, and we've been moving pretty fast. And those single companies that were really successfully launched more than two animated features in a single year. So we wanted – that deal helps us to complement the work that we're doing, like you saw this year with Leo and Chicken Run coming out and Nimona that already came out. So we've got a very – there's a ton of appetite – if you look at the top 10 animated features of since Nielsen has been tracking movie watching and seven of them are animated features. So there's a lot of appetite for animated features, and we're committed to that part of the business. And we do that through a combination of licensing partnerships and original production and original creation and not just in the U.S. but all over the world. So we have to find that right balance of invest finding the right product market fit, which helps us grow those territories and most importantly, helps create a value proposition for consumers, and they could say, "Hey, that what I pay for Netflix I can pay a little bit more because I get so much value there, and I'm spending so much of my time there. So if you think about the – for the last 37 of the last 38 weeks of this year, Netflix has had the number one streaming series on and all of streaming. And for 31 of those 38 weeks, we've had the number one movie too. And in any given week, we might have had the number one, two and three. So we really – we've got a lot going on and we've got to stay focused on continuing to improve the value proposition to consumers, which drive the numbers that we've been talking about on this call.
Jessica Reif Ehrlich: Spence, you announced a very significant increase in your buyback today. Should we think of the $2.5 billion buyback in the third quarter as sort of a run rate moving forward?
Spencer Neumann: I wouldn't kind of read through to that, Jessica. We had kind of slowed down as we – as the business slowed down, and we wanted to – we talked about the fact that we had less, less than typical forward visibility into our forecast over the past year or so as we were looking to reaccelerate the business and also roll out paid sharing. And now much of that is behind us, as we've said, and we've got a better view going forward. And so we ramped up our repurchase because we had built up some cash on the balance sheet as well. Our target minimum cash is roughly two months of revenue. So plus or minus $6 billion of cash that we look to hold on our balance sheet, and we've gotten ahead of that, we're still a little ahead of that. So – but that's really what we're managing to is to: one, primarily drive the business forward, grow the business, expand our cash flow and then as cash – excess cash builds on the balance sheet to return it to shareholders. So we put a pretty specific target out there of roughly two months of revenue in the form of cash on the balance sheet, and that's the way I think you should think about what our pacing will be over time.
Jessica Reif Ehrlich: Moving on to gaming. It feels like almost like the way you describe advertising, like a walk, crawl, run approach, what is the near and midterm strategy in gaming?
Gregory Peters: Well, let's start with the big prize. I think that's the better way to look at it, which is games is a huge entertainment opportunity. So we're talking about $140 billion worth of consumer spend on games outside of China and outside of Russia. And from a strategic perspective, we believe that we can build games into a strong content category, leveraging our current core film and series by connecting members, especially members that are fans of specific IPs with games that they will love. I think it's worth noting that if we can make those connections and as we make those connections as we're seeing, we're essentially sidestepping the biggest issue that the mobile games market has today, which is how do you cost effectively acquire new players. So that's the real proposition. And we think if we deliver that, we give members great games, entertainment experiences that they love at sufficient scale. Then we leverage back into the core business. We increased engagement. We increased retention. We increased value delivered. Those all drive our core business metrics. And I think it's actually just a very natural extension of what you were just talking with Ted about. If you think about the range of content that we're offering the variety of content and entertainment that we're offering, games just adds one extra layer to that variety and that depth. And we're also seeing, I would say, back moving it more to your short-term and mid-term. We're also seeing performance metrics that support that this fundamental strategic hypotheses are sound. So games engagement right now on our service drives core business metrics in a way which is incremental to movies and series. So – but the main challenge ahead of us to get to your mid-term is that our current scale and frankly, our current investment level are both very, very, very small relative to our overall content spend and engagement. So now our job is to incrementally scale to the place where games have a material impact on the business. We've got ambitious plans there. We want to really grow our engagement by many multiples of where it is today over the next handful of years. And we can see how to get there. Looking a layer deeper at the title level. We see – some titles are really working for our members, and they're working for our business. If we can do more of those, we know we can scale into that proposition. We've got to do that through better title selection based on everything that we're learning. We got to do it on better product features to maximize connection with the audience for any given title. And we have to do it by gradually improving consumer awareness, which as we've seen is when we launched other content categories, you can think about unscripted or you can think about film. That broadly lifts overall engagement metrics as consumers learn that we're a place to go to, to find games. I'm excited about what we got going on in Q4. We're going to launch some big high-profile titles, which sort of keeps that drumbeat going. We got Dead Cells. We've got Football Manager 2024. We've got Money Heist. Think about connections with our IP that's coming in Q4 as well. That's Casa De Papel for folks who saw in that language. We also have Virgin River coming in Q1. So as you pointed out, this trajectory is not dissimilar from what we've seen before, when we've launched a new region, think about Latin America or we launched a country like Japan where traditional Western media companies have struggled or we launched new genres like unscripted. We've got a crawl, walk, run and we build it, but we see a tremendous amount of opportunity to build a long-term center value of entertainment, more entertainment value for our members.
Theodore Sarandos: That's a great experience for the super fan to get themselves in the universe in between seasons of a show. It's really exciting. Jessica, we have time for about two last questions, please.
Jessica Reif Ehrlich: Great. Okay, two. So the first of the two sports, you're creating the Netflix Cup tournament to be out next month. Is this a change in your sports strategy at all? Or how should we think about that?
Theodore Sarandos: Yes. I know this was kind of me, Jessica. Given we are in the sports business, but we're in the part of the sports business that we bring the most value to, which is the drama of sport. So look at the success we've had with Drive to Survive, look at the success we've had with Tour de France, quarter back, full swing, untold, most recently with Beckham. David Beckham is one of the biggest stars in the world and his documentary on Netflix brought him almost 0.5 million new social media followers in a week. So we are having a big impact on sports through the things we're most great at, which is the drama of sport. The Netflix Cup as a live event that actually brings together the cast of Drive to Survive and full swing and puts them into a live golf term that we are going to stream live on Netflix on November 14. And it's – I think about it as a great way of extending those great drama of sport brands that we've created. But no core change in our live sport strategy or licensing and live sports. We are investing heavily in increasing our live capabilities so that as the demand grows for that and we find different ways the liveness can be part of the creative storytelling, we want to be able to do that at a big scale.
Jessica Reif Ehrlich: There was some news also today, I guess, on [indiscernible]. But my last question to stay with what Spencer asked – you've talked a little bit more recently about your ancillary businesses, including the Netflix House. Can you talk about what that looks like over time? And will it be a big investment area, but more importantly, will it be a contributor?
Theodore Sarandos: Yes. Look at the – this initiative is inside of our Consumer Products and Experiences Group. Today, they run these successful businesses where they travel these live experiences all over the world and fans engage in them in ways that would shock you. People love these things so much. They show up dozens of people have proposed marriage in the Breath of Bridgerton Ball. It's really important in a way to kind of deepen fandom, a way to express fandom. You kind of see it on a large scale with theme parks, these build-outs are not going to be like a theme park, both in that they won't have that gigantic CapEx. And they also – we expect that fans will go multiple times a year, not just once every couple of years. And it's a way to take a business that's really good at growing our brands and strengthening our brands. And today, it doesn't – has a big start-up and shutdown costs as they travel around and put them under one umbrella where we can add a little technology and make it a really phenomenal experience from being as part of the Money Heist, Escape Room or the Stranger Things experience or the Squid Game challenge all those different things that people can do live together and have a lot of fun. And they can also go to the NETFLIX BITES and have food experience with all the Netflix food brands. So it really kind of strengthens the brands and strengthens the excitement about the things people are watching on Netflix and falling in love with and gives them a place to go and express it. It's not a material investment relative to the court to the big business that we're all in. But it's a great way of building it like our consumer products business.
Spencer Wang: Great. Well, Jessica, thank you very much for your questions, and we appreciate everybody tuning into our earnings call, and we're looking forward to chatting with you all next quarter, if not sooner. Thank you. |
PEP | 3 | 2,023 | 2023-10-10 10:37:07 | Operator: Good morning and welcome to PepsiCo's 2023 Third Quarter Earnings Question-and-Answer Session. Your lines have been placed on listen-only until it's your turn to ask a question. Today's call is being recorded and will be archived at www.pepsico.com. It is now my pleasure to introduce Mr. Ravi Pamnani, Senior Vice President of Investor Relations. Mr. Pamnani, you may begin.
Ravi Pamnani: Thank you, operator. Good morning, everyone. I hope everyone has had a chance this morning to review our press release and prepared remarks both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans, guidance and outlook. Forward-looking statements inherently involve risks and uncertainties and only reflect our view as of today, October 10th, and we are under no obligation to update. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to our third quarter 2023 earnings release and third quarter 2023 Form 10-Q available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. Joining me today are PepsiCo's Chairman and CEO, Ramon Laguarta; and PepsiCo's Vice Chairman and CFO, Hugh Johnston. We ask that you please limit yourself to one question. And with that, I will turn it over to the operator for the first question.
Operator: Thank you. [Operator Instructions] Our first question comes from Bryan Spillane with Bank of America. Your line is open.
Bryan Spillane: Thanks, operator. Good morning, everyone.
Ramon Laguarta: Good morning, Bryan.
Bryan Spillane: So my question is just around volume. There's been a lot of focus on that topic, not just for Pepsi, but just, I think, more broadly. So I know in the prepared remarks, there's a little bit -- there's some commentary about a shift to small packs. But maybe, Ramon, if you could touch on what was happening specifically volumetrically for PBNA in the quarter? And then kind of relative to what your outlook was for volumes coming out of 2Q, just how that might have evolved as the quarter progressed?
Ramon Laguarta: Yeah, good morning, Bryan. Let me step back beyond PBNA to the broader company. We're seeing sequential volume improvement, if you take the last few quarters. So globally, we're improving our volume. But more philosophically how we're thinking about how we're managing the company. There's two big variables that we're trying to optimize. One is consumer interaction with our brands. And the proxy we're using for that is units or specific purchasing act. And then the other one is obviously margin for the overall business. And those are the two variables that we're maximizing. In both cases, units are growing much faster than volume. And we're seeing that -- you mentioned consumers moving to smaller packs. We're also in a way, facilitating that through our pricing and mix strategy. And then we're obviously optimizing margin that, as you saw it was a good improvement in our margin across the company and the particular businesses that you referred to. So that's how we're thinking about volume and margin. When it comes to PBNA, we've been a bit more aggressive than in the other businesses with regards to volume optimization. And we've made some decisions, especially around take home water that we're able to prune some promotions that were not profitable for the business, and that has almost 2.5 points of volume impact. So that's how we're managing volume. It's clearly an important variable for us, but for efficiency in the plants and some others that unit transaction and consumer interaction with the brands are the metrics that we're trying to maximize as we're making these trade-offs between volume you know net revenue and margin expansion.
Operator: Thank you. One moment for our next question. Our next question comes from Lauren Lieberman with Barclays. Your line is open.
Lauren Lieberman: Great. Thanks. Good morning. Carrying on Bryan's question, but taking it a little bit further out into 2024, and it was great to get kind of some preliminary perspective on next year, so early. But I was also curious how you're thinking about that balancing volume and price mix as we go into next year because price mix has continued to outperform? And so just kind of thinking about that more forward look as well. Thanks.
Ramon Laguarta: Yes, Lauren, we'll give you more details, obviously, in February when it comes to the actual composition of some of our key metrics. But what I would tell you at this point, as we've obviously seen all the commercial plans from the different markets and our innovation plans and our productivity plans and our cost trends that there will be still a higher inflation in our business. And therefore, there will be higher price mix versus not the last couple of years, but if you think about the historical price mix that we had in the past, I think '24 will have a bit more elevated price mix in the equation than in the previous years.
Hugh Johnston: Yes. So right, to add a finer point to Ramon's comments, Lauren, if you think of pre-pandemic inflation being kind of in that 2%, 3% range, inflation is going to be a little elevated relative to that. And our pricing will be roughly in line with inflation. So that should at least give you a rough sense as to how things might shake out.
Operator: Thank you. One moment for our next question. Our next question comes from Andrea Teixeira with JPMorgan. Your line is open.
Andrea Teixeira: Thank you. Good morning. So going back to your comments about volumes in PBNA. Was that specific to the quarter or should we still see about this 2.5% headwind to volumes you quoted and potentially into the first half of 2024? And if you can also comment on the volumes in Latin America, so how we should be thinking towards the end of the year and potentially into 2024? Thank you.
Ramon Laguarta: Yes, Andrea. So with regards to PBNA, we continue to optimize the portfolio. So we should be probably thinking about a few -- a couple more quarters where we will continue to see volume decisions that, again, we're trying to maximize units and transactions. And we're trying to continue to optimize the margin of the business. And you saw that this quarter and the balance of the year, we feel very good about the margin expansion in PBNA. Now when it comes to LatAm, there is mostly our snack business, what you see there in our numbers. And we've been making, again, decisions around affordability making sure that our brands continue to be within affordable price points to consumers that we know that this possible income is limited, and they make decisions a lot based on price points. So we've been reducing size -- portion size of our products, making sure that we're still very affordable. And that has a repercussion on -- has an impact on the actual volume. But again, the transactions are much healthier. And that's a metric that we used to assess the health of the business with regards to consumer along with brand equity and some other metrics that we use, obviously, to understand full consumer picture. So we'll continue to make optimizations, Andrea, as we need to absorb inflation and make sure that our brands remain a choice for consumers that are clearly more limited in their disposable income.
Operator: Thank you. One moment for our next question. Our next question comes from Dara Mohsenian with Morgan Stanley. Your line is open.
Dara Mohsenian: Hey, guys. Good morning. Could you just discuss the motivation behind the decision to provide guidance for 2024 a bit earlier than is typical? What do you think your level of visibility is at this point versus a typical year? And as you look out maybe what are some of the areas that give you confidence and what might be some of the areas where there's more uncertainty particularly given the volatile consumer environment here? Thanks.
Hugh Johnston : Hi, Dara. I can answer that one. I think in general, as we build the plans, we're focused on a couple of things. Number one is obviously the level of commodity inflation, and you know we buy forward about nine months. So that's roughly in line with the past. Number two is the balance of the PepsiCo cost structure. And as we've talked about the last couple of quarters, we've put even higher focus than we've had in the past on driving productivity and driving out unnecessary costs using the tools that we've discussed, the investments in digitalization, the investments in global business services, the investments in driving out overlaps within the organization. Because that work has been going on for a longer period of time, I think that gave us earlier line of sight into what we would expect our cost outcome to be for next year. And then number three, we're in a good spot in many of the developed markets in terms of our commercial plans. We do joint business planning with our customers. And we're probably in line to maybe even a little ahead of where we've been historically with all of that. So given the information was available to us a little bit earlier and given there was undoubtedly questions in the investment community on what '24 look like given the evolving pricing and inflationary environment, we thought it was prudent to at least give some indication of what guidance would look like in '24. So that's what drove the decision.
Operator: Thank you. One moment for our next question. Our next question comes from Peter Grom with UBS. Your line is open.
Peter Grom: Thanks, operator, and good morning, everyone. I actually wanted to follow up on Dara's question there. But just more in the context of your actual performance versus your initial expectations historically because it's really been a while since organic revenue growth has actually fallen short of your initial outlook. So can you maybe just characterize your confidence in the '24 outlook at this stage and really whether or not you've embedded enough conservatism just given what remains a pretty choppy backdrop for the consumer? Thanks.
Hugh Johnston: Sure. Happy to address that. We obviously have a long history here of meeting or exceeding expectations, both our internal expectations as well as the guidance, including this quarter, where we beat revenue and we beat EPS. In fact, we've now met or beat consensus for 55 straight quarters. So we tend to be, I think, appropriately conservative in the way that we communicate to you all. So from that perspective I think you can go into 2024 with a similar expectation that we should at least achieve the numbers that we've laid out for you.
Operator: Thank you. One moment for our next question. Our next question comes from Nik Modi with RBC Capital Markets. Your line is open.
Nik Modi: Thank you. Good morning, everyone. Hugh, I was hoping maybe you can just provide some of the macro underpinnings that kind of go into your 2024 viewpoints at this point? Just would love to kind of get your state of the union on the consumer or the economy and kind of how you guys are thinking that will shape up as you go through 2024? Thanks.
Hugh Johnston: Sure. Why don't I start and then Ramon, obviously, you're super deep on the consumer as well, but I'm happy to start on this one. Number one, I do think that we see the consumer right now being more selective, and you see it in a variety of ways, right? You see some trade down in terms of channels of trade that they're purchasing products in. You see some orientation toward value. At the same time, the things that I usually look at with the consumer to detect whether there's high stress, we see good results, Nik. Number one is the convenience store channel. Typically, when gas prices are up and consumer incomes are stressed, you see revenue in those channels under stress as well. For Q3, we saw revenue up 5% in beverages and 8% in foods in the convenience channel. Number two is food service, that's also typically a leading indicator, that's still growing double-digits. So I think we've gone into the year with an approach that says, given all that I laid out during Dara's question, we expect the consumer to continue to be cautious. And to the degree that they are worse than that, we've got cost plans in place that we would use to mitigate whatever challenges we face. But we think our revenue outlook accommodates an increasingly cautious consumer next year.
Ramon Laguarta: Yes. And the other thing I would say is all the long-term structural tailwinds of our categories will continue. If you think about urbanization, demographic shifts, lifestyles, et cetera, that have been driving our snacking categories or beverage category, they move from package-to-package. All those things will continue, and they drive a lot of our confidence in our categories, then obviously, we have almost completed. By now, our innovation plans, our commercial plans are -- I think we've got better at affordability and premiumization of our portfolio. So we think our share of market will be good next year as well. So that's what's driving our kind of confidence for next year.
Operator: Thank you. One moment for our next question. Our next question comes from Bonnie Herzog with Goldman Sachs. Your line is open. Again, Bonnie Herzog, your line is open, and if you have a question, go ahead and ask it. It looks like they didn't have a question, do you want me to go and move on to the next person?
Ramon Laguarta: Yes, please.
Operator: Okay. Sure thing. One moment. Our next question comes from Chris Carey with Wells Fargo. Your line is open.
Chris Carey: Hi. Good morning.
Ramon Laguarta: Good morning, Chris.
Chris Carey: The inflation got a bit worse quarter-over-quarter in the PBNA segment, specifically, whereas in the rest of the segments, the trend is for continued easing. Can you just comment on some of the puts and takes that you're seeing from a commodity inflation standpoint in this segment, particularly and how the beverage side is driving the inflation expectations going into next year relative to food? I'm really speaking to Hugh's comments on above average inflation next year. And just given what we see from commodities in general, I'm trying to parse out where exactly that outlook is coming from? So thanks so much.
Hugh Johnston: Yes. Good morning, Chris. Chris, we don't get into by commodity levels of dissecting the numbers and guidance. That's something that historically we haven't done. As you know, the beverage segment is a little more packaging exposed in foods is just by virtue of the nature of the products. But I'd rather not go any further than that to get into the specifics of individual commodities for competitive reasons.
Operator: Thank you. One moment for our next question. Our next question comes from Robert Ottenstein with Evercore ISI.
Robert Ottenstein: Great. Thank you very much. I just want to shift a little bit more kind of to the long-term. And I was just wondering if you can kind of give us a sense of the vision, your vision for the business, the beverage business and the food business in the US in light of your large investment in Instacart what you're trying to accomplish there? And other kind of strategic moves you're doing on the digital side and the -- all the underlying work that you're doing in terms of automation and productivity. Just kind of what do you see the business looking like in the future? And how does Instacart play into it? Thank you.
Ramon Laguarta: Yes. Good question. Obviously, as Hugh was saying, we continue to drive the transformation of the business with automation at the center of it and digitalization as well. With digitalization, we're trying to obviously give much more precision to our decision-making across everything we do from how we talk to consumers, how we invest in our pricing with our customers? How we run our end-to-end operations from agro to the consumers? How we run our routing and everything all these activities that we do to generate value for our consumers. That is an investment we've been making over time. And we continue -- that still is the priority of the company to make the company more precise on intelligence and empower our front line to make better decisions all the time with the best information possible real-time and ideally forward information. So that is a continuous investment. Now when it comes to Instacart, there is a commercial relationship trying to enhance the capabilities of our DSD system with the shoppers that they have in store, and that is a continuous focus. I think DSD continues to be a competitive advantage. And I think we can enhance that capability with supporting activities from the Instacart shoppers. And that commercial relation led to a very minor investment in Instacart. And just to reinforce the commitment to the commercial relationship, there's nothing more than that in terms of a strategic long-term intentionality with that investment.
Operator: Thank you. One moment for our next question. Our next question comes from Stephen Powers with Deutsche Bank. Your line is open.
Stephen Powers: Hey, thanks. Two questions, if I could. One, just following up on the 24 outlook given the visibility you have on cost and the commercial planning at this point. Should we be expecting a relatively even performance and cadence of growth, both top and bottom line throughout the year? Or is there a reason to see that growth weighted first half versus second half? And then I did want to ask on Gatorade because the improvement we saw this quarter sequentially volumetrically did occur. It just didn't occur at quite the level of improvement that we were expecting from a shipment perspective. I think we went from down high single digits in the second quarter to down mid in the third. So I just would love some perspective on how you view that business performing? Thank you.
Ramon Laguarta: Listen, we will not go into more details on '24. We'll cover that in February in due June time. When it comes to Gatorade, we're very pleased with the G2DSD or the movement of Gatorade to the DSD platform over the summer. We're seeing sequential improvement in the performance of the brand. Better performance in August that we saw early in the summer, et cetera, inventory on display and a number of secondary location, et cetera. So that move is working. On the velocity of the brand, we also saw that the brand is improving its velocity. It is true that the emergence of Prime in the category took some share from Gatorade less than other brands in the category or less proportionally to the size of the brand. But I would say Prime impacted Gatorade in a way some transactions during the peak of the season. We're seeing that the size of Prime in the category getting smaller as we go into the fall, which gives us very good optimism that with the new infrastructure we have with our DSD business, some of the innovation with GFit, Gatorlyte, G Zero, our powders and tablets that are being very well received by consumers that we have a very good you know we're going to have a very good '24 for Gatorade. So we have a stronger foundation to go into next year with potentially weaker competition. But obviously, I don't know what their plans are.
Operator: Thank you. One moment for our next question. Our next question comes from Filippo Falorni with Citi. Your line is open.
Filippo Falorni: Hey, good morning, everyone. So, clearly, there's been a lot of concern in the market around adoption of GLP-1 drugs in the US and the potential impact on your business. So maybe can you comment a bit of what you've seen so far based on your consumer studies, both on the beverage and food side? And how you're thinking that can evolve over the next couple of years, change in consumer behaviors? And then from a Pepsi-specific standpoint, what changes can you make to adopt your portfolio to these new consumer preferences that could emerge if the adoption is greater than that? Thank you.
Ramon Laguarta: Thank you, Filippo. Good question. Listen, obviously, we're looking at this you know along with many other positive and negative potential risk for our business and our category. So far, the impact is negligible in our business. Overall, if you take global consumption, there are obviously a lot of question marks with regards to the obesity drugs when it comes to medical testing or scalability of the usage of this or what is the impact really on consumer choices. So a lot of question marks. We continue to believe that all the structural positive trends that we had to our categories remain, and I mentioned, I referred to that earlier in the conversation. So we're seeing urbanization as a big driver of adoption of our categories. We're seeing middle class development. We're seeing lifestyle and the people snacking to eat, some meals becoming more mini-meals and much more unstructured during the day, being a big driver of our categories, both beverages and snacks. So we're seeing a lot of tailwinds that will continue to drive our categories. Of course, we're observing the growth of these new drugs and its potential impact. The other thing we're looking at is our strategy sound when it comes to portfolio transformation. And everything we've been doing for the last five, six years when it comes to reducing sodium, reducing fat, reducing sugar, reducing the portions of our products, adding some new cooking methods to our snacks, those are all very positive trends that will help us pivot the portfolio if needed in the future. We'll continue to do it. Obviously, it's one of our key strategic pillars. So again, negligible impact today, a lot of these structural trends that are in our category, I think, remain very solid and even we see them accelerating. And our portfolio strategy, we think, is very solid when it comes to a potential protection against some of these future developments 5, 10 years from now.
Operator: Thank you. Our last question comes from Brett Cooper with Consumer Edge. One moment.
Brett Cooper: Good morning. A question for you on the North American Beverage business. You've said in the past your goal is to hold share in that business. When you begin to add things like CELSIUS as an organic business, I'd love to hear how you assess the beverage performance and you're looking to hold share with the own portfolio or you distributed brand as a component to hold share? Thanks.
Ramon Laguarta: Yes. Sorry, we missed a little bit of the question, but hopefully, we got what you're trying to ask. CELSIUS obviously is part of our energy drink strategy. We said we had multiple pillars and our ability to distribute in our system, some third-party brands is part of that strategy. Obviously, CELSIUS continues to grow. We've doubled the distribution and the presence in store of the brand in the last year or so especially in the convenience channel, which is a key channel for energy consumption. That participation of CELSIUS in our track makes our full system more efficient. It makes our salesmen more relevant in the store. It makes our cooler more a go-to cooler in the store and those are all positive that eventually have a halo effect as well in the rest of our portfolio. So I don't know if I'm answering the question because really I couldn't -- we couldn't hear it very well. But I guess you get a sense of the importance of CELSIUS in our energy strategy and the value we get from both the actual monetization of that distribution, but also the halo it has in the rest of the portfolio.
Ramon Laguarta: Okay. So thank you very much for your questions and for joining us today. And especially thank you for the confidence you've placed in us with your investment. We hope you all stay safe and healthy. Thank you very much.
Operator: Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day. |
COST | 4 | 2,023 | 2023-09-26 21:35:23 | Operator: Good day, everyone, and welcome to the Costco Wholesale Corporation Fourth Quarter and Fiscal Year 2023 Operating Results Call. Today's call is being recorded. [Operator Instructions] I would now like to turn the conference over to Richard Galanti, CFO. Please go ahead, sir.
Richard Galanti: Thank you, Lisa, and good afternoon to everyone. I will start by stating that these discussions will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. The risks and uncertainties include, but are not limited to, those outlined in today's call, as well as other risks identified from time to time in the Company's public statements and reports filed with the SEC. Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update these statements, except as required by law. In today's press release, we reported operating results for the fourth quarter of fiscal '23, the 17 weeks ended September 3. These results and the figures presented today compare to last fiscal year's 16-week fourth quarter. Reported net income for the 17-week fourth quarter came in at $2.16 billion or $4.86 per diluted share, compared to $1.868 billion or $4.20 per diluted share in the 16-week fourth quarter last year. In terms of sales, net sales for the 17-week fourth quarter were $77.43 billion, an increase of 9.4% from $70.76 billion in the 16-week fourth quarter last year. Comparable sales for the fourth quarter, and these figures are like-for-like number of weeks. In the U.S., reported was 0.2% comp. Excluding gas deflation and FX in the U.S., it would have been 3.1%. Canada, reported was 1.8%, and excluding gas deflation and FX, 7.4%. Other International reported 5.5%, and again excluding gas deflation and FX, 4.4%. Also total Company reported 1.1% comp and 3.8% ex-gas deflation and FX. In terms of e-commerce, that came in at minus 0.8% reported and minus 0.6% excluding FX. Overall for the fiscal fourth quarter, food and sundries were relatively strong once again, with fresh foods right behind and with some offsets on some of the non-foods categories. In terms of Q4 comp sales metrics, traffic or shopping frequency increased 5.2% worldwide and 5.0% in the United States. Our average transaction or ticket was down 3.9% worldwide and down 4.5% in the U.S., impacted in large part from weakness in bigger ticket non-foods discretionary items, as well as the gas price deflation. Foreign currencies relative to the U.S. dollar negatively impacted sales by approximately 0.3%, and gasoline price deflation negatively impacted sales by approximately 2.5%. Next on the income statement, membership fee income reported in the fourth quarter $1.509 billion or 1.95% of sales in the fourth quarter this fiscal year, compared to $1.327 billion or 1.88% in Q4 of last year, so $182 million increase or 13.7%. If you adjust for the extra week, the 13.7% would be roughly 7%, ex that extra week. Excluding FX and the extra week, the increase would have been around 7.5%. In terms of renewal rates at Q4 end, our U.S. and Canada renewal rates stood at 92.7%, which is up 0.1% from the 92.6% figure as of the end of Q3. The worldwide rate came in at 90.4%, down 0.1%, reflecting the impact of increasing penetration of memberships from international, which renew at a lower rate, in large part because of new openings internationally. Our membership growth continues. We ended the fourth quarter with 71.0 million paid household members, up 7.9% versus a year ago, and 127.9 million cardholders, up 7.6%. That's on the new openings over the past year of - just under 3% increase in new locations. At the fourth quarter end, we had 32.3 million paid executive memberships, an increase of 981,000 during the 17 weeks since Q3 end. The executive members now represent a little over 45% of our paid membership and approximately - paid members and approximately 73% of worldwide sales. Moving down the income statement, next is our gross margin. Our reported gross margin in the fourth quarter came in higher - came in at 10.60%, up 42 basis points from 10.18% a year ago, and that 42 basis points is up 16 basis points excluding gas deflation. As I always ask you to jot down a few numbers with two columns, both reported and excluding gas deflation, the first line item would be core merchandise, on a reported basis, up 51 basis points year-over-year in the fourth quarter and ex gas deflation up 28 basis points. Ancillary and other businesses, minus 32 basis points and minus 38 basis points. 2% reward, minus 4 basis points and minus 2 basis points. LIFO, plus 27 basis points and plus 28 basis points. And if you total that up, on a reported basis, gross margin was up 42 basis points year-over-year and ex gas deflation, up 16 basis points. Starting with the core, again, up 51 basis points year-over-year, and ex deflation, up 28 basis points. In terms of core margin on their own sales, our core-on-core margins were higher by 35 basis points, with food and sundries and non-foods being up and fresh foods being down a little. Ancillary and other business gross margin was lower by 32 basis points, and lower by 38 basis points ex gas. This decrease was driven almost entirely by gas due to the other components of ancillary and other, which would include pharmacy, e-comm, food court, business centers, optical, all those things on a relative basis year-over-year were in a couple of basis points plus or minus from a year earlier. 2% reward higher by 4 basis points and higher by 2 basis points, so a negative 2 basis points including gas deflation. That represents higher sales penetration coming from our executive members. And LIFO, of course, if you recall, last year in Q4, we had a $223 million pre-tax LIFO charge, while there was a small charge this year of $30 million on a year-over-year basis. Of course, that showed the basis point improvement in margin. While we continued - we've continue to see sequential improvement in year-over-year inflation. I'll talk about that a little later. We still had a small amount relative to the first day of the fiscal year, that's a small charge in Q4. A couple of final comments on margins. First, we are of - we're asked often recently about our inventory shrinkage results and whether it has dramatically increased in the past year versus historical shrink results. The answer is, no. In the past several years, our inventory shrink has increased by a couple of basis points, in part we believe due to the rollout of self-checkout. Over the past year, it has increased by less than 1 basis point more. So no, thankfully, not a big issue for us. And second, the year-over-year margin improvement has in part been due to fewer markdowns due to better inventory positions this year than last. Our inventories overall are in good shape. Moving onto SG&A, our reported SG&A in the fourth quarter 8.96%, up from 8.53% a year earlier or up 43 basis points, and ex gas deflation up 21 basis points. Again jot down the two columns of numbers, both reported and excluding gas deflation. Operations, minus 37 basis points, minus being higher by and without deflation, core would be minus 18 basis points. Central, minus 6 basis points and minus 3 basis points. And those are the really only two line items. The others were all zero; stock compensation, preopening and other. So, total reported margins were up 43 basis points year-over-year, and ex gas deflation, up 21 basis points. In terms of the core operations being higher by 18 basis points ex gas deflation and on a reported basis higher by 37 basis points, this negative included the impact of lower sales growth as well as the impact of eight weeks of additional top-of-scale wage increases that went into effect July 4 of '22, so midway through Q4 last year, and full 17 weeks of this past March's higher-than-normal top-of-scale increase. Central being higher by 3 basis points ex gas deflation, again not a lot of sales operating leverage there. And again, as I mentioned, the other line items that I typically read out were flat, both with and without gas deflation, so zero year-over-year change. Below the operating income line, interest expense came in at $56 million this year versus $48 million a year ago, one extra week, of course. Interest income and other for the quarter was higher by $171 million year-over-year, $238 million this year versus $67 million last year. This was driven in large part by an increase in interest income due to both higher interest rates and higher cash balances, as well as the extra week. In addition, FX was slightly favorable year-over-year. In terms of income tax rate, our tax rate this year in the fourth quarter came in at 27.1% compared to 25.4% in Q4 last year, so full 1.7 percentage points higher year-over-year. This increase in our rate as of Q4 is primarily attributable to an increased penetration of international earnings, which overall incurs a higher income tax rate than in the U.S. Overall, reported net income was up 16% year-over-year in the quarter, or 9% if you adjust for the extra week this year quarter - this year in the fourth quarter versus last. A few other items of note, in the fourth quarter, we opened nine net new warehouses, including five new buildings in the U.S., two in China, and one each in Japan and Australia. For the full fiscal '23 year, we finished with 23 net new units, as well as we did three relocations. And for the first quarter, the first 12 weeks of fiscal '24, we plan on opening 10 net new units, as well relocating one unit. All 10 locations net new are in - nine are in the U.S. and one is in Canada. Regarding capital expenditures, we've actually included the cash flow in the quarterly report, but CapEx spend in Q4 was approximately $1.56 billion, and for all of fiscal '23, totaled $4.32 billion. Turning to e-commerce, e-commerce sales in the fourth quarter ex FX, as I mentioned, decreased 0.6% year-over-year. While still negative, relatively speaking, our e-commerce showed good improvement. Results showed good improvement this quarter versus our year-over-year results in Q2 and Q3. In the previous two fiscal quarters, big ticket discretionary majors, home furnishings, small electrics, jewelry and hardware, were down 15% and 20% year-over-year, respectively, and down just 5% year-over-year in the fourth quarter, with those big ticket departments making up over half of our e-commerce sales. A couple of other items to note. Within the sales of big ticket discretionary, appliance were up over 30% in the quarter. Second, I've gotten a couple of calls that people have seen online that we've been selling gold - 1-ounce gold bars. Yes, but when we load them on the site, they're typically gone within a few hours and we limit two per member. And lastly, I'll point out Costco Next. We continue to grow that. We currently have 62 suppliers on costconext.com, and we're continuing to onboard additional ones in many product areas, from home improvement to apparel, to pet, to home and kitchen, to electronics and accessories, to sports and bicycles and toys and the like. Now, a few comments on e-com mobile digital efforts, which we're always asked about. As I discussed during the last quarter earnings call, when I said that we were in the early innings of our digital mobile transformation efforts, progress is being made. In terms of recent additions and upgrades, we've recently redesigned the account page and the digital membership card. We also redesigned the header with larger search bar and expanded selling space. We've added an app box for messages and advertisements right in the app. We've recently, a few months ago, opened an optical digital store where you can virtually try on glasses and then order them for pickup, prescription glasses. And lastly, there are ongoing improvement in our Costco app, offering in-warehouse shopping tools for our customers such as a digital membership card, managing shopping lists, viewing warehouse savings, seeing the gas prices to the extent there's gas station there, and so you'll be able to search warehouse inventory and scan barcodes from the app. With the improvements made thus far over the past year, our app store rating has gone from a dismal 2.3 stars to currently 4.7 stars. Unique visitors in the site are up 40% year-over-year and the Costco app installs are up 46% year-over-year. So all in all, progress is being made. Lastly, a couple of comments regarding inflation, most recently in Q3 '23, we had estimated that year-over-year inflation was in the 3% to 4% range. Our estimate for Q4, inflation in the 1% to 2% range, and it's actually trended downward during the quarter. So hopefully, these inflation trends will continue. We'll have to see. Finally, in terms of upcoming releases, we will announce our September sales results for the five weeks ending Sunday, October 1, on Wednesday, October 4, after the market closes. With that, I will open it up for Q&A and turn it back over to Lisa. Thank you.
Operator: [Operator Instructions] We'll take our first question from Simeon Gutman with Morgan Stanley.
Simeon Gutman: Hi, Richard. How are you?
Richard Galanti: Good.
Simeon Gutman: I guess my first question, I don't mean a tongue-in-cheek, but is - I guess, is the membership price increase part of the fiscal plan? And then part of the question is there a point at which this membership increase is part of, I guess the hedge against inflation? Is there a point at which model feels more weight without it, in other words, can you go another year without it?
Richard Galanti: Well. My pat answer, of course, is a question of when, not if. It's a little longer this time around, since June of '17. So we're six years into it and - but you'll see it happen at some point. We can't really tell you, if it's in our plans or not. We'll let you know when we know. We feel good. These say about all the attributes of member loyalty and member growth. And frankly, in terms of looking at the values that we provide our members, we continue to increase those. It's certainly a greater amount than even more than if and when an increase occurs. So stay tuned. We'll keep you posted, but there's not a whole lot I can tell you about that.
Simeon Gutman: Fair enough. And then an ultra-short term, as gas prices have moved up, have you seen any effect or impact on spending at the store?
Richard Galanti: No, I mean, you look at the numbers over the last few months that we report monthly and quarterly. There has not been a heck of a lot change. Big ticket discretionary, while improved relatively as I mentioned online - those online items, we have seen the number of items in the basket tick up a little in the last few months, but I think that has more to do with the fact that we consciously added. I had mentioned in the last call, we've consciously added 40 or 50, what I'll call smaller ticket indulgent items, whether it's snack items and the like, just impulse items. And so that's what we do as merchants, but overall we haven't seen any big change. We've been able to correlate any big change to what's happened with gas prices.
Simeon Gutman: Hi, thanks, Richard. Good luck.
Operator: We'll take our next question from Michael Lasser with UBS.
Michael Lasser: Good morning - good afternoon, I should say. Thank you so much for taking my question. Richard, you ended your prepared remarks, saying that this quarter or this month inflation is on pace to be 1% to 2% and you suggested it may be even lower than that. So should outside of the reverse be prepared for the prospect of deflation, either because that's what's happening with some underlying cost that Costco has been experiencing or Costco will look to invest in price, as a way to continue to drive volumes, especially at a time when core on core margins are expanding, so nicely?
Richard Galanti: Well, first of all, your comment that there was 1% to 2%, but then as we looked at the 17 weeks if you are the four months roughly, we saw - if we look at it internally at each of the end of those four months, we saw the level that 1% to 2% is from the beginning to the end of the year - I'm sorry, the beginning at the end of the quarter. But during the quarter, we saw that trending downward, if you will, a little. And when I talk to the merchants on the fresh side, it's flat-to-down a little right now on the food and sundries side, it's up a little, primarily in some of the CPG stuff and on big-ticket - not big-ticket, but our non-foods partly because of freight, which is down year-over-year in a nice way. And in some cases, some of the commodity costs on steel and the like that has come down. So that being said, we're not a big change, but at least it's trending that way. Who knows what tomorrow brings. And as it relates to - well, as I say, as it relates to us, we're always pushing prices as fast as we can. We want to be the first to lower them when those things happen and drive sales.
Michael Lasser: And so...
Richard Galanti: I think we've seen that with - I think we've seen that with our traffic.
Simeon Gutman: So just to clarify what you're saying is food and sundries prices are down on an average year-over-year, shelf-stable products are up year-over-year, gen merch is down. So in totality, it would seem like the store - the box is deflating, does it get - does the rate at which you see deflation continue to increase from here and would you expect that to be just driven by the factors that you mentioned or are you driving that as a way to drive this traffic?
Richard Galanti: Well, first of all, I want to correct one thing that it maybe I misstated or you misunderstood. In terms of fresh, fresh is pretty much flat. Food and sundries, which has everything from sundries and package goods and CPG goods that tends to be up a little bit. And I'd like to think that we're pushing the envelope as much as we can with our suppliers that has certain freight costs have come down. Recognizing the headline today in the paper is - oil is approaching $100 a barrel. So, who the heck knows what happens tomorrow.
Michael Lasser: Okay. My follow-up question is, as low - as long as you see big-ticket under pressure, discretionary under pressure, which influences your total sales, because it's important for you to remember to come in and buy these big-ticket items. Is this going to influence how you think about managing labor in the store? Should the market just anticipate late - labor and other SG&A is going to delever as long as the big tickets under pressure?
Richard Galanti: Well, I think we've seen that over the last year, frankly. We had such operating leverage over a couple of years when we had outside sales during the kind of two years of COVID, call the spring of '20 to spring of 2022. And, it was before COVID, when our SG&A was over 10% - slightly over 10%, and we said, would it ever be able to get below that, it's now still below 9%. So, notwithstanding the fact, when I looked at the last several quarters on a year-over-year basis, again, particularly over the last couple of quarters, we've seen some deleverage of that. Look, we want to drive sales and we'll do that in the best ways we can. So - but we recognize when we used to get the question all the time, what comp number do you need to have zero, negative or positive leverage with SG&A, recognizing there was low - very little inflation back then. We used to say somewhere, who knows, but somewhere in the 4.5% to 5% range. So we don't know exactly where it is, but we're certainly not going to change the level of service that we have and we're certainly - you're going to respect our employees in terms of what we've done with wage increases overtime. That's what we do.
Michael Lasser: Thank you very much and good luck.
Operator: We'll take our next question from Chuck Grom with Gordon Haskett.
Chuck Grom: Hi, Richard. Just sticking on this - on the inflation topic here on unit elasticity, particularly in categories where you're seeing prices actually start to fall or compress. Curious, what you're seeing on units, if you're seeing them improve at all to offset those price declines, if there's any examples in either food or in GM that you can talk about?
Richard Galanti: Well, yes, I remember when we talked to a few quarters ago about some of the slowness in big-ticket discretionary, well, we got harder on price. It did a little bit, but not as much as we would have thought to start with. But again, that perhaps was the impact of what's going on with the concerns of the economy and everything else. We know that when we put hard buys and what we call TPDs, temporary price discounts on items, even medium-sized ticket items, we do see - we do leverage - see the units increase, but it's not as predictable I would say as it used to be.
Chuck Grom: Okay, great. And I know you don't provide guidance, but I got...
Richard Galanti: It's a little easier on the food side to see that sometimes more, when taking the price of meat item down.
Chuck Grom: Okay. So you are starting to see some units increase as prices drop in certain parts of the business?
Richard Galanti: Sure. And by - even a big-ticket, when we see $300 and $400 price declines because of freight and raw material cost on some big-ticket non-food items, we'll see some of the sales pick back up on that. But, there's nothing guaranteed.
Chuck Grom: Okay. All right. Thank you. And I know you don't provide guidance, but I actually do remember when you did give some directional help back in the day, but are there any big puts and takes that we should be thinking about on the gross margin and SG&A line over the next four quarters that we should be thinking about? Clearly, the LIFO lap will be it will be an obvious tailwind, but just curious, any other things that we should be thinking about from a modeling perspective?
Richard Galanti: No not really. I mean, LIFO is certainly one that was impacted over the last year and started to slow down. Assuming that trend continues, there won't be much LIFO going forward for right now what we see. Beyond that, no, we're still opening. We opened 23 net new units this past year. We're on board to do something in the mid-to-high 20s this year. But that's not enough to move the needle in terms of the leverage standpoint or anything. No, I'd say it's steady as she goes. And if anything I look to be the margins overall, given everything that's going on, including competition that we're doing pretty well there. We - with some of the wage hikes that we continue to do and sales being a little weaker than they had been a year ago, I think we're doing pretty well on that as well. We're optimistic about our future, but we'll see what happens.
Chuck Grom: All right, great. Thank you.
Operator: We'll take our next question from Peter Benedict with Baird.
Peter Benedict: Hi, guys. Thanks for taking the question. Richard, just - first one, just on LIFO. I was just curious, I mean, $30 million charge is small, but I'm just curious, why they were even last one. Can you give us little more color, maybe what drove?
Richard Galanti: Yes, well, I think it was on things like gas was one, and then in some of the fresh food items there was - even though there was deflation in things like eggs and some dairy products, there was - there were some inflationary trends and beef. Beyond that, do you have that handy. Yes, it's really small, but on $16 billion of inventory, it's a lot. I mean, it's still a small number of $30 million and that, but - that's all. I don't have the details on that.
Peter Benedict: That's fine. Yes, that's fine, just in the context of the broader disinflation it was interesting to see that. And then, just really turning to the international stuff you talked about the rural rates impact, can you remind us maybe on the international membership trends, when you open up a new core outside the U.S., maybe give us some framework or some benchmarks around how many new members tend to sign-up? How does that compare to what you would see, let's say in the next opening in the U.S.? And then, what kind of renewal rates you tend to see year-one, year two, just so we have a frame of reference there? Thank you.
Richard Galanti: I don't have the exact numbers in front of me, but generally speaking, in Asia, whether it's Korea, Taiwan, Japan or China, we'll open a new unit including the 10 or 12 weeks of sign-ups prior to opening, with anywhere from 50,000 to 100,000 new members. We had a couple of extremes like when we first opened in Shanghai Minhang of well over 200. Now, some of that looky-loos that don't renew and we usually in that first year of renewal and those types of outsized numbers, we might be as low as the mid-to-high 50s and it takes a few years to get even to the mid-70s. But we see those numbers overall continue to increase every year and I don't - I can't - I don't - I actually probably go back to what it was in the first 10 years of our 40-year history with even the U.S. My guess, it wasn't that extreme, but we didn't have as many - it wasn't national and local news events, the day we opened. We had a lot of people coming into some of these markets that are signing up that may be live too far away or choose not to come back. So we're seeing that continuing to grow. So by - even as simple - that's slight 0.1% decline, it's round the year in the sense that you opened up a couple of more units a year ago, they've just renewing for the first time that increases that number.
Peter Benedict: Yes. No, understood. Last one, I think I heard you say, mid-to-high 20s in terms of unit opening plan for fiscal '24. Can you give us a sense how many of those are in the U.S. and then how many would be international? Thank you.
Richard Galanti: 70% plus in the U.S. and Canada, mostly U.S., of course.
Peter Benedict: Got it.
Richard Galanti: Which in my view is we're finding more openings - more opportunities in the U.S. to in-fill, given our high volumes. And we got plenty going on over the years, overseas.
Peter Benedict: Yes. Thanks so much, Richard.
Richard Galanti: Thank you.
Operator: We'll take our next question from Rupesh Parikh with Oppenheimer.
Erica Eiler: Good afternoon. This is actually Erica Eiler on for Rupesh. Thanks for taking our questions. So I guess first, I was hoping maybe you could give us a quick download, maybe on how you're feeling about the health of your consumer right now? I mean, obviously some concerns out there on student loan impact starting to roll in here, those restarts. So maybe any color you can provide on how you're thinking about discretionary from here, maybe some of those concerns out there? Anything on trade down or private-label, anything of note on that front in terms of consumer behavior as well?
Richard Galanti: Right, well, look, first of all, first and foremost, our traffic continues to do very well. Being up continually 4% to 5% on a year-over-year basis is great. And our renewal rates continue to be very strong. So that's the starting point. It makes sense to us on big-ticket discretionary that's where you'd see the biggest weakness. We see some of that in some areas going back. When we look at our numbers compared to MBD, that tells us where we are versus our competitors. Overall, not in every category, but overall we tend to do better. So even a negative number here is a lower negative number elsewhere. So - and again, what do we do, we brought in some smaller ticket items that are impulse snack items to get an extra partial item in everybody's basket. So, yes and newness, bringing those new items. And there's not been a whole lot in television. Our unit sales and TVs are pretty good, but the average price point has come down, as they do anyway, there's always deflationary. When you don't have new technology yet and that's just, we haven't seen a whole lot of new stuff yet there. Gaming is good right now and Christmas is good. I mean, we're one of the - not the only one, but one of the few that are bringing in seasonal items early, everything from decor to trees, to toys, that's starting off well so far. But it's new, it's in the last few weeks.
Erica Eiler: Okay, that's really helpful. And then just - go ahead.
Richard Galanti: I'm sorry, what else did you ask?
Erica Eiler: And then just shifting gears, so, I just wanted to touch on Retail Media. So obviously a significant focus on driving retail media at some of your peers. So just curious if you could maybe talk a little bit about what Costco is doing in this area and the bigger opportunities that your team sees here?
Richard Galanti: Well, part of that is some of the things we're doing with digital and mobile and the app. And we're not giving out quantifiable numbers, but certainly, some of our competitors are talking about doubling these numbers in the next two or three years. In my view, there is some low-hanging fruit out there and we're actively working on it. We've hired a couple of people that are helping us with that as well and more to come.
Erica Eiler: Okay, great. Thank you so much.
Operator: We'll take our next question from Paul Lejuez with Citigroup.
Brandon Cheatham: Hi, everyone. This Brandon Cheatham on for Paul. I just wanted to - when you look at the retail landscape, I was wondering, how did your wages compare to your competition? Are you seeing similar trends in inflation pressure on the wage front and anything that you can help us with, what your plans are over the next couple of quarters?
Richard Galanti: Well. First of all, we've always prided ourselves in providing the best hourly wage package out there, wages, benefits, contributions to 401(k). I'm using U.S. numbers here, but our average U.S. - 90% of our employees like many big retailers are hourly. And our average hourly wage is approaching $26 is in the high-$25s. That's on top of a very rich healthcare plan, where the employee only pays around 11% or 12% of it I believe. And on top, little less than that - and on-top of that, irrespective of what employee contributes to his or her 401(k), we contribute anywhere from 3% to 9% based on years of service. So you've got a 20-year cashier making on a full-time basis in the mid-60s with another $4,000 or $5,000 being contributed to his or her 401(k) plan with a very rich healthcare plan. So we stand apart in our view compared to anybody. Our pressure is that, it comes from ourselves. In the last few years, as there have been wage pressure, starting with the frontline workers during the beginning of COVID, we like many retailers added a 2% premium - $2 premium rather. We kept it longer to our knowledge than most anybody for a full year and at the end, we kept a dollar in there. And since then we've had at least three or four increases on top of the normal top-of-scale increase that we do every - generally have done every year - we have done every year. So we'll - in our view, the pressure comes from us and we feel that we're way ahead of our competition in that regard.
Brandon Cheatham: Got it. That's helpful, thanks. And I think you mentioned the next iteration of the app, you're going to be able to scan barcodes. Is the idea that eventually the customer are going to be able to scan and go and how could that help flow operations in your stores, if that is the case?
Richard Galanti: I don't think we're prepared for Scan and Go, yet. We're just going to scan, but they can't go. So at the end of the day, the first order of business is getting the merchandise on there and haven't had numbers that where a member, he goes online to say, hey, you can also get this currently at your local location. So knowing what's in store when somebody wants to come out, I think that's going to be a big positive to start with and part of the scan is to be able to get more product information on the item as well.
Brandon Cheatham: Sure, that makes sense. Okay, I appreciate it. Good luck.
Operator: We'll take our next question from Greg Melich with Evercore.
Greg Melich: Hi, thanks. I have two questions, Richard. First, I'd love an update given the volatility in gas prices last year and a half is to, where we are on penny profit? I know it has improved a lot, but I'm curious it came back down in the last 12 months or if it's sort of stabilized at that higher level?
Richard Galanti: Well, we don't give specific numbers. Gas has been stronger for us and we believe all retailers in the last few years. In fact, it was Q4 last year, which I think it was our strongest quarter, recognizing it's 16-week quarter. This fourth quarter, it was still strong, down from its strongest a year earlier on a weekly basis, but nonetheless quite strong. And so it's part of the profit picture currently of all big retailers that sell gas, the supermarkets, the Walmarts and the Costcos of the world. So it's still a profitable business. It's - our view has been, you used to be when prices - given that the return it so fast, literally almost daily, when profits are going up - I'm sorry, when the price of gas is going up, the guy down the street is turning it every eight or nine days is paying a little less four days ago. And so we're making it the less, when sales went down - gallons - the price per gallon went down, we made a little more. I think that equation, while it's still true, is not the driver of the bottom line of gas. Everybody seems to be wanting to make more on gas, which allows us in our view to make a little more and still be even more profitable. We've seen our competitive spread versus our direct competitors at every location on average improve over the last couple of years to now be in the - I want to say to 30-set range per gallon, mid-30s is the average, which is up. It's an average and it can range from 10 to 45. But at the end of the day, we feel good about our competitive position, it's increased and we're still quite profitable down a little bit from a year ago, but nonetheless quite profitable.
Greg Melich: That's helpful, thanks. And then my follow up is on cash. I think you finished with $13.7 billion. I think the last time you got to 2013 was when you had a special dividend in 2020. What are your thoughts on how much cash you need or want? And especially now that there is a positive interest rate on holding cash, because that would make you more interested in keeping it, than you pay more tax, just how do you think about?
Richard Galanti: Well, I think, look, at the end of day, we've done four special dividends in the past. It's part of our DNA. At some point, we may do that again. Again somewhat like the answer to the other question about membership fees, it's probably a question of when, not if, but we'll let you know. Certainly with earning 5%-ish on that money instead of a clear percent-ish on that money, does make it a little harder to do. But we're not selling the kind of earnings multiple, but we earn 5% on our assets. So, at some point, we'll do something and we'll have to wait and see.
Greg Melich: Got it. Thanks and good luck.
Operator: We'll take our next question from Kelly Bania with BMO Capital Markets.
Kelly Bania: Hi, thanks for taking our question, Richard. Just wanted to ask, I think I've asked this many, many times, but it seems like another huge quarter for executive membership growth of almost 1 million more this quarter. And just curious if you could talk about the profile of that member today that's either upgrading or starting out as an executive? What's the characteristics of that customer? And any changes in how that executive member spends in their first year in that upgrade, compared to the prior years?
Richard Galanti: I was joking you're going to say, first of all, they are very smart to be an executive member. Look, I think we are over the time, we've done a better job of communicating the value of the executive member. So, we clearly get more people to sign up that way in advance and we see that over time a regular member over the first few years will buy more every year and executive members start at a higher level and will buy more every year from that higher level. So that's really the profile that we've seen. I don't have any specifics on how old the member is. I know that when we look at age characteristics of new members, we're still - everybody used to be concerned 10 years ago, how we going to get millennials when we have an older average customer and all that and we did with things, with items, with things like organic. We're doing the same thing now. We're still getting whether it's Gen Z or Gen A or whatever the next is, we're getting our share of those new members when we look at the profile of our members.
Kelly Bania: Thanks, and Richard, I may have missed this, but did you quantify the extra week impact in terms of EBIT or EPS or anything for us?
Richard Galanti: No, it's - I mean, the simple math would just say it's 16, 17 of our quarter is equal to a 16-week quarter. That's about as good as we can do.
Kelly Bania: Okay. Thank you.
Richard Galanti: I think that particularly on net income it takes the 16% or whatever percent number down to 9% or something, and that's just simple math.
Kelly Bania: Perfect.
Operator: Okay. We'll take our next question from Oliver Chen with TD Cowen.
Oliver Chen: Hi, Richard, inventories being well-positioned, what are your thoughts about where they are now and versus - and also how we will model them going forward relative to sales? And then as we look at overall, ticket trending negative, that compare starts to ease. So does that imply that one flexion on partly the nature of the ticket comparisons overall? The same question is for e-commerce, as you anniversary some of the headwinds, can we expect the comparison to help as well? Thanks a lot, Richard.
Richard Galanti: Sure. Inventories, as I mentioned, we feel - the merchants feel very good about our inventory levels right now. Are there a few departments are higher than they want, a few that need a little bit more sure. But overall, they're very good. Look at our fiscal year and inventories stood at just under $16.7 billion and payables stood at $17.5 billion. So I think this - running above 100% on that simple ratio is something new. We used to be - we used to enjoy running 90% to 95%, it fluctuates, but overall, we feel good about our inventories, where they are now. And in terms of supply chain, things coming in on time, we feel good about that as well. Now as it relates to - as we, excuse me, as we anniversary the inflection of when we saw some weakness, I think a couple of quarters ago, I mentioned that will help your big-ticket sales, I said, well, at least in a few several more months we'll anniversary this weakness. So certainly that's going to help. I would like to think that not just that thing that's going to help, but - and the same would be commerce. I mean, we're - again one bright spot in this virtually all e-commerce, not nearly always - is nearly always e-commerce was the appliances that - and I think we've done a better job also of showing the value of these items online, not just the price the item within our case includes delivery and warranty and things like that more so than some of our competitors. And showing great value there.
Oliver Chen: Okay. Thanks, Richard. Just a couple of short ones, would love any thoughts on Instacart. It seems like it's a great partnership that you've had for a while. Also another question we have is, EV charging play a role and how you're thinking about future services for customers? Finally, China, any - it's a smaller percentage of total, but it's an important market for the long-term. I mean lots happening there. Has anything changed the value proposition or the geopolitics? Thanks.
Richard Galanti: Okay. Yes. I had the second and third, what was the first question? Oh, Instacart, I know they just went public. So we've gotten a lot of questions. At the end of the day, we were good partner with them, they were good partner for us. We used them throughout the U.S. and Canada. And as sales are growing, we've added over the last - during COVID, we added some non-food items that still can be carried in the car, if you will. And we're doing, I think prescriptions with them now. And so, no, it's - a good relationship and it has been for a while. Yes, I might add, though that with regard to those sales, we include that in our warehouse sales, not our e-commerce sales, because it's their employee or their employee coming into Costco to shop, purchase at the register and then take it to the customer. So that's not in our mobile e-commerce sales. As it relates to EV charging, we're testing it in a number of locations. Not a whole lot to be said. If there is a charge for it, it's going to be less Costco and we'll wait and see. And then as it relates to China, no, we just opened a few weeks ago, our fifth location. We have two more planned this fiscal year, both in the - I think one in Shenzhen in early calendar '24 and one other one before the end of August. So we'll have seven locations, up from two, a year and a half ago. And so far, our openings there have treated us well overall.
Oliver Chen: Thank you. Best regards.
Operator: We'll take our next question from Scot Ciccarelli with Truist.
Scot Ciccarelli: Good evening, guys. Can you help us understand a bit better how the Costco Next process works? I mean, is it similar to how your e-commerce business used to work, where products were essentially drop-shipped from their vendors? And if that's the case, Richard, how do you control the quality of the product and delivery process, because I thought that became an issue for you guys before you took over your own distribution for e-com?
Richard Galanti: Yes, Costco Next is drop-shipped. We curate the items with these suppliers. And for the most part pretty well-known brands. And so far we have not had an issue on that, recognizing it's - they tend to be items that are easily shipped to home. Yes, we're doing - we have all the tracking information as well. So all I can tell you is, you're right about that, that's a good point. Years ago when we did this, there was a difference, but so far it's worked quite well for us. We've had very few customer issues as it relates to items purchased on costco.com on costconext.com.
Scot Ciccarelli: Okay. Understood. Thank you. And then another inflation question, if we do wind up getting outright deflation outside of improved traffic or unit block, are there ways to protect margin because it seems to me like that could wind up being a deflator to the margin, if we're in a deflationary environment there?
Richard Galanti: Well, yes that's what our business is about, where we'll take a 10-pack and make it a 12-pack, I guess. But at the end of the day, if there's is inflation, it will impact all of us, but again. I think it should be favorable with us because we will show the best value - we'll still show the best value out there.
Scot Ciccarelli: Understood. Thank you.
Richard Galanti: Before you do it, another comment was made in the table here, that if there is deflation and disinflation, we've got a $450 million and $500 million LIFO reserve, that'll be - on a reported basis will be part of a tailwind of disinflation.
Scot Ciccarelli: Got it. Thank you.
Operator: We'll take our next question from Scott Mushkin with R5 Capital.
Scott Mushkin: Hi, Richard, thanks for - thanks for taking my question. I don't think we've talked about it, but what's competition like out there, now that we're seeing inflation come down in volumes, particularly for some guys are negative, just wondering if you - what it looks like out there?
Richard Galanti: I think, look we've said this for a few years now, our competition with Sam's is the most direct and we've seen improvements in parts of what they do from our perspective. They are tough competitors and so are we, and - but I think they continue to get to improve overtime, as have we. I don't - we don't really see a whole lot of other things. BJ's is why we expect their model and what they do. It's a slightly different model. So there's not as much - there is certainly - when we are competing directly as a membership warehouse club, we're making sure we're sharp on pricing, particularly in fresh and things like that supermarket items. Beyond that, our view is on the non-food side, we are gaining share. As evidenced by the numbers we see in some of these NPD results. And the thing that I just called out on appliances grew like that. Recognizing appliances of whatever a $30 billion business, we're still a small piece of it, but growing rapidly.
Scott Mushkin: Thanks. And then, I know it came up earlier about raising membership rates, but I kind of philosophical like this recession, not recession, maybe there will be one, how does the company look at raising the membership fee, if the economy is slow and fast? Does it matter? Does it factor in?
Richard Galanti: I think. I think it matters. It does matter and I think it really mattered as we approached kind of the 5.5 years. Post June 17th, we were in the high - the headline every day was inflation and economy. And so, we're doing great. We've got great loyalty. If we wait a little longer, so be it. And that's kind of how we feel right now. So...
Scott Mushkin: Okay, great. Thanks, I'll yield.
Operator: We'll take our next question from Chris Horvers with JPMorgan.
Chris Horvers: Thanks. Good evening, Richard. So your core and core margins were up a lot in this quarter. Can you talk about what drove that? I think you mentioned food and sundries, that successful vendor-funded promotions, is there anything one-time in nature about that gain that we shouldn't extrapolate forward?
Richard Galanti: Yes, well, aside from LIFO, markdowns were lot less, quarter-on-quarter, so no markdowns. It was a big piece of it, particularly on the non-food side, that helped. Last year we had - it was a year ago that all of us including Costco, I think our inventories on a year-over-year basis were up 26% for two quarters in a row. And, of course, those will come down and so that was probably the biggest single thing in those numbers. And the comment that was made at the table here, we're back on track on seasonal in and out dates. So we're not having - a year - it was a year, year and a half ago where certain seasonal items came in late and just to move them out, not to have to store as much, some we did store, but to move them out where we felt that was the best way to do it, we take extra markdowns. So that helped.
Chris Horvers: And then a follow-up question around the consumer, you just came through the back-to-school season. There are some important electronics categories that are a big part of the basket during that time of year that also become a big part of the basket around holidays. Are you seeing, iPads and PCs and notebooks? Are you seeing positive unit trends and how does that make you feel about the upcoming holiday season?
Richard Galanti: Gaming is up, some of the Apple products are up, TV units are up, but again, the average price points have come down some. Tablets are up and audio is up a little.
Chris Horvers: But not notebooks and computers?
Richard Galanti: No.
Chris Horvers: Got it. Thanks.
Richard Galanti: Let's down was the answer yet.
Chris Horvers: Understood. Thanks so much.
Operator: We'll take our next question from John Heinbockel with Guggenheim.
John Heinbockel: So Richard, first thing, maybe just talk about how you look at cannibalization versus expanding the market in the U.S., right? And if you - obviously, you can now put - it looks like locations closer together. When you kind of look at the U.S. in total, is there a number, right, that you guys have in mind that's now possible, given what you're doing with density?
Richard Galanti: Yes, our view is over the next 10 years that we could add easily another 150 and that's on top of however many business centers, call it, but just in the U.S. So - and that number keeps changing. If you had asked me six or eight years ago, where we'd be today, I would say, if we were 70/30 U.S. back then, we'd be 50/50 by now, outside of the - will be 50. And today, we're at 65, 70 in the U.S. So, we're finding more opportunities here and it's evidenced by just the sheer volumes of the units - that our units are doing today versus three or four years ago. It's much higher than we would have expected three or four years ago. So we think that there is still a lot of runway in that regard.
John Heinbockel: And then just a quick follow-up, I know you guys haven't been particularly interested in BOPIS, right for cost reasons and I assume that's still the case. There's a consumer argument for it, but - I think it's hard to make the cost side of it work, is that still your view?
Richard Galanti: That is still our view overall. In addition to the thing I mentioned a little bit with what we're doing with Instacart on non-food items as well. We are testing in-store some big-ticket items like TVs, but on a limited basis to see what happens for Buy Online and Pickup in Store.
John Heinbockel: Okay, thank you.
Operator: We'll take our last question from Joe Feldman with Telsey Advisory Group.
Joe Feldman: Hi guys, thanks for taking the question. I wanted to ask about the CPG guys, are they funding promotions a little more regularly with you guys? I know you did something, I think with P&G that seems like a clever promotion to get a gift card back from them, it seemed. And I'm just wondering what you're seeing across the other vendors?
Richard Galanti: Yes. Well the CPG, actually we did that last year as well, done it for a couple of years. We will say, we'll do it again. It's growing. So, and once we do that with one, we want to share that excitement with others to see what other types of things we can drive that way. So I'd say there's probably a little bit more increase on that type of promotional things. And then inventory is available for those things. We could really drive sales of those items in a short period of time.
Joe Feldman: Right, that makes sense. They have the volume and you guys do. And then are you guys approaching the holiday any different this year? I know you mentioned Christmas goods are off to a good start, but is that - earlier than normal? I feel like you are about the same timing, but maybe you could share thoughts on the approach to the holiday season.
Richard Galanti: Yes, if it's earlier, it's a week or two earlier. And some things came in early, and yes, it's a little early compared to some of the supply-chain disruptions we had, which screwed up a lot of things. But if you go back to where we were before COVID, we're probably at or very slightly earlier. And in terms of how we're approaching it? We're approaching it aggressively in terms of having stuff to sell to the members. But we want to be - we want to be out to. Typically this is nothing different here, even on things like toys will bring in a few things in the last couple of weeks before Christmas, that if they don't sell through, we're not at risk of having to mark them down dramatically because they're not unique just to Christmas.
Joe Feldman: Understood. No, that's great. Thanks, guys and good luck this quarter, Richard.
Richard Galanti: Well, thank you, everyone. We're around to answer questions. And have a good holiday and we'll talk to you soon.
Operator: And that does conclude today's presentation. Thank you for your participation and you may now disconnect. |
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